The encyclopedia · Finance & Accounting · Financial decision · 2006–2007
FDIC tied deposit-insurance premiums to bank risk, ending the free ride
After 2006 reform, safer banks pay 5–7 cents per $100 of deposits while riskier ones pay more, so banks no longer subsidise each other's risk.
Federal Deposit Insurance Corporation · U.S. insured banks
the move
For years the deposit insurance fund was so well capitalised that most banks paid nothing for coverage, and the old risk schedule was blunt. The 2006 Deposit Insurance Reform gave the FDIC a mandate to charge risk-based premiums.
The FDIC evaluates each bank's risk from supervisory ratings, financial ratios and, for large institutions, long-term debt ratings. Rates for well-capitalised, well-run banks run five to seven cents per $100 of deposits; riskier institutions pay more.
Chair Sheila Bair said the ability to differentiate by risk improves incentives for effective risk management and reduces the extent to which safer banks subsidise riskier ones. The new rates showed up on invoices from June 2007, with about 40% of institutions starting at the minimum rate.
why it works
- Risk-based rates make the cost of risky behaviour visible to the bank itself.
- Supervisory ratings are already audited, so the pricing uses trusted data.
- Differentiation removed the cross-subsidy from safe to risky banks.
- A reserve-fund target kept the system countercyclical: fund built up in good times.
what transfers
Insurance works better when the premium tracks the insured's own risk: pricing the externality per firm improves incentives and stops the safe from quietly paying for the reckless.
what came after
Risk-based pricing became a permanent feature of US deposit insurance and was further refined after the 2008 crisis, with larger banks subject to additional assessments. It is now the standard argument for pricing any government guarantee by the risk of the guaranteed party.
references
- FDIC Approves New Risk-Based Premiums for Deposit Insurance
- Remarks before the California Bank Presidents Seminar (Deposit Insurance Reform)
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