Some reasons to not raise the FDIC insurance cap, at least not yet.

Can we at least wait until we know what happened before "doing something?"

In the wake of the collapse of Silicon Valley Bank and Signature Bank there are discussions on Capitol Hill about raising the deposit insurance cap from $250,000.

At best these discussions are premature. We don’t know what happened. We don’t know what went wrong. We don’t know if the regulators lacked the necessary tools to stop SVB and Signature failing or if they had adequate tools and failed to use them. We don’t know why the FDIC reportedly rejected a bid for SVB. Until we know the answers to these questions we can’t speak to the actual necessity of increasing deposit insurance.

However, those questions not withstanding there are ample reasons to be skeptical of raising deposit insurance. Here are some:

1.       It may not be necessary: The majority of personal deposits fall under the cap. Even for accounts with more than $250,000 there are tools in the market now that will apportion your deposits across multiple banks up to $150 million dollars. Yes, there is the risk that banks or depositors will incompetently not avail themselves of these products, but insuring incompetence rather than necessity is a dubious proposition, especially for the affluent. Additionally, having banks raise more non-runnable capital can also help protect depositors without the other problems on this list.

2.       It is a subsidy to banks: Yes, banks pay for deposit insurance, but as the last expansion of deposit insurance during the 2008 crisis showed (p. 102-103), it can subsidize banks, especially ones in worse shape, but discouraging depositors from exercising market discipline and removing deposits from poorly run banks. This perception of government backstop has also been identified as a way that some banks can offer lower equity returns compared to comparably risky ventures. Expansion would only increase this subsidy.

3.       It is likely regressive: Again, banks do pay for deposit insurance. But how? Like any other cost it will be passed on to one group or another. The most likely candidates will be customers in the form of higher prices or worse service, investors (including those who hold bank stocks in retirement funds) in the form of lower returns, or employees in the form of lower compensation. Guess how many people in those groups do not have bank accounts above $250,000?

4.       It further weakens market discipline: As Prof. Charles Calomiris points out, deposit insurance is linked to greater instability and lower market discipline. If banking is to remain anything resembling a market there needs to be some sort of market discipline. This means the possibility of failure, of bad firms being supplanted by better firms, by mistakes having consequences. Each enhanced government backstop further undercuts the already shaky moral justification for treating banks as private, profit motivated actors. Further, if we also get greater instability out of the deal we will be worse off than we started.

5.       It increases government power: As Prof. Julie Hill shows, we effectively substitute regulation for market discipline. Banks are already incredibly heavily regulated, supervised, and to some degree effectively co-managed by their regulators. Further, bank regulation is opaque, and regulators enjoy significant discretionary power. Expanding deposit insurance will only expand the power of federal regulators who are even less accountable to Congress than average and have had a history of abusing their power.

It is possible, even with those concerns, that raising the deposit insurance cap is justified, but that case needs to be made and debated, not rushed into legislation in the wake of what was maybe a crisis but we don’t know yet. Until we have all the facts and can assess what is really necessary we should not do anything rash.