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Deposit Insurance: The Importance of Confidence

Mar 26, 2013 • Behavioral Economics, Economic Debates, Economic History, Financial Markets, Money and Monetary Policy, Regulation • 215 Views    No Comments

Cyprus’s banking crisis made me think of the FDIC sign in my local bank. Located right where I can see it, the reminder inspires confidence. Similarly, on an FDIC web site, they say at the top, “Since the FDIC’s creation in 1933, no depositor has ever lost even one penny of FDIC-insured deposits.”

By contrast, before the FDIC was created in 1933, most depositors lacked the confidence that their savings were safe. As a result, just a rumor that a bank was troubled could create a run. And, requiring more money than the bank could provide, that run could make the bank fail.

Then came Glass Steagall with its deposit insurance provision. Since then, the number of bank failures caused by small depositor runs has dwindled to almost nothing. We know that the federal government will give us our money when the bank can’t.

I wonder, though, how much Cyprus has changed European attitudes about deposit insurance. Yes, monetary authorities decided that their initial proposal was a bad idea and will not ask insured depositors to pay a 6.75% “tax.” But still, haven’t they eroded the confidence that is the bedrock of deposit insurance?

A little history…

One of the first banking insurance funds was established by New York State in 1829 after a banking crisis. Supporters of the idea emphasized that depositor insurance made banks safer. Opponents worried that healthy banks paid for the excesses of weaker ones and “public scrutiny” would diminish.

While today, we continue to debate the same issues, all agree that confidence is necessary. And that returns us to Cyprus and a short-lived proposal that might have a long term effect.

Sources and Resources: Roger Lowenstein’s NY Times column offered considerable insight and history on deposit insurance. Complementing his insight, this FDIC site provides more practical facts about deposit insurance ($250,000 for a single account in one person’s name) and here, at econlife we have more on Glass Steagall.

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