Dismantling deposit insurance would “force banks to be stronger”, argues the investment banker. In a guest essay, he explains why
“mini banking crisis” in March, when Silicon Valley Bank and Signature Bank collapsed, the Federal Deposit Insurance Corporation used an emergency “systemic-risk authority” to provide 100% protection for all depositors of both banks. Since then, regulators in America and elsewhere have pondered the role of deposit insurance in dealing with the consequences of banking meltdowns.
This tells a more general story. Industry-wide bank runs are extremely rare. The events in America in 1933 that led to the imposition of a national bank holiday by President Franklin Roosevelt are the only episode that comes close to a general bank run in the country’s history—and one that was caused not by confused depositors blindly withdrawing funds but by depositors’ fears that their state would be the next to declare a bank holiday.
The argument in favour is that such insurance is required to protect retail depositors when there is a banking crisis, and that without it they would lack confidence in the financial system. This was the rationale for its introduction in America in 1934 and in Europe during the 1970s.
If the ultimate objective is to reduce the frequency of banking crises rather than just dealing with their consequences, the case against deposit insurance is that dismantling it would force banks to be stronger. Depositors would have to become even more discerning about where to place their money. Riskier institutions would no longer be able to attract depositors from safer banks at no extra cost.
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