The evolution of the deposit insurance debate

A lot has changed since we last had an industry-wide discussion about the role of deposit insurance. The Dodd-Frank Act, enacted in 2010, turned a temporary increase in the coverage limit of $250,000 per account into something permanent, and it changed the insurance premium banks pay into an asset-based calculation from a deposit-based formula..These were significant wins for community banks, although in the last 15 years the too-big-to-fail banks have grown to account for about 70 percent of the banking industry’s assets, leaving only 30 percent subject to market discipline; about half of that is controlled by community banks. In 2010, community banks made 27 percent of loans; today it’s closer to 20 percent, yet that still accounts for 40 percent of all small business loans and 70 percent of ag loans.Following the bank failures of 2023 partially caused by deposit runs, talk has resurfaced about the need for additional deposit insurance protection. No one is worried about the banks with $100 billion or more in assets since they are covered under the concept of systemic importance. But apparently for everyone else, there is a proposal being considered in Congress to increase the deposit insurance coverage level to $10 million per account, which would essentially cover all deposits and eliminate the threat of deposit runs. But I don’t think such a dramatic increase is the solution.Most community banks have found ways to provide sufficient insurance to cover most of their deposits. Reciprocal deposit networks have come a long way. There are also collateralization options and letters of credit from wholesale funders which provide a solution in many cases. The fact is, the smaller banks that are “too small to save” are living within the discipline of the market, respecting moral hazard. They are figuring out private sector ways to meet market demand. In addition to appealing to many customers, this approach discourages additional regulatory scrutiny. (The Trump administration won’t be in power forever.)Community banks have lost deposit share to larger, regional banks in recent years. I am not sure that higher deposit insurance limits will do anything to recapture those deposits. Innovation is going to play a role in any likely solution — efforts to attract more deposits from new market segments. Furthermore, loan funding is likely to shift more to wholesale options away from core deposits. As I said at the beginning, a lot has changed in the last 15 years.