Inside Financial Services

It’s Time to End Open-Ended Deposit Insurance

The FDIC's TAG program was vital during the crisis, but isn't needed anymore.

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My pal Cam Fine typically does a great job advocating on behalf of community banks, but he was off base last week, in my view, when he argued in American Banker that the FDIC should indefinitely extend its open-ended Transaction Account Guarantee deposit insurance program. The TAG program is an idea that has way outlived its usefulness. Community banks can compete against big banks just fine without it; the sooner they start doing so, the better.

TAG was instituted, you may recall, in 2008 during the dark days of the credit panic, when consumer confidence in the banking system was so low that no one was quite sure if any institution was safe. To help allay those fears, the government responded via TAG by lifting its $250,000-per-account limit on deposit insurance and making the guarantee open-ended on non-interest-bearing deposits. The program worked. Confidence in the system returned. The panic ebbed, the recession ended, and the economy began to grow again.

And yet Cam thinks community banks need to stay on TAG life support. “While it may or may not be appropriate to continue the TAG program forever,” he argues, “it should be continued as long as the economy remains fragile.” No. This recovery may be weak by historical standards, it is a recovery nonetheless. Community banks have successfully competed against larger institutions under similar economic conditions without the benefit of TAG many times in the past. They can compete TAG-less against the big banks now, too.

Cam worries that, since the typical community bank depends on a handful of high-dollar depositors for a large chunk of its funding, those depositors would shift to larger, to-big-to-fail institutions if TAG were ended. That’s mistaken. A lot more than simply a federal deposit guarantee typically ties a large depositor to his community bank. He might also be a big borrower, for example. Or simply civic-minded. For that matter, he might prefer the superior service that community banks traditionally provide. Put another way, if the only thing that’s keeping large depositors at a given community bank is the open-ended FDIC insurance, the bank deserves to see that money walk across the street.

Cam also complains that regulators consider community banks “too small to save,” which in turn puts the banks at an unfair disadvantage compared to their too-big-too-fail competitors. That gets things exactly backwards. Too-big-to-fail is the problem, not inadequate government deposit insurance. Granting an open-ended deposit guarantee to community banks only compounds the government’s risk. (Nor, for that matter, do the incremental FDIC premiums the banks pay for TAG come close to covering the incremental risk the government has taken on.) As far as that goes, the TAG safety blanket is only an inducement for community bank managements to run their institutions less prudently, rather than more so. If you don’t have to worry about big depositors wondering about your solvency, why not go a little crazy?

Community banks have thrived for years with FDIC deposit caps and there’s no reason they shouldn’t be able to now. When the banking system was on the verge of collapse, the TAG program was vital. But the system is back from the brink. It’s time for TAG to go.

What do you think? Let me know!

9 Responses to “It’s Time to End Open-Ended Deposit Insurance”

  1. Banker9

    As a community banker, I feel that we would be better off with no federal deposit insurance. Not only is it costly (in today’s rate environment), but it makes most customers indifferent to the financial condition of their institution. This is bad. We’d do better if financial stability mattered more, not less.

  2. Captain137

    Tom : Love your comments and observations !

    This one — Yawn !

    Edward McGinley in Villanova, PA.

  3. rps

    If you’re hurting from serious injury, pain medicine can be helpful. If you stay on the medicine after you’re no longer in pain, you are a “junkie”. Banks were seriously injured, the insurance was good medicine. If we keep taking the insurance, we will go from being a bank, to being a “utility”. It’s time TAG to go.

  4. Texas community banker

    As long as TBTF exists, the TAG program makes sense. Commentators seem to forget that FDIC is funded by industry premiums. It is in no way funded with taxpayer dollars. Yes, the government provides a backstop (as they do with the TBTF crowd) but unlike TBTF, the backstop has never been used. The industry recapitalized the FDIC when reserves ran low. The real risk to the FDIC is low because community banks are mostly sound.

    And your luducruis comment that TAG would give incentive to community banker to take more risk: Are you as nutty as you sound? Have you ever even met a community banker? The bank is their life. The capital is mostly their entire personal wealth. You think a TAG program would induce them to risk their family’s assets?

  5. FrankM

    Spot on Tom – time for community banks to stand on the strength of their franchises – propping up weak institutions via TAG only escalates cost for all banks – and “Texas community banker” – maybe you haven’t noticed but the failures today are all community banks – those are the institutions without access to capital (or an unwillingness to dilute themselves / their families)

  6. rivvir

    “Or simply civic-minded.” Hah!

    Solution is, if you really want to cut down the insurance cost and keep depositors, keep offering free checking for depositors while the tbtf banks tack on the charges. I believe that was done in the past, no? You think your big banks offered free checking out of the goodness of their heart, or “civic-mindedness?” How is that banks made money prior without the need to resort to the shenanigans of subprime and the offshoots bred, and the absence of the debatable issue to add fees, yet now need those charges you stand behind in your prior argument? Answer, they don’t. Just they want to squeeze, squeeze, squeeze every last drop they can. Make the ceo’s bonuses, make wall street happy. Since checking seems to be a necessary item for consumers it’s a target for the squeeze. Is it needed by the banks? No. Is it simply another profit target. Yes. Just like the credit/debit card swipe fee.

    As for your argument against too small to fail where you say the problem is too big to fail, perhaps both are a problem. One does not necessarily obviate the other. I won’t pretend to know enough to offer an opinion other than one side of the coin may not be an exclusive issue.

  7. Texas community banker

    As long as TBTF exists, the TAG program makes sense. Commentators seem to forget that FDIC is funded by industry premiums. It is in no way funded with taxpayer dollars. Yes, the government provides a backstop (as they do with the TBTF crowd) but unlike TBTF, the backstop has never been used. The industry recapitalized the FDIC when reserves ran low. The real risk to the FDIC is low because community banks are mostly sound.

    And your luducruis comment that TAG would give incentive to community banker to take more risk: Are you as nutty as you sound? Have you ever even met a community banker? The bank is their life. The capital is mostly their entire personal wealth. You think a TAG program would induce them to risk their family’s assets?

  8. Jmad

    Time is running on tag program which was as much a result of money market fund guarantee as it was to level small versus tbtf banks. Small banks can compete without it but most weren’t taking any risk with excess deposits anyway as some seem to forget there is little loan demand ajnyway, even if they somehow went risk on with their precious capital, and the regulators somehow would suddenly and somehow miss that? Come on people, get real. Sorry for run on sentences.

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