Feature Article: 

Increasing Deposit Insurance Coverage for 

Municipalities and Other Units of General 

Government: Results of the 2006 FDIC Study 

Foreword 

The Federal Deposit Insurance Reform Conforming 

Amendments Act of 2005 (FDIRCAA) required that the 

Federal Deposit Insurance Corporation (FDIC) study the 

feasibility and consequences of privatizing deposit insurance, establishing a voluntary deposit insurance system for 

deposits in excess of the maximum amount of FDIC insurance, and increasing the limit on deposit insurance coverage 

for municipalities and other units of general government. In 

February 2007, the FDIC sent its report to Congress. The 

results of the FDIC’s findings on privatizing deposit insurance and establishing a voluntary deposit insurance system 

for excess deposits appeared in previous issues of the FDIC 

Quarterly (available at www.fdic.gov/bank/analytical/ 

quarterly/index.html).1 This article summarizes the 

FDIC’s findings on providing additional coverage for 

municipal and other public deposits. 

Introduction 

Industry consolidation, globalization, the expanding 

use of technology, and other changes in the banking 

industry have dramatically altered the financial landscape. Accordingly, in March 2000, the FDIC began a 

comprehensive review of the deposit insurance system 

to ensure that it would continue to meet its responsibilities as deposit insurer in this new banking environment. Additional coverage for municipal deposits was 

one of many issues to emerge during this review, and 

the FDIRCAA required the FDIC to study the issue 

further. This article examines the findings from the 

FDIRCAA study, including the arguments for and 

against additional coverage for municipal deposits. It 

then considers whether options that are currently 

available in the private sector provide a viable alternative to traditional public deposit collateralization programs. 

1 Christine Bradley and Valentine V. Craig, “Privatizing Deposit Insurance: Results of the 2006 FDIC Study,” FDIC Quarterly 1, no. 2 (2007): 

23–32, and Bradley and Craig, “Establishing Voluntary Excess Deposit 

Insurance: Results of the 2006 FDIC Study,” FDIC Quarterly 1, no. 3 

(2007): 30–35. 

Background 

Municipal, or public, deposits are the funds of a state, 

county, municipal, or political subdivision that are 

held as deposits in an FDIC-insured institution.2 

Municipal deposits held in the same state as the public 

entity are insured up to $200,000 ($100,000 in time 

and savings accounts, and $100,000 in demand 

deposits) in any one depository. Out-of-state public 

deposits are insured up to $100,000.3 To limit the risk 

to public entities and, ultimately, local taxpayers, most 

state laws require banks to collateralize public deposits, 

typically with high-quality government securities, to 

the extent that they are not covered by federal deposit 

insurance (see Text Box on page 36.) At the end of 

2006, state and local governments had $2.4 trillion in 

financial assets.4 Of this amount, FDIC-insured commercial banks held $289.7 billion, of which almost 76 

percent ($219.3 billion) was uninsured and secured. 

Throughout the 1990s and into the next decade, 

depository institutions faced new funding challenges as 

asset growth outstripped the growth of core deposits. It 

was against this backdrop that FDIC-insured institutions began to look more closely at municipal deposits 

as a potential source of liquidity.5 Between 2000 and 

2005, several bills were introduced in Congress that 

would have increased coverage of municipal deposits. 

A number of the bills recommended that the FDIC 

insure 80 percent of in-state municipal deposits above 

2 Public deposits also include deposits of Puerto Rico and other U.S. 

possessions and territories, and deposits of Indian tribes. 12 C.F.R. § 

330.15(a)(2)-(5)(2007). 

3 12 C.F.R. §330.15(a)(2) (2007). Insurance coverage for municipal 

deposits, as for general deposits, may be adjusted for inflation beginning January 1, 2011. Federal Deposit Insurance Reform Act of 2005, 

Pub. L. No. 109–171, § 2101–2109, § 2103, 120 Stat. 4, 9–11 (2006) (to be 

codified at 12 U.S.C. § 1821(a)(1)(F)). 

4 Board of Governors of the Federal Reserve System, Flow of Funds 

Accounts of the United States, December 6, 2007, www.federal 

reserve.gov/releases/z1/Current/z1.pdf (accessed January 3, 2008), p. 

66. 

5 Christine M. Bradley and Lynn Shibut, “The Liability Structure of 

FDIC-Insured Institutions: Changes and Implications, FDIC Banking 

Review 18, no. 2 (2006): 1–37. 

FDIC QUARTERLY 32 2008, VOLUME 2, NO. 1 
Increasing Deposit Insurance Coverage for Municipalities 

the basic insurance coverage limit, up to a maximum 

of $2 million. Other legislative measures suggested that 

the maximum coverage for in-state municipal deposits 

be raised to $5 million or that the FDIC provide 100 

percent coverage of all municipal deposits, regardless of 

size. In August 2000, the FDIC evaluated various 

reform options, including additional coverage for 

municipal and other public deposits, but did not take 

an official position.6 In 2003, then FDIC Chairman 

Donald E. Powell commented on one legislative proposal to increase coverage for municipalities: 

Raising the coverage level on public deposits could 

provide banks with more latitude to invest in other 

assets, including loans. Higher coverage levels 

might also help community banks compete for public deposits and reduce administrative costs associated with securing these deposits. On the other 

hand, the collateralization requirement places a 

limit on the ability of riskier institutions to attract 

public funds, while a high deposit insurance limit 

would not. Traditionally, we [the FDIC] have taken 

a dim view of treating one class of deposits—in this 

case, municipals—dramatically differently than the 

others, and we have communicated that concern to 

Capitol Hill.7 

While Chairman Powell expressed reservations about 

raising the limit on municipal deposit insurance, proponents of excess deposit insurance presented a number of reasons for increasing the coverage amount. 

Arguments for Increasing Municipal Deposit 

Coverage 

Early proponents of excess deposit insurance for 

municipalities argued that increased coverage would 

allow municipal deposits to remain in local institutions, where they would be used to meet local needs.8 

In recent years, other arguments have emerged. Propo6 Federal Deposit Insurance Corporation, Options Paper, Washington, 

DC: FDIC, August 2000, www.fdic.gov/deposit/insurance/initiative/ 

OptionPaper.html (accessed January 8, 2008). 7 Federal Deposit Insurance Corporation, Reducing Regulatory Burden—Deposit Insurance Coverage, Washington, DC, FDIC, 2003, 

www.fdic.gov/regulations/resources/reducing/comments/DI.html 

(accessed September 27, 2006). 

8 For example, U.S. Congress, House Report on Federal Deposit Insurance Reform Act to May 16, 2002, 107th Cong., 2nd sess. H. Rep. 467; 

(2002) and U.S. Congress, House Report on Federal Deposit Insurance 

Reform Act to March 27, 2003, 108th Cong., 1st sess. H. Rep. 50 (2003). 

nents contend that increased municipal deposit coverage would make bank operations more efficient and 

less costly, provide a higher degree of safety and additional protection for taxpayers, and permit smaller 

institutions to compete more effectively for these 

deposits. 

Bank Costs. Increasing municipal deposit insurance 

coverage would benefit insured institutions by lowering 

bank costs. State collateralization laws that require 

banks to secure municipal deposits with low-risk, lowyield investments impose opportunity costs by preventing participating institutions from investing in 

higher-yielding assets. It is estimated that collateralization typically costs 15 to 25 basis points in yield on the 

assets used to collateralize the deposits.9 

Safety of Public Deposits. Increasing municipal 

deposit insurance coverage would provide a higher 

degree of safety for public deposits. For collateralization 

to safeguard public deposits, the collateral must be adequate and the security agreement enforceable. In situations involving bank fraud, collateral may be missing 

or otherwise unavailable if an insured institution fails. 

The failure of Oakwood Deposit Bank in February 

2002 illustrates this risk. When the Ohio bank failed, 

some municipal depositors discovered that the collateral securing their deposits was valued at significantly 

less than agreed, while other depositors found that the 

bank had pledged the same collateral multiple times. 

Even if there is no malfeasance, the market value of 

the collateral may have deteriorated at the time of the 

failure. 

Proponents of additional coverage for municipal 

deposits argue that because these deposits primarily 

consist of taxpayer funds, increasing the coverage limits would reduce local government exposure to a bank’s 

credit risk and, ultimately, provide additional protection to taxpayers. 

Competition for Municipal Deposits. Increased insurance coverage for municipal deposits may allow smaller 

institutions to compete more effectively for these 

deposits without having to pay higher interest rates. 

However, recent data suggest that smaller institutions 

are already attracting these deposits. As of December 

31, 2006, FDIC-insured institutions with less than 

9 Steve Cocheo, “You Want $5 Million in Deposits to Be Insured?” 

ABA Banking Journal 95, no.11 (2003): 28–30. 

FDIC QUARTERLY 33 2008, VOLUME 2, NO. 1 
$1 billion in total assets held only 15.2 percent of total 

insured deposits but approximately 24 percent of all 

collateralized public deposits. 

Arguments against Increasing Municipal 

Deposit Coverage 

There are three primary arguments against increasing 

municipal deposit insurance coverage: (1) additional 

coverage is not justified on the basis of the traditional 

goals of deposit insurance; (2) increasing coverage for 

municipal deposits could adversely affect moral hazard 

and market discipline; and (3) excess coverage is likely 

to increase deposit insurance assessments. 

Consistency with Traditional Goals of Deposit Insurance. The traditional goals of deposit insurance are to 

promote financial market stability by maintaining 

depositor confidence in the banking system; to protect 

the country’s local, regional, and national economies 

from the disruptive effects of bank failures; and to protect the deposits of small savers.10 While there are 

credible arguments for increasing the insurance coverage of municipal depositors, the traditional goals for 

the insurance program provide little justification for 

such an increase. In addition, as mentioned earlier, the 

FDIC does not generally advocate favoring one depositor class over another.11 

Effect on Moral Hazard and Market Discipline. 

Greater insurance coverage for public deposits could 

remove an aspect of market discipline that is currently 

in the system.12 State and local governments are gen10 See, for example, Christine M. Bradley, “History of Deposit Insurance,” FDIC Banking Review (13: 2) 2000, pp. 1–25; Gail Otsuka Ayabe, 

“The Brokered Deposit Regulation: A Response to the FDIC’s and 

FHLBB’s Efforts to Limit Deposit Insurance,” UCLA Law Review (33), 

December 1985, pp. 594–641. 

11 Although the FDIC supported increased coverage for retirement 

accounts, it did so for unique reasons. First, increasing the coverage 

level for retirement accounts should help increase the saving rate by 

encouraging depositors to invest more of their retirement savings in 

insured bank deposits. Second, retirement accounts are usually held 

for the long term and depositors are less likely to respond to higheryield offers or other attempts by riskier banks to gather deposits 

quickly. This would not necessarily be the case with insured municipal deposits. 

12 See, for example, Congressional Budget Office, Modifying Federal 

Deposit Insurance, 2005, www.cbo.gov/ftpdocs/63xx/doc6342/ 

05-09-DepositInsurance.pdf (accessed March 5, 2008). 

erally considered more financially sophisticated than 

the average small saver and better able to monitor the 

performance of the depository institutions they use. 

Increasing insurance coverage on public deposits 

removes the incentive for public depositors to monitor 

the risk behavior of their depository institutions, thus 

increasing moral hazard. Also, to the extent that collateral requirements no longer constrain the investment options of depository institutions to investments 

in “safe assets,” such as Treasury securities, depository 

institutions have an incentive to invest in riskier 

assets, increasing their overall risk profile. 

Effect on Deposit Insurance Assessments. FDICinsured deposits would likely increase by at least 

$277.8 billion (the total amount of uninsured, secured 

public deposits held by commercial banks and thrifts as 

of year-end 2007) if all municipal deposits were fully 

insured.13 An increase of this amount at the end of 

December 2007 would have reduced the reserve ratio 

of the Deposit Insurance Fund from 1.22 percent to 

1.15 percent, potentially leading to higher assessment 

rates.14 The financial industry press has reported that 

industry support for additional coverage of municipal 

deposits diminished when it became apparent that 

deposit insurance premiums might increase as a 

result.15 

Structuring Increased Municipal Deposit Insurance 

Congressional authorization would be required for the 

FDIC to provide excess deposit insurance for municipalities and other general units of government. However, the FDIC has considered a number of options for 

structuring this additional coverage, including limiting 

its availability, restricting excess coverage to protect 

taxpayers and the insurance fund, and establishing a 

13 As explained later in this article, excess coverage might be made 

available only on a limited basis, in which case the increase in 

insured deposits might be less. 

14 Under the FDIC Reform Act of 2005, whenever the reserve ratio for 

the Deposit Insurance Fund falls below 1.15 percent (or is projected to 

fall below 1.15 percent within six months), the FDIC must adopt a 

restoration plan that provides that the reserve ratio reach 1.15 percent 

within five years. 12 U.S.C. § 1817(b)(3)(E) (2007). 

15 See, for example, Steve Cocheo, “Community Bankers See Pluses 

and Minuses in FDIC Reform Plan,” ABA Banking Journal 93, no. 6 

(2001): 7–9. 

FDIC QUARTERLY 34 2008, VOLUME 2, NO. 1 
Increasing Deposit Insurance Coverage for Municipalities 

premium pricing structure based on risk.16 Each option 

seeks to limit the FDIC’s loss exposure, constrain moral 

hazard, and restrict the ability of riskier banks to use 

municipal deposits as a source of deposit gathering. 

State legislatures could assist in meeting these goals by 

amending their laws so that excess municipal deposits 

could be placed only in institutions that are eligible to 

receive increased insurance coverage. 

Availability. Excess municipal deposit coverage might 

be made available only on a limited basis. For example, 

term policies could be cancelled if an institution failed 

to maintain the qualifying standards, or only well-capitalized institutions might be eligible to offer increased 

coverage. If a participating institution lost its eligibility 

to offer extra coverage, the insurance coverage of existing municipal deposits could revert to the amount covered under the general deposit insurance rules after 

some period (unless the excess coverage were allowed 

to continue on existing municipal deposits).17 

Although a depository institution could be required to 

be responsible for informing public officials of any loss 

of coverage, this responsibility might be shifted to the 

FDIC to ensure that depositors received prompt and 

adequate notice. 

Caps and Other Limits. A cap could be placed on the 

amount of additional coverage for a municipal depositor. In addition, the municipal depositor might share 

in any loss on the excess deposit. For example, insurance coverage for any municipal depositor could be 

limited to a maximum of $2 million per institution, or 

only 80 percent of the excess deposit might be insured 

up to the designated cap. 

Despite the appeal of a system in which municipal 

depositors share in any losses, such a system has the 

potential to contribute to a bank run in the event of 

financial problems, as recently occurred in the case of 

Northern Rock in the United Kingdom. Under the 

British deposit insurance system, only 90 percent of 

the deposit above a basic level is covered by 

16 Because of the added costs involved, we have assumed in this part 

of the discussion that premiums for excess municipal deposit coverage would be paid only by institutions that offered the additional coverage. However, this need not be the case. Assessments for excess 

deposit insurance could be structured so that all insured institutions 

bore the additional cost. 

17 Pass-through coverage for employee benefit plans and coverage 

for brokered deposits do not terminate when a bank or thrift ceases 

to become eligible to accept them. 12 U.S.C. §§ 1821(d) and 1831f. 

insurance.18 As a result, most depositors stood to lose 

money if Northern Rock failed, which contributed to a 

run on the bank when it experienced financial difficulties.19 Because deposits made by municipalities are typically quite sizable, public withdrawals during a period 

of financial difficulty would likely exacerbate a bank’s 

liquidity problems. The prevention of bank runs has 

been one of the great successes of the U.S. deposit 

insurance system, and any change that might diminish 

the ability of this system to contain bank runs would 

need to be carefully considered. 

Other limits could be imposed on additional insurance 

coverage for municipal deposits. For example, to control aggressive deposit gathering and consistent with 

some state requirements, increased insurance coverage 

could be limited to deposits from a municipality in the 

same state as the insured institution. Limits could also 

be placed on the aggregate value of the public deposits 

held by any one institution. 

Pricing. A decision would need to be made as to 

whether all participating institutions would pay a uniform premium. One option might be to reduce the premiums of participating institutions based on the 

amount of low-risk assets held, but not pledged, as 

security. Another possibility would be to deduct lowrisk assets from the total value of the municipal 

deposits assessed, which might reduce some of the 

administrative costs associated with a strict pledging 

arrangement. 

Private Sector Options 

There are public sector options currently available that 

allow depository institutions to satisfy the safety 

requirements of many municipal authorities without 

requiring collateralization or increased FDIC coverage. 

These options include surety bonds and deposit-placement services. (Reinsurance, which was discussed in a 

previous issue of the FDIC Quarterly, is a private sector 

option that could be used to limit the FDIC’s exposure 

18 Under the British deposit insurance system, approximately the first 

$4,000 is fully insured, and 90 percent of the next $68,000 receives 

insurance coverage. Unlike the U.S. system, deposits held at failed 

British banks are not immediately available. 

19 In the case of Northern Rock, the Bank of England and the British 

Treasury provided depositors with greater assurances than required 

under the law. 

FDIC QUARTERLY 35 2008, VOLUME 2, NO. 1 
Current Practices in Supervising and Administering Collateral 

All states currently require one of three options for the supervision and administration of collateral: uniform 

statewide collateralization; statewide collateral pools; or uncoordinated, autonomous collateral pledging.* 

Uniform Statewide Collateralization. This model prescribes a single system of collateralization for all political subdivisions throughout the state. States that use a uniform statewide system commonly require that public deposits be fully collateralized. Local officials are typically responsible for enforcement and implementation 

of the collateral requirements under this system. Banks bear the full expense of establishing the custodial 

account and forgo the higher income they would normally earn by making loans. 

Although full collateralization of public funds would appear to completely protect municipal deposits, a number of risks remain. For example, the market value of the collateral pledged by the bank may turn out to be 

less than the face value, making the protection inadequate. This can occur when the collateral accepted by 

the government entity is subject to interest rate risk, credit risk, or liquidity risk. One example is municipal 

bonds. These bonds, which are accepted as collateral in several states, are interest-rate sensitive and contain 

liquidity risk because they have a limited secondary market. A shallow secondary market can also delay recovery for the depositor. For example, mortgage-backed securities, which are accepted as collateral in some states, 

have recently lost market value because of their perceived credit risk. Finally, fraud can result in unexpected 

losses to the collateralized depositor. (Fraud is a potential risk in any of the three collateralization options.) 

Statewide Collateral Pools. Some state legislatures have created statewide collateral pools. These pools are 

supervised by a central state agency that administers all collateral set aside by banks as security for the portion 

of the municipal deposits not covered by FDIC deposit insurance. For example, Florida requires that banks 

deposit with the state central agency acceptable securities equal to 50 percent of the deposit not covered by 

FDIC insurance. Statewide collateral pools reduce the costs to individual depository institutions in two ways. 

First, banks save the cost of individually supervising and administering the assets used as collateral. Second, 

because full collateralization is not required, a greater portion of an institution’s assets can be invested in 

higher-yielding assets, such as loans. Local governments and agencies also save with this method, as a central 

agency manages the administration of the collateral. States typically require the collateral pool to exceed the 

total public deposits held by the largest institution in the state. 

Uncoordinated, Autonomous Collateral Pledging. Some states permit public treasurers to obtain collateral 

for public funds at the treasurer’s discretion. This method, called the “home rule” or permissive approach, 

places complete responsibility for collateralization practices with local officials. However, because of the lack 

of uniformity in collateralization agreements, each agreement must be separately negotiated by the depository 

institution and the public official. This lack of standardization results in an increased risk of error or negligence in market-monitoring processes and safekeeping procedures, as well as an increased cost to the depository institution. This increased cost is usually passed on to the municipality through deposits bearing a lower 

yield. 

* Much of the information about the supervision and administration of collateral is derived from Corinne M. Larson, An Introduction to 

Collateralizing Public Deposits, Government Finance Officers Association, 2006. 

FDIC QUARTERLY 36 2008, VOLUME 2, NO. 1 
Authors: 

Increasing Deposit Insurance Coverage for Municipalities 

to excess coverage of municipal deposits.20 Reinsurance is not discussed further in this article.) 

Surety Bonds. Most states allow municipal governments to protect their local deposits by means other 

than collateralization. At least 30 states allow the use 

of a surety bond. Surety bonds, which are issued by 

insurance companies, guarantee the payment of principal and interest on the covered deposits. Most states 

provide guidelines for insurance company eligibility. 

Surety bonds eliminate much of the administrative 

burden for both the municipality and the bank because 

they do not require custodial agreements, security 

agreements, or a continual revaluation of the collateral. In the event of a default, payment on the bond is 

generally made within two days. From the bank’s perspective, these bonds are more economical and efficient because they do not tie up bank security, thus 

saving the bank administrative and opportunity costs 

normally associated with collateralization. 

Despite their advantages, some public officials are wary 

of using surety bonds because the municipality must 

relinquish some control. For example, the municipality 

is not part of the contract negotiation, which is 

between the bank and the insurance company. Nevertheless, if proper precautions are taken, surety bonds 

can be a reasonable and efficient alternative to collateralization. 

Deposit-Placement Services. As discussed in a previous issue of the FDIC Quarterly, the FDIC issued an 

advisory opinion in 2003 confirming that pass-through 

deposit insurance rules apply to funds placed with a 

deposit-placement service. As a result, FDIC-insured 

institutions that use deposit-placement services can, in 

effect, insure deposits in excess of the statutory limit.21 

20 Bradley and Craig, “Establishing Voluntary Excess Deposit Insurance.” 

21 Ibid. A bank belonging to a deposit-placement service can divide 

large deposits into $100,000 increments, which it transfers to other 

participating institutions, resulting in full coverage of the deposit. 

Currently, a depositor can obtain insurance coverage 

for a $50 million deposit by using a deposit-placement 

service. These services can reduce the administrative 

costs of collateralization. They also reduce the opportunity costs incurred when the bank sets aside collateral necessary to secure municipal deposits. 

Because most state laws clearly describe how public 

deposits must be secured, use of a deposit-placement 

service may require state legislative action. However, 

some states (for example, Missouri, Ohio, and Oregon) 

have amended existing laws to permit their use. Other 

states are allowing local governments to use depositplacement services with certain restrictions, such as 

requiring municipal deposits to be kept within the 

state or placing a limit on the amount of the deposit. 

Summary 

Increased federal coverage for public deposits could 

benefit local communities, lower bank costs, and 

increase safety for taxpayers. However, additional 

municipal deposit insurance would represent a departure from the traditional goals of deposit insurance and 

would likely increase both moral hazard and deposit 

insurance assessments. Credible private sector options, 

in the form of surety bonds and deposit-placement 

services, currently offer protection for municipal 

deposits. If federal deposit insurance coverage were to 

be increased on municipal deposits, concerns about 

increased exposure to the Deposit Insurance Fund, 

moral hazard, and appropriate pricing of such coverage 

would need to be addressed. 

Authors: Christine M. Bradley 

Sr. Policy Analyst, cbradley@fdic.gov 

Valentine V. Craig, CFA, 

Sr. Program Analyst, mcraig@fdic.gov 

FDIC QUARTERLY 37 2008, VOLUME 2, NO. 1 
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States, March 9. Federal Reserve Statistical Release. www.federalreserve.gov/RELEASES/ 

z1/20060309/z1.pdf (accessed January 10, 2007). 

Bradley, Christine M. 2000. History of Deposit Insurance Coverage. FDIC Banking Review 13 

(2):1–25. 

Bradley, Christine, and Valentine V. Craig. 2007. Privatizing Deposit Insurance: Results of the 2006 

FDIC Study. FDIC Quarterly 1 (2):23–32. 

_____. 2007. Establishing Voluntary Excess Deposit Insurance: Results of the 2006 Study. FDIC 

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Bradley, Christine and Lynn Shibut. 2006. The Liability Structure of FDIC-Insured Institutions: 

Changes and Implications. FDIC Banking Review, 18 (2):1–37. 

Cocheo, Steve. 2001. Community Bankers See Pluses and Minuses in FDIC Reform Plan. ABA 

Banking Journal 93 (6):7–9. 

———. 2003. You Want $5 Million in Deposits to Be Insured? ABA Banking Journal 95 (11):28–30. 

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FDIC QUARTERLY 38 2008, VOLUME 2, NO. 1