What Is the Economic Rationale for Government-Backed Deposit Insurance?

Topics: Federal Deposit Insurance Corporation, Investment, Banking Pages: 2 (636 words) Published: December 12, 2011
What is the economic rationale for government-backed deposit insurance?

Case Study: The Federal Deposit Insurance Corporation (FDIC) The most important government agency is The Federal Deposit Insurance Corporation, whereby each depositor is insured to at least $250,000 per insured bank in the case that a financial intermediary should fail. This protects people’s deposits so that they do not face a great financial loss.

* When a bank fails it means they are unable to meet their obligations to pay its depositors and other creditors. Therefore deposit insurance was introduced in 1934 in order to protect those, for when a financial intermediary failed. * In the first 10 months of 1930, a total of 744 US banks failed. In November and December of that same year, 600+ more banks failed. Throughout the entirety of the Great Depression, over 9,000 US banks failed, which is by far the worst stretch in US history when it comes to bank failures.

* The main reason for deposit insurance is that individuals are more inclined to put all their money in the bank, instead of holding on to it in the case of their deposits becoming inaccessible due to the bank being illiquid or insolvent. Therefore by having insurance it provides a reason for these individuals not to have to pull all their money out of the bank by knowing that the government is guaranteeing their deposits. As a result, the entire banking system becomes much more secure and stable. * Banks receive money from people lending them money in the form of savings and checking accounts. With more money put in accounts, the bank has more funds to access. This means there are more funds to lend, which in turn will decrease the interest rate. However if people lost confidence in banks, their money would go elsewhere, for example into property investment. Leaving banks insolvent and going out of business. * Another benefit for banks is the protection offered to them through deposit insurance....
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