The Case For Raising The FDIC Cap Just Doesn’t Add Up

Last week, Treasury Secretary Scott Bessent and Senator Bill Hagerty (R-TN) took to The Wall Street Journal to defend their proposal for raising the Federal Deposit Insurance Corporation cap from $250,000 to $10 million. In addition to many other problems with the proposal, their latest defense falls flat from the very first sentence.

They note that “billions of dollars of deposits fled from regional and community banks to the largest banks” during the bank panic of 2023. Supposedly, people moved their deposits because they believed the largest banks enjoy implicit government backing (they’re too big to fail). Because this implicit backing (allegedly) creates an unfair advantage for the largest banks, Bessent and Hagerty claim that raising the FDIC cap is needed to level the playing field and shore up small banks.

At best, their story is incomplete.

As researchers from the New York Fed demonstrated in May 2023, virtually all these deposit outflows were concentrated in the 30 so-called super-regional banks (those with total assets between $50 billion and $250 billion), but the nearly 4,000 banks with less than $100 billion in assets “were relatively unaffected.” If any part of America, small town or big city, really is at risk of falling apart when those 30 super-regional banks lose deposits, it’s a real mystery what the other 4,000 banks are doing.

Outflows Occurred Prior to 2023

Their argument is on even shakier ground, though. For starters, this outflow was an acceleration of a trend that began (roughly) in the spring of 2022.

Before Silicon Valley Bank (SVB) failed in March 2023, people removed about $500 billion of their deposits from the banking system. And during that round of outflows, banks did not replace those deposits by borrowing new funds. Likely, the level of deposits was still artificially elevated in the wake of the COVID-19 pandemic.

Then, as the NY Fed paper recounts, people took out another $450 billion in deposits after the SVB failure. This time, though, most of the outflow occurred during the weeks after the government invoked the systemic risk exception (SRE) to cover uninsured deposits. For those who insist that more government backing is needed to quell panic, that sequence of events does not support their narrative.

Their argument does not improve from there.

While this later round of deposits initially flowed from the super regionals to the largest banks, many of those depositors soon moved their deposits out of the banking system altogether. Obviously, if these depositors were so panicked and dependent on implicit government backing at the too-big-to-fail banks, they wouldn’t have moved their money outside of the banking system.

Another fun fact is that during this post-SVB failure period, banks did offset the deposit outflows with new borrowings. And in this case, they used the private and public institutions that already existed, outside of the SRE situation, to satisfy their need for precautionary liquidity. That is, they relied on credit from the Federal Home Loan Bank system and the Federal Reserve.

So, while there was a net outflow of deposits after the SVB failure, banks used the institutions that are in place to provide emergency liquidity when such events occur. (These institutions could, perhaps, work even better with less government backing and better rules, but that’s best left to another column.)

Outflows Don’t Justify Raising the FDIC Cap

Either way, the basic justification Bessent and Hagerty lay out for raising the FDIC cap doesn’t really hold. Still, they want to implement a plan that would protect the banking sector with the Federal Home Loan Banks, the Federal Reserve, special federal power to guarantee uninsured deposits, and explicit backing for the less than 1 percent of accounts that don’t already have FDIC coverage.

Their plan expands “too big to fail” to smaller banks and expands into “too big to lose your customers.” Their justification explicitly assumes that the federal government needs to step in so that banks don’t lose deposits, even though the federal government already stands as a provider of emergency liquidity.

At its core, their plan suggests that the federal government must explicitly protect the 30 super-regional banks from losing customers at the risk of the typical American worker losing his or her job. That’s a huge leap.

Taking the plan to its logical conclusion is even worse. It implies that the government should protect all businesses from losing customers. Call it whatever you like, that’s not free enterprise.

The fact that some banks are larger or more successful than others does not justify tilting the system against those banks. And, to whatever extent special government advantages made those banks larger and more successful, the best solution is to get rid of those advantages.

Raising the FDIC Cap Broadens a Bad System

The FDIC system was the original sin in the banking sector, so paring it back is a great place to start. For nearly a century now, FDIC insurance has been used to justify increased federal involvement in banking, including ridiculously complex regulations that don’t seem to work too well. This latest FDIC expansion will magnify all these problems, make the system more fragile, and force millions of Americans to bear the cost.

Bankers should be allowed to be bankers, just like any business owner should be allowed to run their business. If banks can build their business with uninsured depositors, more power to them. If it turns out they really need some kind of deposit insurance, then private markets should be allowed to provide as robust a solution as they can. That’s what financial markets do, and the more we rely on FDIC insurance, the less of a chance we’ll ever see private financial markets work as they should.

The truth is that a handful of banks now want more special protection based on the bumpy road they faced in 2023. But that road was bumpy, at least in part, because of the federal system we have in place. Expanding that system is the wrong solution, and the broader implications endanger the U.S. economy in ways that few acknowledge.

The logic behind this latest expansion suggests that people should use their money based on what government officials fear might happen to someone else, rather than on one’s own views of their best risk-reward trade-off. This reversal elevates a vague notion of the “greater good,” defined by whoever is in power, above the freedom of the individual. Again, that’s not free enterprise.

The math for this new proposal doesn’t work, either. Raising the FDIC coverage limit from $250,000 to $10 million protects a very concentrated few Americans, not the average American worker or small business. If members of Congress want to do more to protect the average American, they’ll lower the FDIC cap and pare back government involvement in financial markets.