Why the FDIC & CDIC Shouldn't Move to Unlimited Insurance per Bank Account

Why the FDIC and CDIC Need to Spread Bank Insurance Risk Around

There's been quite a bit of talk as to whether and/or how much the FDIC (in the USA) and the CDIC (in Canada) should raise the limit for deposit insurance on for deposits in eligible bank accounts, GICs, CDs and other insured vehicles.

I see mostly no good reason for increasing CDIC/FDIC deposit limits. 

I think it is good for the government to be essentially diversified in its insurance. Insurance is all about spreading risk around. Think about it, if one bank were to offer an absurdly high interest rate because it was willing to take on a lot more risk in its investment portfolio (which we've seen with mortgages and Asset-Backed Commercial Paper), everyone would plow their every last dollar into that account. Without limits, there could be a nearly unlimited amount that the FDIC and CDIC insurance schemes would have to cover when that bank inevitably fails (see IndyMac in California).

This would be no different than a home/property insurance company offering insurance in only one town. What happens when a hurricane plows through that town? Who's premiums are they going to use to rebuild when every policy holder's home got destroyed?

With limited insurance, at least everyone in the country wouldn't be able to pile all of their funds into these risky players in the market.

Another good reason against raising these limits is that people/businesses should stay diversified too. Don't keep all of your funds in one (bank account) basket. If you have a substantial amount of money (ie: these people with more than $100 000 in one account), you should really split it across different banks, in case one goes under, or you have some hassles with one bank. Although I do have faith in the CDIC/FDIC, they're not going to be able to act instantly. And like I said, with unlimited insurance, those rogue players that offer really high rates due to risky investments could get very big and make things harder for the Federal Deposit Insurance Corporation to handle things smoothly.

Luckily, we've yet to see a bank fail that another bank didn't want to pick up (some are even fighting over) the pieces left in the aftermath.

The case for increased deposit limits for CDIC/FDIC Accounts

There is one good reason I can see for raising the limit (perhaps in certain situations only), and that is for companies that plain and simply need to have lots of funds in a bank account for one reason or another, for example, meeting payroll, they may need to have a substantial sum of money in one account at one time to electronically pay their employees the next day/week, etc. Paying your employees from multiple accounts at multiple banks could get a bit dicy. There are a bunch of alternative situations I could offer, but for consumers, I'm not particularly for unlimited insurance when people are just trying to stash money at high interest rates. 

Another reason is those that wish to, say, keep their RRSP/IRA accounts (ie: retirement accounts) in GICs/CDs, because having to spread risk around to different bank accounts can be difficult when you want to have multiple registered/retirement accounts, and having to keep track of say, how much you can contribute to each, rather than having all of the paperwork in one place. 


Deposit Insurance: Commenting from the Asian perspective

The deposit insurance law in Thailand

provides fairly limited protections in the case of deposits, and this amount is currently being trimmed down to reach about 35,000 Canadian dollars per bank by the year 2012. I am in full agreement with Dan Matan's comments relating to why insurance rates should not be increased without due consideration to the overall economic climate. As Dan makes clear above, such a decision is fraught with moral hazard, because in essent the government becomes the insurer for dangerously high levels of risk. It might make more sense if there was a rating on the risks banks were taking as a pre-requisite to any decision to ensure deposits by government. At any rate, it seems that increasing insurance without limit would invite disastrous decision making by bankers who would feel, 'too safe' in their management.

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