FDIC suggests ‘targeted’ coverage best option for deposit insurance reform

A “targeted” deposit insurance system in which additional coverage would be extended to business payment accounts would be the best option for balancing financial stability and depositor protection relative to its costs, the FDIC said today in its long-awaited review of the system. The review, prompted by recent bank failures, considered three options for reforming the Deposit Insurance Fund: The limited coverage option that exists now, an unlimited option that would cover all deposits, and a targeted system with additional coverage for business payment accounts. The FDIC said the latter was the most promising option but acknowledged there are “significant, unresolved practical challenges” to implementing it. Any modification to the coverage level must be approved by Congress.

The FDIC report did not weigh in on a possible special assessment fee to make up for the hit to the DIF resulting from the agency’s systemic risk exemption declaration for Silicon Valley Bank and Signature Bank. The agency plans to issue that decision at a later date. Instead, the report offered a history of the fund along with possible changes lawmakers could pursue.

The FDIC’s report presented options that all come with tradeoffs, including potentially increased regulation. An unlimited system in which all deposits are covered would mostly eliminate bank runs, but would also eliminate depositor discipline while generating possible broader market disruptions and increased insurance assessments, FDIC said. The targeted option could achieve financial stability with only a limited decrease in depositor discipline, but it would be challenging to define business accounts and would also require additional DIF funding.

“The extent to which the DIF would need to expand would be a function of both how business payment accounts are defined and the extent to which the demand for business payment accounts results in inflows from other asset markets,” the agency said. “Although assessments would likely need to increase, it is difficult to estimate to what extent.”

In a separate statement on the report’s conclusions, FDIC Chairman Martin Gruenberg said business payment accounts may need additional protections because the inability to access those accounts can result in broader economic effects. “In addition, business payment accounts may pose a lower risk of moral hazard because those account holders are less likely to view their deposits using a risk-return tradeoff than a depositor using the account for savings and investment purposes,” he said. “The report points out that providing a practical definition and ensuring that banks and depositors cannot circumvent those definitions to obtain higher coverage are important to implementation of targeted coverage.”

The FDIC report is a useful starting point for a discussion on deposit insurance reform, but not the last word on the matter, American Bankers Association President and CEO Rob Nichols said. “As the report makes clear, every potential change to the existing system has costs and benefits and operational challenges, including the FDIC’s ‘targeted coverage’ option, that must be weighed very carefully.”

“[ABA] will evaluate the options outlined in the FDIC report and other ideas that come forward with one key test in mind: whether the proposed changes will enhance the ability of banks of all sizes to compete and succeed in serving their customers and communities,” Nichols added. “We look forward to participating in the conversations to come, informed every step of the way by our members.”

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