Imagine this situation: Your company is mandated by the federal government to purchase $10 million of fire insurance. Only one company--owned and operated by the government-- offers policies. It is pleased to sell you the insurance, with one catch: You must pay for $10 million worth of coverage, but you may collect only $100,000 if one of your plants burns down.
As ridiculous as this may sound, it is the reality faced by corporations insuring their bank deposits. Typically, large companies maintain sizable deposits, often totaling several million dollars in each account for payroll, accounts receivable, and so on. These corporations are then required to reimburse the banks for charges the Federal Deposit Insurance Corp. (FDIC) assesses--charges based on the total in each account. But if a bank should fail and a corporation needs to collect on a multimillion-dollar account, the maximum collectable is $100,000.
In effect, the nation's largest corporations are subsidizing the FDIC's entire Bank Insurance Fund, because their charges are based on balance size, not insured amount. The companies have been protesting this situation for years, but the banks have been unresponsive. FDIC coverage, and the implied credit of the U.S. government behind it, has given the banks a competitive advantage over other financial services organizations. In addition, the FDIC has been in no rush to change its rules.
Recent developments, however, are focusing renewed attention on this unfair practice. For one thing, President Clinton and Congress are moving closer to opening up financial services to greater competition. For another, large banks seem prepared to finally give up the perceived advantage that the phantom FDIC insurance provides--in exchange for federal permission to move into certain nonbank industries. The Bankers Roundtable, which represents 125 large banks, for example, recently argued that the archaic rules are a barrier to alliances with other financial service organizations.
Given these developments, you might expect that the abandonment of the deposit insurance rules would be a done deal. Not exactly. Smaller banks, not surprisingly, continue to see a competitive advantage in the current FDIC coverage. What is surprising, though, is that the FDIC itself is still resisting. The agency, for example, came out against the Bankers Roundtable position as anticonsumerist.
Why is the FDIC being so stubborn? Simply stated, the current system provides ongoing subsidies to consumer accounts. The fact that such subsidies are both unfair and economically regressive seems not to bother the FDIC. This situation is not unlike the situation in Social Security benefits, whereby today's workers subsidize those already retired; or in local telephone regulations, in which high business rates keep an artificial lid on consumer rates.
Fortunately for today's workers, there are alternative retirement benefit options in addition to Social Security. And local phone service is gradually opening up to competition. But with only one player in the bank insurance market, and that one a government agency, increasing competition isn't necessarily the answer. Instead, the FDIC must recognize that the survivors in the brave new world of financial services will be those who don't penalize their best customers.
It wouldn't take anything as radical as forcing the FDIC out of business to accomplish the necessary changes. Rather, deposit insurance could simply be made voluntary. This would help remove the argument that institutions with government deposit insurance must be "protected" from entering risky businesses and thereby exposing taxpayers to a bailout of insured institutions.
Under a voluntary system, corporations would pay for insured deposits only, saving hundreds of millions of dollars annually in payments for insurance not received. There would be other spillover benefits, as well. For example, a voluntary system would effectively do away with cross-subsidies for the FDIC's "too-big-to-fail" policy under which some banks are considered unsinkable.
In today's global market, corporations need not be forced to subsidize their own government's deposit insurance program. In addition, real competition will come to financial services only when banking and government interests abandon their own "pork" projects.