Deposit insurance exists because the governments of many countries, including the United States, need to promote confidence in the banking system. This is done to prevent a panic by individuals that rush to banks to convert their deposits to cash. Problems in the past, such as the banking crisis of 1933 in the United States, are a reminder of whey deposit insurance plays a role in the stabilization of the economies of many countries.
The availability of deposit insurance solves a variety of problems that exist with the state of the economy and the current banking environment. The problems consist of “runs” or a rush or requests for withdrawals for cash, choosing a safe bank and preventing a widespread panic about the availability of a depositors cash in a bank. Deposit insurance exists to keeping the system of banking in any country running smoothly.
Individuals deposit funds in chartered banks knowing that there money is safe because it is guaranteed or insured by the government. In the United States a bank is insured if it is a member of the Federal Deposit Insurance Corporation of FDIC. Individuals that deposit money into banks need to know that there money is available whenever they need access to it. This means that deposit insurance is required when a bank whether large or small fails.
Types of Protection
Protection is provided to bank deposits in a variety of ways which include government appropriations as well as established funds. In the United States the FDIC has a deposit fund that is used as a back stop for deposits in banks that have failed. Fees from banks that are members of the FDIC are used to contribute to the fund to help keep it solvent and capable of insuring deposits. Other countries may need to appropriate funds through government legislation to provide public funds to insure deposits of failed banks.
Insurance for deposits will continue to be provided by many governments but there are alternatives that banks can use to help prevent failures form occurring. One such alternative is market discipline and disclosure of a banks activities to reduce the amount of risk that banks may take to increase their profit margins. Regular disclosure of a banks activities can prevent risky behavior that can lead to a condition where banks become insolvent which require government intervention.
Deposit insurance requires features that are required for the public’s confidence in the banking system and continued stability when banks eventually fail. One such feature is an established framework that has been publicized heavily to the general public. This is a requirement to make sure that benefits of deposit insurance are understood as well as any limitations that might exist. Another feature of deposit insurance is that all banks are participating in a government program for the insurance of all bank deposits.