BUSI 683 Week 6 DB Forum 4 Example

Discussion Board Forum 4: Thread and Replies

BUSI 683 Money & Capital Markets, Discussion Board Forum 4 (thread and two replies)

Thread by [Student Name]

The forum prompt and the classmates are composites standing in for the course's own; the facts about deposit insurance and the 2023 decisions come from the FDIC and the federal agencies' public statements, and the textbook, Scripture and research cited are real; the requirements follow Liberty's public course guide for BUSI 683.

Thread

The prompt asks whether the United States should insure all bank deposits. Two facts frame the question. Standard FDIC coverage stops at $250,000 for one depositor at one insured bank in one ownership category. On March 12, 2023, the Treasury, the Federal Reserve and the FDIC invoked the systemic risk exception to protect all depositors of Silicon Valley Bank and Signature Bank, including the large uninsured balances that had fled in the run. In practice, uninsured depositors at those banks were treated as if they were insured, which raises the question of whether the limit still means anything. If large depositors now assume that any bank big enough to matter will be rescued in full, the limit protects the insurance fund only at small banks, and it pushes deposits toward the largest institutions.

Cecchetti and Schoenholtz (2015) explain why governments build a safety net. Deposit insurance and the central bank's role as lender of last resort protect small savers and prevent runs from spreading through the banking system. But they also warn that the safety net creates moral hazard: insured depositors stop monitoring their banks, and banks that know their funding is protected can take more risk, which is why regulators pair insurance with capital requirements and supervision.

The research shows both effects in the data. Demirgüç-Kunt and Detragiache (2002), studying a large panel of countries, linked explicit deposit insurance with more frequent banking crises, an effect that was strongest in countries that had freed bank interest rates and had weak legal and regulatory institutions. Anginer et al. (2014) looked at the years before and during the global financial crisis and found that generous safety nets were associated with greater bank risk and systemic fragility before the crisis, yet with lower bank risk and greater stability during it, and that good supervision reduced the harm in normal times. Insurance that calms a panic in a crisis can feed risk-taking in the years before one.

Paul's letter to the Galatians holds the same tension. He urges believers to carry each other's heavy burdens and, three verses on, says that every person must still carry his own pack (English Standard Version Bible, 2001/2016, Galatians 6:2, 5). Read together, the verses describe a community that carries what an individual cannot while still expecting each person to carry what he can. Deposit insurance should work the same way: shared protection for losses no depositor can reasonably prevent, and responsibility where depositors and banks can manage risk themselves.

I would therefore recommend a middle course rather than unlimited coverage. First, raise coverage substantially for business payment accounts, the operating accounts firms use for payroll and bills, which the FDIC identified in its 2023 review of reform options as a group whose losses spread quickly to employees and suppliers. Second, keep the standard limit for other balances, so large savers retain a reason to choose sound banks. Third, tie deposit insurance premiums and capital requirements more closely to each bank's interest-rate and funding risk, so banks that rely heavily on uninsured deposits pay for the extra danger they create. That design keeps the safety net strong where runs do the most damage while limiting the moral hazard that unlimited coverage would invite. It also treats small and large banks more evenly, because a payroll account at a community bank would be as safe as one at the largest bank in the country.

Reply to Noah

Noah, you argued that the 2023 exception proves the limit is a fiction and that Congress should simply insure every deposit, ending runs for good. You are right that an explicit guarantee would remove the motive for the kind of run that sank Silicon Valley Bank, and Anginer et al. (2014) support part of your case: during the global financial crisis, countries with deposit insurance coverage had lower bank risk and greater systemic stability. But the same study found that generous safety nets increased bank risk and fragility in the years before the crisis, and that over the full period the destabilizing effect in normal times outweighed the stabilizing effect in turmoil. Cecchetti and Schoenholtz (2015) explain the mechanism in chapter 14: protected depositors have no reason to watch their banks, so the job of restraining risk falls entirely to regulators. Unlimited insurance would make that dependence total. A bank funded by fully insured deposits could buy long-term bonds or make risky loans, and its depositors would never move their money in response. Proverbs 22:3, which pictures the wise person noticing trouble and taking shelter, (English Standard Version Bible, 2001/2016) assumes someone has an incentive to look for danger, and unlimited insurance would remove that incentive from every depositor at once. I would rather see coverage extended where runs are most damaging, such as payroll accounts, while large savers keep some reason to watch. Would you accept unlimited coverage only if it came with much higher capital requirements? If so, we may be closer than our threads suggest, since capital is the cushion that protects the insurance fund when depositors stop watching.

Reply to Leah

Leah, your thread made the opposite case: abolish deposit insurance beyond small balances so depositors police their banks again. Your concern about moral hazard is well founded, and Demirgüç-Kunt and Detragiache (2002) tied formal deposit guarantees to a higher chance of systemic banking trouble, most of all where rate controls had been lifted and oversight was poor. But market discipline has a known failure. According to the model of Diamond and Dybvig (1983), since banks finance long-lived loans with deposits payable whenever savers ask, a run can happen even at a sound bank if depositors expect others to withdraw, and that deposit insurance can eliminate that bad equilibrium. Without insurance, the speed of modern withdrawals, over $40 billion from one bank in one day in 2023, would expose many banks to runs driven by rumor rather than weakness. Cecchetti and Schoenholtz (2015) note that bank failures can spread through the system because depositors cannot easily tell sound banks from weak ones, so a run at one bank can trigger runs at others. Proverbs 3:27 forbids keeping back a good thing from someone it belongs to when it lies within reach to give it (English Standard Version Bible, 2001/2016). Small savers and employees whose paychecks sit in a business account cannot assess bank balance sheets, and protecting them seems a good within the government's power. Discipline can come from large depositors and from risk-based premiums instead. Would risk-based premiums give you the discipline you want without the risk of contagious runs? They would put a price on the very behavior you want to restrain, and the bank, not the payroll clerk, would pay it.

References

Anginer, D., Demirgüç-Kunt, A., & Zhu, M. (2014). How does deposit insurance affect bank risk? Evidence from the recent crisis. Journal of Banking & Finance, 48, 312-321. https://doi.org/10.1016/j.jbankfin.2013.09.013

Cecchetti, S. G., & Schoenholtz, K. L. (2015). Money, banking, and financial markets (4th ed.). McGraw-Hill Education.

Demirgüç-Kunt, A., & Detragiache, E. (2002). Does deposit insurance increase banking system stability? An empirical investigation. Journal of Monetary Economics, 49(7), 1373-1406. https://doi.org/10.1016/S0304-3932(02)00171-X

Diamond, D. W., & Dybvig, P. H. (1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy, 91(3), 401-419. https://doi.org/10.1086/261155

English Standard Version Bible. (2016). Crossway. (Original work published 2001)