Deposit Insurance

What Is Deposit Insurance?

Deposit insurance is a government guarantee that protects money held in bank accounts up to a specified limit, so that depositors do not lose their savings if a bank fails. By assuring savers their funds are safe, it removes the incentive to rush to withdraw money at the first sign of trouble, which is what makes bank runs so destructive. In the United States, the Federal Deposit Insurance Corporation (FDIC) was created in 1933 to insure bank deposits after roughly one-third of banks failed during the Great Depression. The standard coverage limit was raised from $100,000 to $250,000 per depositor in October 2008.

Why It Matters

Deposit insurance matters because it is one of the most effective tools ever devised for preventing banking panics. After the FDIC began operating, the classic bank runs that had plagued the early 1930s largely disappeared from American life for decades. Yet insurance also carries a cost: by protecting depositors regardless of how their bank behaves, it can encourage risk-taking, a form of moral hazard that was on display in the savings and loan crisis, where insured thrifts made reckless bets. Raising the FDIC limit during the 2008 crisis was itself a confidence measure, showing how deposit insurance remains a frontline defense against panic.

Test Your Knowledge

Questions on this topic from the EconRecall fact bank:

• What federal agency, created in 1933, insures bank deposits to help prevent bank runs?
  The Federal Deposit Insurance Corporation (FDIC)
• In October 2008, the FDIC raised its standard deposit insurance coverage limit per depositor from $100,000 to what amount?
  $250,000
• What federal agency, which had insured savings and loan deposits, became insolvent and was formally abolished in 1989?
  The Federal Savings and Loan Insurance Corporation (FSLIC)