NCPA - National Center for Policy Analysis

Is it Time for the Bank Safety Net to Go?

January 26, 2001

Consumers are increasingly turning to innovative alternatives to traditional banks for their financial needs. Thus the role of banks in the payments system and in channeling credit to the rest of the economy is diminishing. These alternative institutions -- such as money market mutual funds -- are not federally insured; therefore, the case for providing a federal safety net for banks, savings and loans and credit unions in the form of federal deposit insurance is becoming much weaker.

Last summer the Federal Deposit Insurance Corporation proposed doubling the maximum limit on federally insured deposits to $200,000 per account.

Instead, the maximum should be slashed, says economist James H. Smalhout, a visiting fellow at the Hudson Institute.

  • Smalhout says Congress should cut the maximum limit drastically -- say to $10,000 -- because additional coverage is available, if desired, from private insurers.
  • Banks held 61.4 percent of all checkable deposits as late as 1993 -- today, that market share is only 33 percent.
  • Entrepreneurs operating without federal deposit insurance are taking market share from the banks and bringing innovative products to market, such as electronic bill paying and stored-value cards.
  • FDIC rules and regulations block banking industry innovations, while the insurance encourages risky lending, which led to the $180 billion bailout of savings and loan companies in the 1980s.

The costliest part of the safety net, says Smalhout, is the special treatment reserved for banks that are Too Big To Fail (TBTF). The 46 largest banks, each with more than $20 billion in assets, hold almost 50 percent of the banking system's core deposits. These TBTF institutions receive special treatment from bank regulators, Smalhout concludes, and the 1991 FDIC Improvement Act promises that the government will catch them if they fail.

Source: James H. Smalhout, "Costly Safety Net," Barron's, January 1, 2000.


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