The Insurance of Bank Deposits

EIGHT times the insurance of bank deposits has been tried in the states and failed. Now the national government is making a trial. What shall we think of it?

It is charged that the plan set up in the Banking Act of 1933 is unreasonable and unjust, unreasonably demanded by the depositing public and unjustly exacting of the insured banks; that it puts a premium on bad banking and will result in the closing of many banks.

The plan, omitting the provisions for temporary insurance during the six months preceding July 1, 1934, when the permanent insurance goes into effect, is this. The Federal Deposit Insurance Corporation is set up under the management of the Comptroller of the Currency and two others appointed by the President. For capital stock the Federal Government subscribes $150,000,000, the Federal Reserve banks an amount ($139,300,000) equal to half of their surplus, the insured banks an amount (estimated at $175,000,000) equal to ½ per cent of their deposits. The insured banks must pay in additionally from time to time whatever may be needed to cover insurance liability.

The institutions whose deposits are covered by the insurance are the national banks, the state bank members of the Federal Reserve System, and, until July 1, 1936, other state banks found on examination to be solvent. The deposits are covered fully up to $10,000, and thereafter 75 per cent up to $50,000 and 50 per cent beyond.

Is this plan unreasonable? Is the depositing public unreasonable in demanding the protection? Why should depositors be protected by governmental instrumentality any more than purchasers of merchandise?

Something might be said for setting up and operating banks with as much freedom as that with which stores are set up and operated. Such a policy would at least tend to develop caution and self-reliance in the depositing public and would give to character and skill in banking their full reward. But the fact is that the other policy has been followed, and will of course continue to be followed in these days of disappearing laissez faire. Government has assumed control of the whole process of deposit banking. Even the word ‘bank’ may not be used without permission. Only those whom government has approved may have a charter to engage in the business. The charter when granted is subject to multiplied limitations and regulations. Government reserves the right and assumes the duty to examine the bank periodically, to supervise it generally, and, when unsoundness develops, to close its doors. Under these circumstances may not ordinary people, those apart from the few able to discriminate for themselves, reasonably assume that the bank whose doors government permits to remain open is sound? If so, is not the demand reasonable that government shall set up some instrumentality for making good this assumption?

Is the plan unjustly exacting of the insured banks? Is it just for the wellmanaged bank to have to contribute to meet losses which would otherwise fall on depositors in the mismanaged bank? Clearly it is not; but is not the injustice of the kind that is unavoidably present in any organization of society? It is unjust that those who are law-abiding should be burdened by taxes for protection against those who are lawbreaking. It is more unjust that the strong who could protect themselves against lawbreaking should be taxed for the benefit of the weak who cannot protect themselves. To be sure, it may be said that by the analogy the cost of protecting depositors should come from the general tax fund. Perhaps the answer is that, $150,000,000 having been taken initially from the general tax fund, the taking of the remainder from the insured banks, directly or through the reserve banks which they own, is justified by the fact that even the well-managed banks will gain something in the increased confidence of their depositors, and by the fact that the banks, on account of their contributions, will watch more critically the administration of the insurance.

Will not the plan for the insurance of deposits, by penalizing good banks for the benefit of depositors in bad banks, tend to stimulate bad banking and thus to impair our banking structure? There is something in the charge, but not as much as might be thought. The tendency doubtless will be toward increased deposits in weaker banks and in those unworthily managed. Moreover, the worthy banker, relieved partially from anxiety about runs, will tend to maintain less liquidity. But, after all, the worthy banker’s advantage, the legitimate advantage of every banker, will continue to depend on the maintenance, in self-interest, of his invested capital unimpaired by losses. It is the depositor, not the banker, who is insured. There is, then, likely to be only slight, if any, effect from insurance on the conduct of the worthy banker’s business except in the matter of liquidity, and somewhat less liquidity will be justified by the insurance. As to the unworthy banker who seeks his advantage in speculation with his depositors’ money rather than in legitimate earnings on unimpaired invested capital, it must be admitted that there is a hazard in the insurance plan which can be met only by increased stringency in governmental supervision.

Finally, it is charged that the plan will result in closing many of the excluded state banks, which will be at a disadvantage with the public in that their deposits are not insured. Against this it is recalled that all state banks, not members of the Federal Reserve System, are admissible to the insurance until July 1, 1936, if found solvent on examination. ‘Solvent’ has been interpreted by the chairman of the board of directors of the Insurance Corporation as meaning, in this connection, ability ultimately, not immediately, to pay all deposits. The test, in other words, is to be solvency, not liquidity. Shall we not, then, say of the charge now considered, that keeping all banks open, good or bad, is no virtue, and that banks, state or national, which cannot stand the test of solvency had better be closed?

Thus far it appears that the demand for the insurance of deposits is not unreasonable, and, assuming effective governmental supervision of the insured banks, that the injustice involved is not intolerable or the premium on bad banking considerable, and, finally, that the closing of banks inadmissible to insurance because of insolvency is not undesirable.

But in the assumption just made lies a serious question. Can effective governmental supervision be expected? Success for the insurance plan will depend largely on the rigor with which the insured banks are held up to standard. There is the crux of the whole matter, for if the banks are not held up to standard the burden of contributions to the insurance fund may become intolerable and the national experiment may follow the state experiments into collapse. That this rigorous governmental supervision can be expected is, it must be admitted, at least doubtful in view of the failure of supervision to prevent the closing of a third of our banks in recent years. This doubt suggests that by way of penalty, as it were, for the failure of government to do its part, it might be fair to provide for the replenishment of the insurance fund equally by the Federal Government and the insured banks, or, perhaps preferably, by the banks up to, say, ¼ per cent of their deposits in any year and thereafter by the government. Thus, certainly by the second suggestion, would be met a cogent objection to the plan of the Act — namely, that it lays on the banks an unlimited and unpredictable liability. This objection, if not met, may indeed interfere with the attraction of capital to the banking business and possibly induce the withdrawal of strong banks from the Federal Reserve System.

But withal, even though the Act be not so amended, doubt about the effectiveness of governmental supervision had probably better not lead us to advocate repeal, had better not hold us back from this ninth experiment, since it has a purpose so worthy as the socializing of losses which would otherwise fall on blameless and helpless people.