The US "bail-out" bill that passed over the weekend included a measure to extend deposit insurance from $100,000 to $250,000. There are also moves in the UK to extend it from £35,000 to £50,000. In Ireland and Greece they have removed any limit whatsoever. This is sad. It is a very regressive form of government intervention.
Ostensibly, the impetus is not to safeguard the finances of the well off. It is prevent runs on teetering banks. But the effect is essentially to use public money to insure the deposits of the rich. The poor simply do not have so much saved. So it ends up being a subsidy of the rich by the poor. It is not even clear that the various governments can afford it. Ireland, for instance, has guaranteed deposits equal to twice its GDP.
And there is a limit to how effective merely extending the insurance can be? What motivated the run on Northern Rock was fears about having accounts frozen rather than losing deposits. The process in the UK for making a claim against the insurance is somewhat bureaucratic. That is one of the reasons why the rescue of Bradford & Bingley bypassed the process altogether and handed the deposits over to Banco Santander.
In any case, bad banks deserve runs. Even good banks have no right to depositors' confidence. And, in the long term, depositors moving their money to better banks is what the industry needs. It's been a consistent message in this blog that it is not that the banking sector is under-capitalised, but over-invested (although too small a proportion of that investment is equity).
We need to allow banks to fail and if, necessary, to allow depositors to lose some of their funds.
That said, depositors should be first in line to recover money from the bankruptcy. And I think there is an argument for structuring deposit insurance better. The real social purpose of deposit insurance should be to ensure that "ordinary people" are not impoverished by the collapse of banks. But that could be better implemented by providing the insurance to individuals, across all their accounts, even when they are with institutions. This would also remove some of the incentive for moving deposits to new accounts at other banks. At present if I $100,000 with one bank and $100,000 with another I am fully insured; whereas if I have $150,000 at one bank I am not. There is also an argument for providing more insurance to those who are older. Most of us save over the course of lives, and we save for retirement. Therefore, the older we get, the greater need we have for deposit insurance.
With deposit insurance scheme more geared towards protecting individuals, rather than failing banks, there probably is a stronger argument for raising the overall headline figure. But overall, the government would not be insuring that much more (disclaimer: I've done no analysis of the statistics here but the intuition seems sound) because it would not have to insure multiple accounts of one individual in full.
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Being Irish, I will of course step in to defend the govt's actions there...
The UK and the US are very different from Ireland in terms of what can threaten the economy. Ireland has a population of 4.5m, with about 6 banks of any size and a similar number of building societies. That's it.
If either of Bank of Ireland or Allied Irish Banks goes belly-up, the whole country is likely to be screwed. They are vulnerable to the failure of 1 or 2 firms in a way that a larger country is not.
Plus, the agricultural and food sector, about 20% of the GDP, needs yearly loans from the local bank (usually BoI and AIB) as part of their business model. There are numerous small business and sole traders (including farmers) involved here. All of whom will be screwed if financing isn't available.
I can see the inflationary risks, and the flip side, but I can understand why that decision was taken. I can also understand why a larger country wouldn't need to do that.
I'm not convinced. I think the US and UK both have banks that are too big to fail as well.
Business, yes, needs funding. But insuring deposits seems to be a very indirect (and ineffective) way of encouraging banks to actually lend money to anyone.
Admittedly, the deposit insurance scheme I discussed is more geared to individuals than businesses. But businesses aren't being efficient if they have large amounts of cash sitting around anyway.
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