Bank Deposit Guarantees: Pros and Cons

Background

The recent collapse of Silicon Valley Bank (SVB) has renewed calls for the government to guarantee all bank deposits. On March 10, 2023, SVB failed after a bank run, marking the second-largest bank failure in United States history and the largest since the 2007–2008 financial crisis. The US federal government’s Federal Deposit Insurance Corporation (FDIC) stepped in to guarantee customer deposits, however, SVB’s downfall continues to reverberate across global financial markets today.

Pros

Proponents of the proposal argue that guaranteeing all bank deposits would provide peace of mind for depositors and prevent bank runs like the one that led to SVB’s collapse. One of their arguments is that this would help stabilize the banking system and prevent future bank failures. In addition, it could also help restore public confidence in the banking system and encourage people to continue saving their money in banks.

Furthermore, proponents argue that guaranteeing all deposits could help prevent a domino effect in which the failure of one bank leads to a loss of confidence in other banks and a subsequent wave of bank failures. The government could help prevent such a scenario from unfolding by providing a safety net for depositors.

Historically, there have been instances where increasing deposit guarantees have helped stabilize the banking system. For example, during the 2008 financial crisis, Congress temporarily increased deposit insurance per depositor to $250,000 from $100,000.

Cons

However, opponents of the proposal argue that it could create a moral hazard. If all deposits are guaranteed by the FDIC, banks may be more likely to take on excessive risk, knowing that their depositors will be protected no matter what. This could lead to more bank failures and ultimately put taxpayers at risk.

Another potential consequence is that it could lead to increased costs for banks. If banks are required to pay higher insurance premiums to cover the cost of guaranteeing all deposits, they may pass these costs on to their customers in the form of higher fees or reduced interest rates on deposits.

Guaranteeing all bank deposits can also have potentially negative impacts on smaller banks Smaller banks may not have the resources to pay higher insurance premiums and may be forced to merge with larger banks or go out of business. This could lead to decreased competition in the banking industry and potentially higher costs for consumers.

In addition, some experts argue that guaranteeing all deposits could lead to increased government involvement in the banking industry. This could result in more regulations and restrictions on banks, limiting their ability to innovate and compete.

Furthermore, opponents argue that guaranteeing all deposits could create a false sense of security among depositors. If people believe that their money is completely safe no matter what, they may be less likely to monitor the health and stability of their bank and less likely to take action if there are warning signs of trouble.

Historically, there have been instances where increasing deposit guarantees has led to unintended consequences. For example, after Congress increased deposit insurance guarantees during past crises, banks were able to erode the rigor of regulatory policies over time.

Alternative Solutions

Instead of guaranteeing all bank deposits, other potential solutions could be considered to prevent bank failures. For example, regulators could increase their oversight of banks to ensure their engagement in safe practices. This includes frequent and rigorous examinations, as well as stricter enforcement of existing regulations.

Another potential solution is to increase transparency in the banking industry. By requiring banks to disclose more information about their financial health and risk-taking activities, regulators and the public can better monitor the stability of individual banks and banking systems. This could help prevent bank runs and failures by allowing depositors to make more informed decisions about where to keep their money.

Expert Opinions

Experts have weighed in on both sides of this issue. Peter Conti-Brown argues that an unlimited guarantee would only benefit banks at a price borne by taxpayers. On the other hand, some experts argue that temporarily expanding FDIC coverage is necessary to head off a potential financial crisis.

Conclusion

While the proposal to guarantee all bank deposits has its merits, it also has potential drawbacks that need consideration before taking action. The benefits of increased stability and public confidence must be weighed against the risks of moral hazard and increased costs for banks and consumers. Ultimately, any decision on this issue must be based on a thorough analysis of all available evidence and careful consideration of all relevant factors.