Why big increases in deposit insurance will weaken the best banks

Banks are not in the business of losing money. In an opinion piece intended to support an increase in federal deposit insurance, it is important to state the obvious up front.

Precisely because banks make their money from the spread between the interest rate paid on deposits and the interest rate at which deposits are lent out, there is little or no incentive for banks to make loans that will not be repaid. This is because one bad loan can wipe out the earnings of a much larger number of good loans.

This brings us to the proposal to increase federal deposit insurance from $250,000 per non-interest-bearing account to $10 million. It’s hard to argue that considering the business banks are in precisely because they don’t care about losing money born of big, bold swings for the proverbial fences with depositors’ savings. Again, a wrong, highly risky loan at a bank can easily wipe out returns on 99.9999% of the good ones.

This is why increased deposit insurance would be so damaging to – yes – the banks themselves. That’s because nothing is free, and that includes deposit insurance.

As has been widely reported, a significant increase in per-account deposit insurance would cost banks $10 billion in the very near future, with surely more to come. The latter is made evident by the existing deposit insurance which for example cost the banks $12 billion in 2024 alone. Do the math.

The costs associated with maintaining insurance at much higher deposit levels will clearly hurt banks because of valuable capital flowing into the FDIC’s deposit insurance fund instead of profitable lending. Which means banks would lose twice in such a scenario: they would pay more for insurance that ignores the business they are in, while doing less banking (the business they hectare media) thanks to the cost imposed on them to maintain a much larger insurance umbrella. It’s just not necessary.

Some will say that insurance is necessary on the assumption that the mistakes of mismanaged banks should be contained through the FDIC. Such a view is exactly backwards. If banks are poorly managed or inept at loan origination, the answer is not more federal insurance, but they should be acquired quickly so they can’t make costly mistakes. Call the expanded FDIC insurance subsidizing the smaller and often worse banks at the expense of the bigger and better ones.

Evidence to support the above claim is again in the sentence itself. If a bank’s lending requires such substantial insurance, then it should not be in banking. See the original sentence of this opinion piece.

It cannot be said enough that if banks are operating as they should, carefully lending to reliable borrowers, nosebleed levels of insurance are unnecessary. Put another way, banks asking for $10 million per account in FDIC insurance are either incompetent or clearly not in banking. The former should be acquired, while the latter should not have their risky behavior subsidized.