Securing public funds bank deposits is normally not top of mind. Nor is it the prime responsibility of any official—until something goes wrong. When that happens taxpayer money can be lost and municipal officials will be on the hotseat.

That was the case in Oklahoma when a small bank became insolvent last year. The Federal Deposit Insurance Corporation stepped in and fully paid insured deposits of the First National Bank of Lindsay, Oklahoma but municipalities whose deposits were in excess of insured amounts were paid only 50 cents on the dollar notwithstanding that they were collateralized.

The risk of this outcome leads depositors to yank money from smaller banks at the hint of a problem and deposit it in government money market funds or the mega-banks which are effectively too big to fail. That was the case in 2023 when Silicon Valley Bank and Signature Bank failed in rapid succession.

Reforming FDIC Insurance

In the aftermath of these failures the FDIC issued an analysis and series of recommendations for reforming deposit insurance to better protect deposits. We wrote about this in April 2024, urging state and local governments to press for an increase in insurance limits for public unit deposits to better protect taxpayer assets. 

Increasing insurance limits would reduce reliance on collateralization, a cumbersome alternative that may or may not fully safeguard funds, and it would reduce reliance on services to multiply deposit insurance that have taxpayer-borne fees of ten to 25 basis points and require (sometimes overlooked) complex accounting to assure that the public unit’s financial statements accurately reflect ownership of what could be dozens or hundreds of bank CDs at any given time.

Now there is  a bipartisan bill in Congress, the Main Street Depositor Protection Act (S. 2999) that would expand FDIC insurance for non-interest bearing transaction accounts to $10 million.  Transaction accounts are deposits that fund payrolls and other payables. State and local government balances in these accounts have grown over the past five years to the point where they total nearly $400 billion of public funds financial assets.

The Main Street Protection Act is cosponsored by Senators Hagerty (R) and Alsobrooks(D). Treasury Secretary Scott Bessent, while not promoting the specific bill, has commented favorably on the effort to reform FDIC insurance, and a Senate hearing in November put the bill in position for further consideration.

The legislation is strongly supported by the community banks who saw their deposits shrink in the flight caused by the 2023 bank failures. Predictably, the Global Systemically Important Banks (the G-SIBs) have opposed the change. Presumably, they see no benefit for their businesses. They gained assets in the flight from Silicon Valley and Signature Bank because their size means the government is likely to step in to rescue depositors. The big banks don’t want to pay for the cost of added insurance, and perhaps if they have a competitive bent, they do not mind having a (free) safety advantage over smaller community institutions.

While the Senate bill seeks to deal with this issue by expanding FDIC insurance, a House bill, H.R. 3234  sponsored by Representative Emmer seeks to loosen restrictions on banks using deposit multiplication services. Opponents of the FDIC insurance expansion bill have latched on to this as an alternative to raising the insurance limit, though it really doesn’t address directly the core issue of the administrative burden and uncertainty of recovery that depositors face with the current insurance limits. (As an aside, it is likely that the objectives of this legislation  could be accomplished by the federal bank authorities simply changing their rules.)

Should Public Unit Depositors Bear Risk?

Some say depositors should bear the full risk of bank failures, and do diligence to avoid weak banks, but diligence is not practical for most municipalities and businesses (who would also benefit from higher insurance on transection accounts). In the case of the Lindsay bank, which had only about $100 million of assets when it failed, the CEO was subsequently accused of bank fraud, something which escaped the examination of bank regulators for years. To expect ordinary depositors to ferret out such actions is simply unrealistic.

I can imagine going before the board of supervisors of the township where I live and asking the farmer, construction estimator, agricultural equipment salesperson, junk yard owner and owner of a small manufacturing company who are the board if they’ve evaluated the creditworthiness of the bank that handles the township’s payroll and payable accounts creditworthiness.  They would think I had lost touch with reality, and if they turned to their part-time administrative manager, she most likely would roll her eyes.

Yet with the current FDIC insurance limit it’s either that or dependence on Pennsylvania  state law that the bankers wrote nearly 50 years ago that permits collateral that can be valued at a multiple of its market value, leaving the balance unsupported by the real value of collateral.

Collateralization Is Problematic

Most public funds bank deposits in excess of insured amounts are collateralized under a patchwork of state laws. Some states have centrally administered programs, as in California, Florida, or New Jersey, to approve banks, value collateral etc. but in many locales the public unit is left to do this on their own. It’s challenging to identify leading practices or to benchmark costs when so much varies across the country.

Programs that multiply insurance by spreading deposits among multiple banks to stay within insurance limits offer an alternative, but they involve broker or similar fees that reduce the deposit rate by ten to 25 basis points.

And then there is the matter of administration and accounting. To properly account for these arrangements the public unit should book each component deposit—and there could be 100 or more for a $10 million account. And where transaction account balances can change daily, as they do for transaction accounts, so can the deposits that reside in the reciprocal banks. The requirement for reflecting this on a public unit’s financial statements is so burdensome that it likely is ignored by many public units.

Expanding the insurance limit to $10 million would address this for the vast majority of deposits.

Is $10 million the right limit? It’s hard to know because there is no comprehensive source of data on public unit deposit accounts, but my guess is that 90% of public agencies could maintain transaction accounts within this limit.

Insurance comes with a cost, of course. In the case of deposit insurance, the cost is assessed on all banks based on their size and financial health, but it is not directly assessed on the insured or collateralized deposits. This is certainly an element in the opposition that large banks have to increasing the limit: they would bear cost whether or not they get a direct benefit. But the argument about who pays for insurance is not unique to deposit risk. Think health insurance, casualty insurance, or flood insurance. Rates never fully reflect the individual insured risk because if they did there would be no way the pooled risk—which is at the heart of insurance—would work. There must be a common good (a healthier population, a more stable banking system, etc.)  to support the structure. And supporting the community banking structure and the community banks,  small businesses and the taxpayer assets that are held by public units, would seem to meet that test.

Bottom Line

At a time when much of what Washington does seems to add stress to the mission of state and local governments and communities, expanding deposit insurance would provide a welcome measure of support.