The Case for Ending Deposit Insurance

The Fed proposes looser lending standards. I propose ending deposit insurance.

The standard deposit insurance coverage limit is $250,000 per depositor, per FDIC-insured bank, per ownership category. Deposits held in different ownership categories are separately insured, up to at least $250,000, even if held at the same bank

Do we need deposit insurance?

No, assuming a sound banking structure.

In response to Just in Time Stimulus: Fed Proposes Looser Rules for Large U.S. Banks a reader asked: "If we got rid of deposit insurance, what protection would savers have?"

That's a good question.

The answer is none. But with 100% reserve requirements there would not need to be any, except to protect against theft and fraud. Banks would not be able to lend checking deposits. Savers take a risk on interest-bearing deposits, as they should.

My Proposal

  1. End the Fed
  2. End fractional reserve lending
  3. End the bailouts
  4. End deposit insurance
  5. Let the free market select what is money

Point number two is the key. A 100% reserve requirement eliminates the need for deposit insurance. Money held for deposit only, has no lending risk.

There is a tiny risk of theft or fraud which could be covered by private insurance. Warren Buffet would probably be willing to undertake the endeavor as risk of theft from banks is extremely small.

If you lend money for interest there should be risk. The risk is banks make bad loans.

Savings deposits and CDs are not really "savings" accounts at all. In both, you agree to let the bank lend your money in return for interest.

Checking accounts are supposed to be available on demand. Banks cannot lend checking accounts under my proposal.

Mike "Mish" Shedlock

Comments (42)
No. 1-17
Kinuachdrach
Kinuachdrach

It would be nice if I could find a reputable institution which would lend my savings in return for paying me meaningful interest. (Joke!)

It not clear what the implications of 100% reserve requirement would be. Banks still would have the age-old problem of borrowing short to lend long.

Big problems with Deposit Insurance today are (a) that it is "free", versus being paid explicitly by the depositor, and (b) we all know it is a sham anyway; if there is a real run on a major bank, the FDIC will not have the funds to cover the losses.

Six000mileyear
Six000mileyear

#6. End duration mismatch.

I Listen
I Listen

How do we get there from here? Realistically is it even plausible given where things are at?

Wagner_4
Wagner_4

Full Reserve Lending is anti-libertarian because it would require to introduce a new regulation that prohibits entities to lend money and borrow it back (through any intermediaries).

If you don't have that regulation and allow some entities in your system to lend and borrow money (at the same time) you have de-facto Fractional Reserve Lending. You can call those entities "unregulated banks", if you want.

We have never had Full Reserve Lending in the whole history of humanity. And Full Reserve Lending would never work, because any attempt to introduce it would cause Shadow Banking System to thrive which paradoxically would be de-facto Fractional Reserve Lending.

Fractional Reserve Lending is government's admittance that they can't ban entities that are lending and borrowing money at the same time. If you can't ban something, then just legalize it and introduce requirement that those entities have to maintain reserve ratio between their liabilities and their cash reserves. Call those entities "regulated banks".

Anyone in Computer Science should understand that Full Reserve Lending has to be acyclical graph, where nodes are entities and edges are money lent between them. Once you have local loop in the graph, you have unregulated Fractional Reserve Lending system.

Having said that, Fractional Reserve Lending system is unavoidable and people should rather embrace it instead of hoping that mythical Full Reserve Lending possibly with Gold Standard will somehow solve all the financial problems. And as long as we have FRL we will also have deposit insurance. We are at mercy of Federal Reserve whether they will bail out FDIC in case FDIC can't satisfy all the claims in case of systematic banking failures.

wootendw
wootendw

FRL is okay with interest-bearing accounts because the 'depositor' (investor) is risking his money (slightly) for a (minuscule) return. FDIC not warranted for risk-taking, 'savings' accounts.

Demand deposit account money should go in the vault and remain until the depositor writes a check against it or otherwise withdraws it. FDIC not needed for such 'checking' accounts because there is very little chance of loss and private insurance could easily handle those cases.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

"FRL is okay with interest-bearing accounts because the 'depositor' (investor) is risking his money"

Ridiculous - That is like saying it's OK to steal your neighbor's cow if another neighbor agrees.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

"Full Reserve Lending is anti-libertarian because it would require to introduce a new regulation that prohibits entities to lend money and borrow it back (through any intermediaries)."

Total bullshit for obvious reasons

Mike Mish Shedlock
Mike Mish Shedlock

Editor

"It not clear what the implications of 100% reserve requirement would be"

It's completely clear there would be less speculation by banks and zero bailouts.

AlexSpencer
AlexSpencer

Often institutions don't do what they claim. A small depositor would have recourse in the law for fraud etc. But practically only the wealthy have full access. Winning and collecting for a small deposit subject to fraud could cost more than the original loss.

Small depositors would then always need a reliable party to audit the bank regularly and guarantee their accounts. Who best to serve that function ? The government with infinite resources of printed cash or some company with only a good reputation to maintain. Since the 1980's the government has been doing a poor job with the regular audits but at least printed enough cash to cover their poor monitoring of the banks.

Stuki
Stuki

For this to properly work, you also need sound money. Otherwise, banks can always lend out checking deposits by debasing them. Then lending out the share of them acquired by this, indirect, route..

Roger_Ramjet
Roger_Ramjet

I'm not sure why anyone would want to operate a bank if there is a 100% reserve ratio requirement. I mean it costs a lot to operate a bank and provide depositor services. What would be the incentive to provide that service? Or would the bank then pass through those costs to the depositor, who would then find that it is too expensive to keep their money in a bank. I'm not sure that this is a rational solution.

Having worked at the FDIC, they do a very good job of overseeing bank lending activities, particularly for the small local and community banks that they oversee. When a bank gets into trouble, the FDIC immediately takes on an oversight role and limits the bank's future lending activities. The FDIC is funded by premiums paid by the banks. I don't think there is a big problem at the local and community bank level. The oversight is really quite good.

On the other hand, it's the big banks, those overseen by the Fed and the former Comptroller of the Currency, that flex their size and leverage to have already low reserve requirements reduced even further and take extraordinary risks through their investment banking arms, with the full understanding that they will be bailed out if they ever get into trouble. I think that is where your real problem lies.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

"I'm not sure why anyone would want to operate a bank if there is a 100% reserve ratio requirement."

Lots of misconceptions. 100% reserve requirements does not mean banks would be unable to lend. Rather, it implies that lending would be duration matched. And banks would up fees for checking accounts and safekeeping.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

"For this to properly work, you also need sound money. Otherwise, banks can always lend out checking deposits by debasing them. Then lending out the share of them acquired by this, indirect, route."

Stuki that makes no sense. In a 100% reserve setup, it would constitute fraud and executives would land in prison if they lent money available on demand (e.g. checking accounts).

Kinuachdrach
Kinuachdrach

It would seem likely that one of the consequences of 100% Reserves Requirement would be to push normal people to an all cash economy. Since a bank would have no opportunity to earn income from checking deposits, we would all have to pay fees for having checking accounts. This would cause workers to pressure businesses to pay them in cash.

For lendable savings-type deposits, the problem of matching deposit duration to loan duration would become quite a high-overhead issue. Since it would not be possible to access deposits even in an emergency, most savers would probably go for short term deposits (3-6 months). That means the entrepreneur who needs a 5-year loan to build his business would likely end up with a series of short term loans that would have to be renegotiated frequently -- and possibly would not be available at all at some point, depending on the flow of deposits.

I understand the positive features of 100% RR -- but there would need to be a lot of thought given to how to ameliorate the downsides.

Wagner_5
Wagner_5

Ok, so Mish is actually not proposing Full Reserve Banking but rather Fractional Reserve Banking where everything is the same except banks have to offer a new product called "safe box secured checking account".

The funny thing is that it does not change anything.

The requirement for banks to do duration matching between depositors and borrowers also does not change anything, because bank failures will still happen as bank's asset side deteriorates (in case one of the borrowers default) or liability side explodes (in case interest rates are not fixed).

And Bank Runs will still happen under such system except they will be rate limited until deposits mature. Banks under current system already can rate-limit withdrawals by imposing withdrawal limits. So really no benefit here.

And the big question is whether in his system depositors can sell their deposits in secondary market or cancel by paying early withdrawal penalty? If yes, this would have immense upwards pressure on interest rates once everyone will dump their deposits in a failing bank.

BlauGloriole
BlauGloriole

Subsidies by the state and cross products need to stop. Lets say there is transparency regarding risk and return by product line in a bank (wishful thinking I know) and the government stops subsidies (even greater wishful thinking). Also lets say core money supply is formulaic. It is Item 2 on Mish's list that I am not sure about. Whilst it is anchoring perhaps it is too anchoring for a society. Leverage is a form of optimism and permits experimentation and growth. I am not certain but my inclination is that as long as the targeted investors take the hit for the leverage item 2 is a solid positive add to society. It is kind of like, is bankruptcy law fair or does it permit risk taking so that net net it is a positive npv facilitator for society.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

"It would seem likely that one of the consequences of 100% Reserves Requirement would be to push normal people to an all cash economy."

Disagree

Ponder a bank that does not make loans. It would need no loan officers. Few tellers. Almost nothing.

Al this bank would do is take deposits and charge fees. The fees would be minimum. It would provide checks and do wires in and out for fees.

100% of the money would be available on demand.

A small 0.5% annual fee would likely be enough to make a profit.

Who would use such a bank?

Well, as soon as you end FDIC, damn near everyone who is thinking.

MIsh