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Economists' Recommendation to FDIC: Increase, Index and Simplify Coverage

MAY 4, 2001



The FDIC this week released a report from two outside economists that recommended increasing substantially the deposit insurance coverage level, indexing it to income or wealth levels, and simplifying existing rules so that the limit applies per institution, per person, without separate coverage for joint accounts, trust accounts, etc.

Former Federal Reserve Vice Chairman Alan Blinder, currently an economics professor at Princeton and a managing partner with Promontory Financial Group, and Robert Wescott, former special assistant to President Clinton for international economics and finance, also endorsed refined risk-based premiums, a soft target reserve ratio so premiums remain steadier, rebates based on premiums paid in the past and a merger of the BIF and SAIF-recommendations also included in the FDIC's own report on deposit insurance reform.

On coverage levels, Blinder and Wescott argue that small depositors should not be asked to take on the task of appraising and monitoring the riskiness of their banks. And they suggest that the dividing line between small and large depositors can be rationalized at several times $100,000 in light of the gains in wealth in recent years. But in the interests of conservatism, they recommend a prudent first step of increasing coverage to $125,000 or $150,000.

As for indexing, they believe indexing only for inflation is too narrow and that indexing to mean or median wealth (which has grown faster than inflation) is more appropriate. They recommend setting an appropriate coverage level, and then indexing it for changes in wealth going forward. Like the FDIC, they suggest indexing coverage only every several years and only in round numbers, such as $25,000, to avoid customer confusion about the coverage level.

Separate insurance coverage for each right and capacity in which an individual holds an account (multiple account coverage) makes a "mockery" of the $100,000 limit, the report states. Simplicity is a virtue in its own right, the economists argue. "Intelligible and straightforward laws and regulations are likely to elicit greater public understanding, respect and compliance than obscure, labyrinthine ones," the report states.

Blinder and Wescott also imply that coverage levels are linked to other aspects of deposit insurance reform. "While the banks are anxious to increase [coverage] substantially, many economists seem to oppose the idea-as does the U.S. Treasury," the report states. "Frankly, we are a bit baffled by the strength of this opposition. It is presumably based on fear of moral hazard. . . . But if the deposit insurance premiums were set to reflect expected losses, as we have recommended, most objections based on moral hazard and/or unwarranted subsidies should evaporate."

The full report is posted on the FDIC's Web site, www.fdic.gov.