Where Have All the Deposits Gone? Do We Really Need Federal Deposit Insurance?

In the wake of the FDIC-mandated closings of Silicon Valley Bank and Signature Bank, deposits at commercial banks have declined a net $161.0 billion in the two weeks ended March 15, 2023 (see Chart 1 below). In that same two-week period, money market funds that invest in US government securities and repurchase agreements collateralized with US government securities experienced a net inflow of $130.8 billion, according to the Investment Company Institute. These money market funds gained another $131.8 billion in the week ended March 22, 2023. Each share in these money market funds is valued at $1 or par. But there is no federal guarantee that these shares are redeemable at par. Yet there were large inflows of monies into these taxable government money market funds at the same time there were large outflows of deposits from commercial banks. Deposits at commercial banks are insured to be payable at par of up to $250 thousand per account ($500 thousand for joint accounts) by the Federal Deposit Insurance Corporation (FDIC). It would seem that the nonbank public has more confidence in the full faith and credit of the US government than the FDIC (unless the federal government is forced to default on its debt because of Congress failing to increase the ceiling on Treasury debt issuance). To the best of my knowledge, no government-only money market fund has ever experienced a decline in its share value below $1. Assuming that the debt ceiling is raised in time to avoid a Treasury default, do we really need federal deposit insurance?

Given that we do not live in a world of barter, we do need some means to transfer payments. Depository institutions such as commercial banks, saving banks and credit unions provide this service by offering checkable deposit accounts and electronic funds transfer services. But so do many government money market funds or the brokerage companies sponsoring those money market funds. Alternatively, depository institutions could set up segregated units that offer checkable deposits and electronic funds transfer services and would be required by law to invest only in very short maturity US Treasury securities or repurchase agreements collateralized by US Treasury securities. These special banks would be required to report daily to some federal oversight authority their asset holdings. In a March 23, 2023 podcast (“Odd Lots”) Bloomberg journalists Joe Weisenthal and Tracy Alloway interviewed Cornell Law Professor Saule Omarova who floated the idea of having these special segregated “banks” invest only in Federal Reserve liabilities. Actually, government money market funds partially do this by placing funds with the Fed via the Fed’s reverse repurchase agreement (RRP) facility. Chart 2 shows that RRPs increased by $223.8 billion in the week ended March 22, 2023, the largest week-to-week increase in RRPs in the past 13 months. Other types of financial institutions have access to the RRP facility. So, I do not have any data as to whom the participants were in recent weeks. But it is a safe bet that government money market funds were among those who availed themselves of the Fed’s RRP facility.

FDIC-insured depository institutions, of course issue, deposits that are not for transactions purposes. Wouldn’t investors want some kind of insurance on these deposits? Sure, but why does it have to be federal insurance. Why couldn’t there be deposits insured by private entities? The depositor, not the depository institution, could purchase this insurance. The private insurer would have an incentive to do its own analysis of the risk profile of an institution whose deposits it is insuring. If the riskiness of a depository institution is assessed to have risen, the premium charged for insuring that institution’s deposits would rise commensurately. The depositor would have an incentive to move her deposits to an institution with a lower deposit insurance premium, all else the same. And the institution that is experiencing an increase in the insurance premium on its deposits would have an incentive to reduce the riskiness of its assets or suffer the consequences. With the elimination of federal deposit insurance, the private deposit insurers would likely hire some of those laid-off federal bank examiners. Of course, there remains the issue of who insures the private insurer.

This scheme would greatly reduce government regulation of depository institutions. The only regulation “transactions” banks would require would be to assure that their earning assets were government securities of some specified short maturity. The same would hold true for government-only money market funds. If other depository institutions wanted to “innovate”, the government would not stand in their way. However, the private insurers of their deposits might. But that’s the free market at work.