Earlier this week we filed formal comments with the Federal Deposit Insurance Corporation advocating for reform of the bank insurance program to raise limits on insurance and reduce the need for collateral to secure public deposits.

The filing, in response to an FDIC Request for Information, is accessible here.

Raising the limit for public units from its current maximum of $250,000/$500,000 per bank would account for inflation since the limit was set in 2008. It would also be justified by the strong growth in total bank deposits in this 16-year period (They grew 240%.) But a key rationale—beyond accounting for inflation or growth in bank deposits—is that it would reduce reliance on collateral to secure public funds. Collateral is a costly and inefficient way to protect state and local government deposits. It discourages some smaller banks from bidding for deposits. It adds costs to local government deposits—costs that mean lower interest rates paid to depositors—and potentially complicates payouts to public agency deposits if a bank were to fail.

The history. The banking crisis stemming from the failure of Silicon Valley Bank in the spring of 2023 spurred calls to reform insurance to increase protections for business accounts and reduce the run risk for uninsured deposits. The $250,000 limit on business accounts is not seen as sufficient to protect transaction accounts for payrolls and other vital operating payments.

In 2023 depositors quickly moved funds from smaller community banks to a few mega institutions that are considered too big to fail. This run temporarily destabilized the financial system leading the Treasury Secretary to invoke a” systemic risk” event to protect all deposits regardless of size.

But systemic risk events are not a preferred move, and the follow-on assessments on all banks to pay for the cost of recovery were unpopular within the banking community.

Congressional hearings led to calls to reform the insurance program, and the FDIC published an options report in May 2023. Among the options, a targeted increase in insurance aimed at better protecting business transaction accounts has gained some attention. But public unit accounts would not benefit from expansion of insurance on business transaction accounts.

The details. The comments we filed urged a parallel targeted expansion option for public units. From the comments:

“For example, we estimate that raising the limit to $2 million for all deposits in an IDI [Insured Depository Institution] or by setting a maximum limit of $5 million per public unit could eliminate the need for collateral for all but the 50 states and the largest local governments. States that administer collateral programs on behalf of their local governments (e.g., California, Florida, New Jersey to name a few) would also experience savings because the need for collateral programs would be greatly diminished. Expanding data collected by the FDIC would help make this analysis more precise.

“A targeted increase in insurance should not be considered an increase in security for public unit accounts. Rather it would shift the security from collateral to insurance. Depositors more easily understand insurance, it is more efficient to administer than collateral, and it is uniform across states. In these respects, it should reduce run risk without inflating moral hazard and, over time if costs are evaluated comprehensively, it should reduce the overall cost of protecting the banking system.”

Reforming insurance would require Congressional action, and depending on the outcome of the 2024 election, there might or might not be an appetite for change. Donald Trump and many Republican members of Congress are obsessed with rolling back regulations, and many in the banking industry argue that it is healthy and well-capitalized so should not be subject to any added regulation. Bank regulators have a different view, but their leadership could change depending on the election outcome.

In the current Congress both parties favored reforming the FDIC, but as with many initiatives in the past two years nothing happened. If banking/FDIC legislation were to move forward in the new year expanding insurance for business accounts and to help community banks retain deposits will gain some traction. In this event public agencies should have a seat on the bus, so they are not left behind.

Bottom line:  If you are interested in filing comments, the deadline is December 6, and they can be filed directly with the FDIC.

The request for Information and filing link is available here.

The FDIC publishes comments here.

The FDIC’s Request for Information has not gotten a lot of attention, but it is a small step forward in what will be at best a tortured path to reforming insurance.