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Hidden costs of Federal Deposit Insurance

Posted by
April 1, 2015
in Blog

Everyone loves government-provided deposit insurance! Well, not everyone. But nearly everyone. It makes them feel secure knowing that, if their bank goes belly up, the Federal Deposit Insurance Corporation will swoop into action. What’s not to love about that?

Co-blogger Thomas Hogan and I have argued that, contrary to standard models of deposit insurance, FDIC is costly. Some of these costs are explicit. Others, as we point out in our latest paper, are implicit. Here’s the abstract:

Most people believe the benefits of deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC) clearly exceed the costs. However, a growing literature suggests the benefits of FDIC insurance are overstated while the costs are understated. We add to this literature by considering the implicit costs of FDIC. Specifically, we consider the costs arising from (1) an implicit taxpayer backstop and (2) suboptimal pricing. Since such costs are routinely omitted from traditional cost-benefit analysis, most studies of the FDIC tend to be biased in favor government-provided deposit insurance.

Before concluding that government-provided deposit insurances is a good deal, one should consider all of the costs and benefits relative to the relevant alternatives. We hope our latest paper pushes the conversation along in that direction.