PRIVATIZING DEPOSIT INSURANCE

The Federal Deposit Insurance Corporation (FDIC) was established under President Franklin D. Roosevelt during the Great Depression. Its established purpose was to prevent or limit the effects of bank failures. Bank failures have historically led to a run on the deposits of various banks, sparked by fears that additional banks would fail, causing additional banks to fail. At a quick glance, the FDIC is a great idea, and it is. However, I contend that it is prudent and much more favorable to privatize deposit insurance (D.I.).

Privatizing D.I. will lead to an improvement in bank operations through the increase availability of information. Consumers will be able to discern the reliability and the level of risk a bank takes. This is reflected through the rates a bank pays for D.I. As it is with automobile insurance where high risk groups (i.e. teens, unmarried males, etc.) pay higher premiums due to being a higher risk category, high risk-taking and unstable or unreliable banks would face higher D.I. rates. This would be evident in the interest rates a bank charges for loans or the rates a bank pays for savings. Due to the higher costs it will see, a high-risk bank will charge higher interest rates for loans, and pay out lower interest rates for savings as compared to a low-risk bank. Consumers will be attracted to the low-risk banks without even knowing it.

Along with the previous point, privatizing D.I. will encourage high risk-taking banks to stop or reduce their risky ventures. This will be due those banks losing customers to the low-risk banks who have competitive interest rates for loans and savings. The high risk banks, in order to stay in business, will have to reduce the risk they are facing in order to reduce costs.

The benefits of privatizing D.I. cannot be seen through the FDIC. The FDIC charges a fee to member banks (Federal Deposit Insurance Act, Sec 5 (d)). There are seven factors that are considered when the FDIC admits a new bank Sec 6), one of which is the risk presented by the bank (subset 5). However, this only involves banks seeking to become an FDIC member institution. This does not stop banks who are already FDIC members from engaging in risky areas. This can be seen in the recent sub-prime mortgage crisis. The laws and regulations of the FDIC could not prevent this issue from arising. Privatized D.I. would have.

Privatized deposit insurance has many benefits that the United States and the world need to adopt. Through deregulation, incentives will be created to inhibit banks from engaging in high-risk ventures. Those incentives are seen through higher business costs through higher premiums paid for higher risks. These higher costs will encourage consumers to seek low-risk banks, which carry higher interest rates for savings and lower interest rates for loans. Through this system, the United States would have adverted the sub-prime mortgage crisis.