Feature Article: 

Privatizing Deposit Insurance: 

Results of the 2006 FDIC Study 

Foreword 

The Federal Deposit Insurance Corporation (FDIC) was 

required by the Federal Deposit Insurance Reform Conforming Amendments Act of 2005 (FDIRCAA) to 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 local government. In February 2007, the FDIC sent its report to Congress. This article summarizes the FDIC’s findings on the 

first issue: privatizing deposit insurance. Subsequent editions of the FDIC Quarterly will report the FDIC findings on the other two issues. 

Introduction 

Since its inception in 1933, the federal deposit insurance system has promoted financial market stability, 

protecting the economy from the disruptive effects of 

bank failures as well as protecting the deposits of small 

savers. Notwithstanding the successes of the federal 

deposit insurance system, some have argued that a private deposit insurance system would be an improvement. The FDIC explored privatization arguments in 

great depth in 1998 as part of Confidence for the 

Future: An FDIC Symposium. After almost ten years 

and the enactment of the Federal Deposit Insurance 

Reform Act (FDIRA), the FDIC has revisited the privatization debate. This article presents the FDIC’s 

most relevant findings. 

The article begins with a review of the general arguments in favor of privatization. These generally are 

that privatization would diminish moral hazard, reduce 

unwarranted government supervision and regulation of 

depository institutions, and eliminate taxpayer responsibility for losses arising from systemic failure. The article next reviews specific privatization proposals and 

examines the validity of the assumptions underlying 

these proposals. The article concludes with a discussion of other considerations important to the debate 

about private versus public deposit insurance. These 

considerations include the historical record of private 

deposit insurance systems, the sufficiency of private 

capital to underwrite a private deposit insurance system, the cost of deposit insurance in the absence of the 

federal guarantee, and other public policy concerns. 

The FDIC finds that the conclusions reached in 1998 

continue to hold today—namely, that privatization is 

not a remedy for problems arising from deposit insurance. 

Arguments for Privatizing Deposit Insurance 

Privatization proponents generally maintain that the 

costs arising from a government-run deposit insurance 

system are greater than the benefits, that the problems 

associated with a government-run deposit insurance 

system are inherent and insurmountable, and that the 

only solution to the problems is to privatize deposit 

insurance. The various reasons given for this stance, as 

outlined in the next section, are different but overlapping and generally involve concerns about moral hazard, government supervision and regulation, and a 

perception that some institutions are “too big to fail.” 

Concerns about Moral Hazard. In the insurance context, the term “moral hazard” refers to the tendency of 

insured parties to take on more risk than they would if 

they had not been indemnified against losses. The 

argument is that deposit insurance reassures depositors 

that their money is safe and removes the incentive for 

depositors to critically evaluate the condition of their 

bank. With deposit insurance, unsound banks typically 

have little difficulty obtaining funds, and riskier banks 

can obtain funds at costs that are not commensurate 

with their levels of risk. Unless deposit insurance is 

properly priced to reflect risk, banks gain if they take 

on more risk because they need not pay creditors a fair 

FDIC QUARTERLY 23 2007, VOLUME 1, NO. 2 
The Modern Deposit Insurance System 

Although federal deposit insurance was implemented in the United States in 1933, the modern federal 

deposit insurance system has been shaped by legislative changes during the past two decades. In the 

1980s, a crisis in the savings and loan industry culminated in the insolvency of the Federal Savings and 

Loan Insurance Corporation (FSLIC) and taxpayer funding of the FSLIC’s deposit insurance obligations. 

Almost concurrently, a similar crisis in the banking sector—the worst since the 1930s—nearly exhausted 

the resources of the FDIC’s deposit insurance fund. Congress responded to the two crises by reevaluating 

the federal deposit insurance system and enacted a series of reforms. One was the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). Many of FDICIA’s provisions were designed to 

remedy the weaknesses in the deposit insurance system that the recent crises had brought to light. Specifically, FDICIA— 

Required the banking industry to recapitalize the deposit insurance funds, reducing the likelihood the 

public would have to fund deposit insurance obligations in the future. 

Permitted the FDIC to borrow up to $30 billion from the Treasury so that funds would be available to 

close and resolve insolvent institutions quickly. 

Introduced Prompt Corrective Action (PCA), which restricted the activities of banks with low capital 

levels and required timely closure of critically undercapitalized banks. 

Mandated that the FDIC use the least costly solution to resolve bank failures. An exception may be 

made in the case of systemic risk, which requires a recommendation by at least two-thirds of the FDIC 

Board of Directors and the Board of Governors of the Federal Reserve, and an emergency determination by the Secretary of the Treasury in consultation with the President. 

Introduced risk-based deposit insurance premiums so that riskier banks pay higher premiums, thereby 

mitigating moral hazard. 

Recently, Congress again addressed deposit insurance, enacting the Federal Deposit Insurance Reform Act 

of 2005 (FDIRA), which built on the reforms instituted under FDICIA. FDIRA— 

Merged the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) into a 

single Deposit Insurance Fund (DIF). 

Allowed the FDIC to manage the level of the DIF within a certain range. 

Allowed the FDIC to charge risk-based premiums regardless of the level of the reserve ratio. 

Authorized a one-time credit toward future assessments for institutions that replenished the insurance 

funds in the early 1990s and provided for dividends when the reserve ratio reaches certain thresholds. 

Authorized future increases in insurance coverage levels to adjust for inflation and immediately 

increased the insurance coverage limit of retirement accounts to $250,000. 

risk-adjusted return. A truly risk-based assessment discourages such risky behavior.1 The moral hazard problem is particularly acute for insured depository 

1 As discussed below, historically the moral hazard problem created 

by deposit insurance has also been mitigated by banking regulation 

and the supervision of depository institutions. Among the regulatory 

actions that have been used to reduce the risks associated with 

moral hazard are capital standards, examinations, safety-and-soundness regulations, and enforcement actions. 

institutions that are at or near insolvency but are 

allowed to operate freely because any losses are passed 

on to the insurer, whereas profits accrue to the owners. 

Thus problem institutions have an incentive to take 

excessive risks with insured deposits in the hope of 

returning to profitability. 

Concerns about Government Supervision and Regulation. A major concern of some privatization proponents is the degree of government oversight they 

FDIC QUARTERLY 24 2007, VOLUME 1, NO. 2 
Privatizing Deposit Insurance 

consider to be a by-product of government-sponsored 

deposit insurance. They argue that government-sponsored deposit insurance is responsible for intrusive regulations, product restrictions, and social obligations 

that are placed on insured banks and thrifts. They contend that without government-sponsored insurance 

there would be no need to subject banks to intense 

safety-and-soundness regulation and to limit the products they might offer or their business affiliations.2 

They claim that the regulations made necessary by 

deposit insurance not only limit choices and opportunities, they also hinder rapid response to changes in 

the business environment and are expensive. Inasmuch 

as costly regulations are imposed on only one segment 

of the financial industry (depository institutions), 

insured depository institutions are less competitive 

than financial providers that are not so encumbered. 

As described in the next section, many proponents of 

privatization therefore seek to decouple deposit insurance from the “full faith and credit” of the U.S. government, or otherwise reduce a perceived taxpayer risk, 

to remove the justification for federal supervision and 

regulation of the banking industry.3 

Concerns about “Too-Big-to-Fail” (TBTF). Privatization proponents are especially critical of the systemicrisk exception provided in the Federal Deposit 

Insurance Corporation Insurance Corporation 

Improvement Act (FDICIA) because they argue that it 

has the potential to shift the costs for megabank failures to the taxpayer.4 They argue that when Congress 

provided a statutory exception from the least-cost resolution in the case of systemic risk, it acknowledged 

that certain depository institutions were too big to fail. 

Thus, because of size or perceived importance to the 

financial system, large institutions’ uninsured depositors and unsecured creditors are treated differently 

from those of smaller institutions. As long as the fullfaith-and-credit backing of the U.S. Treasury supports 

deposit insurance, they allege that taxpayers inevitably 

will be responsible for any losses resulting from large 

bank failures. 

2 See Bank Administration Institute and McKinsey & Co. (1996) and 

Kovacevich (1996) for their arguments on deposit insurance and bank 

regulation. 

3 See Bank Administration Institute and McKinsey & Co. (1996). 

4 See Bankers Roundtable (1997). 

Proposals for Privatizing Deposit Insurance: 

Commonalities and Differences 

Consistent with concerns about moral hazard, proponents of privatization generally favor market-oriented 

alternatives to federal deposit insurance. One proposal 

would replace publicly provided deposit insurance with 

a system of cross-guarantees under which small groups 

of banks would form syndicates with joint and several 

liability for the deposits of banks that contracted with 

them.5 Another proposal would convert the FDIC into 

a privately owned and operated insurance company, 

reducing the current system’s reliance on regulation 

and guidance.6 A third proposal would transfer ownership and management of the FDIC to the banks and 

would set an explicit limit on the use of deposit insurance in order to encourage market discipline.7 A 

fourth would retain the FDIC as a public entity but 

would reduce its powers.8 

A common theme among these proposals is a rollback 

of bank supervision and regulation. Most seek to 

reduce the regulatory and supervisory powers of bank 

regulatory agencies to allow banks to become competitive, full-service providers of financial products and 

services. One proposal would exempt banks from federal safety-and-soundness regulations and reporting 

requirements, replacing them with private restrictions 

by member banks.9 This proposal would also abolish 

the FDIC and the regulatory and supervisory functions 

of the Federal Reserve Board (FRB), the Office of the 

Comptroller of the Currency (OCC), and the Office of 

Thrift Supervision (OTS). Another proposal would 

recognize well-capitalized, well-managed institutions 

with less extensive regulation, expanded product 

opportunities, and lower regulatory “taxes.”10 

Many proposals are particularly concerned with the 

issue of TBTF. Most proposals would provide deposit 

insurance coverage for small deposits only. All seek to 

protect the taxpayer from responsibility for a systemic 

collapse by preventing the insurer from funding a systemic-risk exception. Most proposals would eliminate 

5 Petri Proposal, introduced by Rep. Thomas E. Petri (R-WI) (U.S. Congress, House [1996]). This proposal was introduced once and was not 

discussed in the subsequent debate on deposit insurance reform. 

6 Bank Administration Institute and McKinsey & Company (1996). 

7 Kovacevich (1996). 

8 Bankers Roundtable (1997). 

9 Petri Proposal (U.S. Congress, House [1996]). 

10 Bank Administration Institute and McKinsey & Co. (1996). 

FDIC QUARTERLY 25 2007, VOLUME 1, NO. 2 
the full-faith-and-credit backing of the insurer as well 

as the insurer’s line of credit with the Treasury. However, one proposal sees the need for a bank-funded backup fund to explicitly protect insured deposits against a 

systemwide collapse.11 

Evaluation of Privatization Claims 

Can Privatization Alleviate the Moral Hazard 

Problem? 

Proponents of privatization generally assume that the 

moral hazard fostered by deposit insurance can be 

eliminated through privatization. In fact, the problem 

of moral hazard is inherent in insurance itself, regardless of management or ownership. The private provision of deposit insurance does not by itself alleviate 

the moral hazard problem. 

Although moral hazard was clearly problematic in the 

savings and loan crisis, subsequent improvements in 

federal banking regulation and supervision have given 

the FDIC better tools to control moral hazard. The 

moral hazard problem created by deposit insurance has 

been mitigated by capital standards, examinations, 

safety-and-soundness regulations, enforcement actions, 

and timely bank closure policies. In particular, Prompt 

Corrective Action (PCA), introduced under FDICIA, 

has been effective in preventing banks with low capital 

levels from taking on excessive risk in an effort to 

return to profitability while the FDIC bears the risk. A 

properly constructed risk-based premium assessment 

system can also address moral hazard, and the FDIRA 

has enhanced the FDIC’s ability to manage the insurance fund and set premiums according to the riskiness 

of the insured entity. 

Would Privatization Release the Banking 

Industry from Unnecessary Regulatory 

Constraints? 

A privately funded and administered system of deposit 

insurance would not free the banking industry from all 

regulation and constraints. Many nations have privately administered deposit insurance systems and all still 

impose systems for bank supervision and regulation. 

Bank supervision predates the federal deposit insurance 

system. Many bank regulations do not flow from the 

FDIC as deposit insurer but instead are imposed by the 

chartering and supervisory authorities, including not 

only the FDIC, but the OCC, the OTS, the FRB, and 

state banking authorities. Much of the regulatory burden on insured institutions flows from statutes and regulations unrelated to deposit insurance. For instance, 

one month after the events of September 11, 2001, the 

USA PATRIOT Act was passed. The USA PATRIOT 

Act amended the Bank Secrecy Act, with which banks 

must comply. Several provisions and implementing 

rules were added to bankers’ compliance obligations. 

Reporting requirements under such laws are unrelated 

to deposit insurance coverage and are unlikely to be 

eliminated if deposit insurance is privatized. 

Public policymakers are unlikely to abandon concern 

for prudent banking practices if deposit insurance 

reverts to the private sector. In 1998, then U.S. Representative James Leach expressed this idea clearly when 

he noted, “Because a sound economy requires a safe 

and sound banking system, public liabilities exist even 

if public funds are not placed in jeopardy by statute.”12 

Even without federal deposit insurance, policymakers 

would remain concerned about implicit public guarantees. These concerns likely would be manifest in government regulation designed to promote the efficient 

operation of the financial system and ensure the protection of taxpayers and individual savers. 

It is more likely that, in addition to continued public 

regulation, a privately owned and profit-seeking 

deposit insurer would demand oversight. At a minimum, any prudently operated for-profit deposit insurer 

would probably require adherence to best practices and 

would insist on access to management and site visits to 

monitor the condition and riskiness of the institution 

it insured. It is unlikely that the private insurer would 

rely on market-generated information alone. Virtually 

all insurance policies—health, life, and liability—contain restrictions and limitations on coverage as well as 

conditions on approval in order to control risk. 

For instance, American Share Insurance Company, a 

private primary and excess deposit insurer to credit 

unions, requires monthly financial reports from its 

members, examines them regularly, and supervises 

them closely. A review of the history of state-spon12 Leach was speaking at the FDIC conference Confidence for the 

11 Petri Proposal (U.S. Congress, House [1996]). Future (FDIC [1998]). 

FDIC QUARTERLY 26 2007, VOLUME 1, NO. 2 
Privatizing Deposit Insurance 

sored deposit insurance plans also reveals that the 

more successful private insurers were extremely vigilant in regulating and supervising member banks. In 

the pre–Civil War Indiana plan, regarded by some as 

the best of the nonfederal deposit insurance plans, 

insured banks were branches of the State Bank of Indiana. Bank examinations were semiannual, and the 

directors of the State Bank had powers that exceeded 

those granted to bank regulators today. The State Bank 

of Indiana also had the authority to dictate whether 

banks in the state expanded or contracted the availability of credit, and on occasion it exercised this 

authority. In contrast (as described below), weak supervision of member banks was considered a major factor 

in the collapse of the Ohio, Maryland, and Rhode 

Island private deposit insurance plans in 1985 and 

1991. It is unclear, therefore, how the change from a 

public to a private deposit insurance system would 

affect the regulatory constraints under which the banking industry operates. 

Would Privatization Protect the Taxpayer from 

Responsibility for Losses from a Systemic Failure? 

Several of the privatization proposals call for eliminating the government’s ability to exercise a systemic risk 

exception to the least-cost resolution requirement in 

FDICIA. They maintain that when Congress provided 

a statutory exception from this requirement in the case 

of systemic risk, it acknowledged that certain depository institutions were too big to fail. They believe that 

uninsured depositors and creditors of large institutions 

may be treated differently than those of smaller institutions.13 

Economic Policy Issue. The possibility of a systemic 

risk determination—which allows government intervention to prevent broader problems—is not simply a 

deposit insurance issue, but rather an economic issue 

that is best evaluated within the context of a wider 

public policy debate. Eliminating the possibility of a 

systemic risk exception would require a government 

commitment to allow banks—and in the broader context, other very large and important businesses—to fail 

even when their failure would jeopardize the stability 

of the U.S. financial system. If the failure of a private 

firm were to threaten the stability of the U.S. economy—whether that firm were a bank, a financial servic13 See, for instance, Kovacevich (1996). 

es company, or a nonfinancial business—it is unrealistic to assume that the government would not intervene in the national interest. History is replete with 

examples of such intervention. 

In the United States, the federal government has provided financial assistance to avoid large corporate 

bankruptcies (for example, Chrysler and Lockheed), 

assisted the banking and financial sectors when they 

were threatened by the less-developed-country debt 

crisis in the 1980s, and provided financial aid to the 

Mexican government—an important trading partner— 

during that country’s financial crisis in 1995. 

More recently, ten days after the terrorist attacks of 

September 11, 2001, Congress passed a $15 billion 

package of direct cash infusion and loan guarantees to 

aid the domestic airline industry. Subsequently, when 

affordable commercial terrorism insurance became 

unavailable, Congress passed temporary legislation that 

established a federal government backstop for 90 percent of insured losses resulting from certain terrorist 

acts up to an annual $100 billion industry-aggregate 

limit.14 (In December 2005 this legislation was modified to reduce the government’s potential liability.) 

Foreign governments have also intervened when their 

financial systems are in distress. In the early 1990s, 

Norway and Sweden stepped in when their banking 

systems came under severe stress. Japan has launched 

several expensive bailouts of its banks in the recent 

past, and the so-called “East Asian Tiger” countries 

(South Korea, Thailand, Indonesia, and others), 

responding to the global currency crisis in the late 

1990s, undertook massive interventions to strengthen 

their financial sectors. In fact, the vast majority of 

industrialized nations in modern history have intervened to save their largest banks as a means of protecting their financial systems.15 

Reduced Potential for a Systemic Situation. Reforms 

enacted in 1991 as part of FDICIA make a potential 

bank failure substantially less likely to pose a systemic 

risk. Certain provisions in FDICIA were designed 

specifically to reduce systemic risk. They include PCA 

(with the establishment of capital requirements), limits on interbank credit exposures, final net settlement 

14 The federal payment is subject to an insurance company 

deductible. An insurer’s deductible is calculated as a percentage of 

the value of direct earned premiums. 

15 Caprio et al. (2005). 

FDIC QUARTERLY 27 2007, VOLUME 1, NO. 2 
authority, and reinforcement of netting provisions for 

interbank payments. Additionally, authority provided 

by FDIRA has enabled the FDIC to make the premium 

structure more risk-focused and discourages moral hazard. Finally, the use of certain failed-bank resolution 

techniques, including the use of bridge banks and 

advance dividend payments to uninsured claimants, 

has mitigated some of the adverse consequences associated with bank failures. Overall, these powers and policies make it less likely that bank regulators and 

policymakers will need to invoke a systemic risk determination under FDICIA. 

Greater Difficulty Making a Systemic Risk Determination. FDICIA also requires that in order to make a 

systemic risk determination and waive the least-cost 

requirement for resolving insolvent institutions, the 

Secretary of the Treasury, in consultation with the 

President, must determine that there would be “serious 

adverse effects on economic conditions or financial 

stability.” Such a decision can be reached only after 

favorable written recommendations from both the 

FDIC Board of Directors and the Board of Governors 

of the Federal Reserve System, with at least two-thirds 

of the members of each board voting in favor of the 

recommendation. FDICIA further requires that the 

Government Accountability Office review any determination under this extraordinary exception.16 These 

requirements ensure that a systemic risk determination 

can be made only after serious discussions at the highest levels of government. 

Funding the Costs of a Systemic Risk 

Determination. FDICIA also affords taxpayers an additional layer of protection in the event of a systemic 

risk determination. The law requires that banks pay a 

special assessment to the FDIC to recoup the amount 

by which the resolution cost exceeds what it would 

have been under the least-cost resolution 

requirement.17 

Systemic Risk and Too Big to Fail Are Not Synonymous. Finally, it is important to emphasize that the 

16 12 U.S.C. § 1823 (c)(4)(G)(iv) (2001). 

17 12 U.S.C. § 1823(d)(4)(G)(ii) (2001). The assessment is proportional to 

each bank’s total assets less the sum of tangible equity and subordinated debt. Larger banks rely more than smaller institutions on nondeposit liabilities for funding. Therefore, the assessment would fall 

more heavily on large institutions (the likely source of systemic problems) than if the assessment were charged only on domestic 

deposits. 

systemic risk exception does not protect large banks 

from failing: large banks can still fail, with stockholders, uninsured depositors, and creditors incurring losses. 

FDICIA permits the FDIC to waive the least-cost resolution requirement only where there is systemic risk, 

which might result in more protection for uninsured 

depositors and unsecured creditors than under a nonsystemic bank failure. However, as mentioned above, 

FDICIA provisions make this scenario less likely. 

Other Considerations: History, Availability, 

Cost, and Public Policy 

Other considerations raise questions about the advisability of replacing public deposit insurance with a private system. One such consideration is the fate of past 

private deposit insurance systems in the United 

States.18 Another is the ability of private capital to 

underwrite a private deposit insurance system. Cost in 

the absence of the federal guarantee and the public 

policy perspective on deposit insurance also are important considerations. 

History and Lessons of Private Deposit Insurance 

in the United States 

The state of New York implemented the first deposit 

insurance plan in the United States in 1829, and 

between then and the Civil War, five other states created programs. In all these programs, the emphasis was 

on protecting holders of banknotes rather than depositors. Three of the insurance plans failed, and the other 

three vanished soon after the establishment of the 

National Banking System. After the panic of 1907, 

eight mostly midwestern states created mutual deposit 

insurance systems. All these plans failed by 1931. After 

the 1930s, at least 30 additional nonfederal insurance 

plans were established to protect the deposits of all 

depository institutions—banks, thrifts, industrial banks 

and industrial loan companies, and credit unions. Most 

of these plans failed or ceased operation during the 

thrift crisis of the 1980s. Others were phased out when 

18 Historically, private deposit insurance systems have acted as primary insurers (playing the FDIC’s current role as insurer) or as excess 

deposit insurers (providing insurance in addition to the FDIC insurance limit). As discussed below, there are no longer any private primary insurers for banks and savings associations in the United 

States. 

FDIC QUARTERLY 28 2007, VOLUME 1, NO. 2 
Privatizing Deposit Insurance 

their sponsoring states decided, after witnessing the 

problems elsewhere, to require federal deposit insurance for all state institutions. Today, no private 

provider of primary deposit insurance to banks and 

savings associations remains. (American Share Insurance Company continues to provide primary and 

excess deposit insurance to credit unions.) 

With a couple of exceptions, these private deposit 

insurance plans were sponsored by state governments, 

though the states did not back the plans financially. 

Almost all the plans were mutual insurance funds, 

though three of the early plans were based on a system 

of mutual guarantees in which banks guaranteed one 

another’s banknotes. One completely privately held 

company began insuring credit union deposits in 1962, 

and several private companies provided reinsurance for 

deposits until they left the business in the mid-1980s. 

Historically, private insurance plans have had to contend with two serious issues: concentration of risk and 

lack of liquidity in the midst of a crisis. Nearly all private insurance plans collapsed because of the failure of 

one or more large insured institutions. In many of 

these cases, insured depositors either were not protected (or were protected only with substantial assistance 

from state taxpayers) or received access to their funds 

only after a prolonged delay. 

One study of the commonalities of failed private 

deposit insurance systems in the United States found 

that these systems typically shared five characteristics: 

(1) free exit from the system; (2) concentration risk 

(the failure of large institutions often brought down 

the entire system); (3) fraudulent acts by regulators, 

banks, and politicians; (4) limited regulatory powers; 

and (5) inaction on the part of insurers and state regulators.19 

Many of the failed systems actually had relatively high 

reserve ratios when their crises occurred. However, 

they were unable to handle the failure of a very large 

member of their system. The system could not ensure 

immediate access to depositor funds (i.e., the system 

was not able to fulfill the liquidity function of an 

insurer), and this lack of liquidity eroded public confidence, which in turn led to runs on other member 

banks, overwhelming the entire system. Typically, 

deposits were frozen, and state governments had to 

19 English (1993). 

step into the breach. Lacking funds to cover the 

insured deposits immediately, the states generally 

repaid them over a period of time, sometimes years. 

In the more recent failures of private insurance systems 

(Ohio and Maryland in 1985, Rhode Island in 1991), 

many insured depositors had to wait months—and in 

the case of Maryland, years—to receive the full return 

of their principal.20 Ohio was forced to commit $151 

million of nontax revenues to support a bond issue to 

fund depositor claims; most Ohio depositors received 

full availability of their funds within six months. Maryland committed state-sponsored bond revenues sufficient to satisfy insured depositor claims over a five-year 

period. Some depositors did not receive their funds in 

full until 1989, four years after failure. Rhode Island 

requested and received a federal loan guarantee of the 

state bonds it issued to satisfy insured depositor claims. 

In the end, Rhode Island covered the losses on its 

own, and depositors eventually received their funds in 

full, although many had to wait at least a year after the 

failure of the state deposit insurance fund. 

As the history of private deposit insurance systems suggests, private insurers have been unsuccessful in fulfilling all three of the responsibilities traditionally 

assumed by federal deposit insurance.21 A private, 

industry-funded deposit insurer not only needs enough 

resources to protect small depositors but also must be 

capable of providing stability to the entire banking system, especially in times of great financial and economic turmoil. Insufficient public confidence in the 

deposit insurance guarantee could render the system 

unable to prevent or stem banking panics. 

There are legitimate questions as to whether any private deposit insurance system could attain or maintain 

the necessary level of confidence in the deposit guarantee to prevent market instability during times of 

financial or economic turmoil. As history has shown, 

the insurance system must have not only the resources 

to handle isolated failures but the ability to handle 

catastrophes. Bank failures often come in waves—with 

one failure building on, and leading to, another. During a crisis, a private insurance fund typically must 

acquire financing from the banking industry through 

20 Todd (1994). 

21 The responsibilities are to promote financial market stability by 

maintaining depositor confidence in the banking system, to protect 

the economy from the disruptive effects of bank failures, and to protect the deposits of small savers. 

FDIC QUARTERLY 29 2007, VOLUME 1, NO. 2 
its line of credit—or from other private sources—at a 

time when the entire industry and perhaps the economy is in financial trouble. This is expensive in the 

short run, and related interest costs can hamper 

attempts to recapitalize the insurance fund for many 

years after the crisis has passed. 

It is doubtful that depositors would continue to have 

confidence in a depleted or weakened insurance fund 

unless the U.S. Treasury stood behind the deposit guarantee. As Milton Friedman notes in his 1963 monetary 

history of the United States, federal deposit insurance— 

has succeeded in achieving what had been a major 

objective of banking reform for at least a century, 

namely, the prevention of banking panics. . . . 

[B]anking panics have occurred only during severe 

contractions and have greatly intensified such contractions, if indeed they have not been the primary 

factor converting what would otherwise have been 

mild contractions into severe ones. That is why we 

regard federal deposit insurance as so important a 

change in our banking structure and as contributing so greatly to monetary stability—in practice far 

more than the establishment of the Federal Reserve 

System.22 

Availability of Private Capital 

Another consideration is whether enough capital is 

available to underwrite private deposit systems. In the 

1990s, in keeping with a provision of FDICIA, the 

FDIC explored the feasibility of establishing a private 

reinsurance system for deposit insurance.23 The resulting Marsh & McLennan study (2001) found that reinsurers had only limited interest in engaging in 

reinsurance agreements with the FDIC on terms 

acceptable to the FDIC. Doubts about the availability 

of sufficient private capital to fund a private deposit 

insurance system were reinforced by events following 

the terrorist attacks of September 11, 2001. As mentioned, subsequent to September 11, the private insurance/reinsurance industry required a government 

risk-sharing arrangement to continue providing commercial terrorism insurance. The small number of pri22 Friedman and Schwartz (1963), 440–42. 

23 FDIC (1993). The study was conducted in three phases beginning in 

1993. The final report (Marsh & McLennan Companies [2001]) was 

completed in December 2001. 

vate insurance firms currently providing excess deposit 

insurance in the United States (as will be described in 

a forthcoming FDIC Quarterly article) also heightens 

concern about the sufficiency of private capital to support a private deposit insurance system. 

Cost in the Absence of the Federal Guarantee 

There is also the issue of cost. The Marsh & McLennan study found that a reinsurance company’s price for 

excess deposit insurance coverage could be expected to 

be higher than if the FDIC were providing the coverage, because reinsurers’ pricing would represent a freemarket charge without government support. 

Federal Reserve Chairman Alan Greenspan testified in 

2002 about the likely cost of deposit insurance in the 

absence of the federal guarantee.24 He stated that realistically, the government subsidy could not be eliminated because, without it, the average premium would 

need to increase to such a high level to insure against 

the improbable case of very large losses that most 

depository institutions would be discouraged from 

offering broad insurance coverage. He made the case 

that in deposit insurance, unlike life or casualty insurance, each insured loss is not independent of others. 

Deposit-run contagion produces a far larger extremeloss tail on the probability distribution and therefore 

requires substantially higher premiums to offset this 

risk. No private deposit insurer would ever be able to 

match the FDIC premium and cover its risks. 

Public Policy Perspective 

An issue that has been infrequently addressed in this 

debate is the difference between the goals of a public 

deposit insurance system and the goals of a privately 

run system.25 These differences are considerable. To 

maintain economic stability, public regulators historically have promoted the entry of newly chartered institutions into banking markets and have encouraged 

vigorous competition among banking organizations. 

Federal deposit insurance is available to all qualifying 

banks, and it is not easily terminated. In contrast, the 

major objective of a private system would be to maximize the profit of its deposit insurance business, not to 

achieve any public policy goal. Under a mutual guar24 Greenspan (2002). 

25 Hanc (1999). 

FDIC QUARTERLY 30 2007, VOLUME 1, NO. 2 
Authors: 

Authors: 

Authors: 

Authors: 

Authors: 

Privatizing Deposit Insurance 

anty system, one might expect members to be interested in minimizing cost, risk, and competition. To 

accomplish this, it would not be surprising if a mutual 

insurance system denied coverage to newly chartered 

or otherwise risky banks, or agreed to insure them only 

at very high rates or for very short-term contracts.26 

Summary 

Privatization may not eliminate moral hazard, as moral 

hazard is an effect of all types of insurance. Recent regulatory and statutory improvements in federal banking 

law have given the FDIC better tools to control moral 

hazard. Significant regulatory burden on banks is unrelated to deposit insurance, and this burden will not 

necessarily end with privatization. It is unclear how 

privatization would shield the taxpayer from responsibility for losses arising from a systemic crisis more completely than does current law. Government 

intervention in a systemic failure—to prevent broader 

problems—is a macroeconomic policy issue, not a 

deposit insurance issue. The powers and policies enacted in FDICIA and FDIRA have reduced the risk of a 

systemic failure as well as made it considerably more 

difficult to make a systemic risk determination and 

pass the associated costs to taxpayers. In fact, if privatization eliminates the special assessment provisions that 

allow the FDIC to recoup losses for a systemic risk 

determination from the banking industry, privatization 

could actually increase taxpayer exposure in a systemic 

crisis. 

26 Ibid. 

The failure of earlier private insurance systems, the 

availability of private capital to replace the federal 

guarantee, the cost of deposit insurance in the absence 

of the federal guarantee, as well as the public policy 

considerations, are other important factors in the privatization debate. A review of the record of private 

deposit insurance systems in the United States reveals 

that insufficient confidence in the private deposit 

insurance guarantee increased the fragility of these systems and rendered them unable to prevent panics. It is 

questionable whether a private insurer could enjoy a 

high degree of public confidence unless the government stood behind the guarantee. Additionally, the 

availability of private capital to underwrite a private 

deposit insurance system is limited—a finding reinforced by insurers’ unwillingness, subsequent to September 2001, to provide terrorism insurance absent a 

government loss-sharing agreement. Overall, the evidence suggests that the costs of private deposit insurance would likely be prohibitively high, and it is 

questionable whether the goals of a private system 

would coincide with public policy goals. 

Authors: Christine Bradley, Senior Policy Analyst, 

Division of Insurance and Research 

cbradley@fdic.gov 

Valentine V. Craig, CFA, Sr. Program Analyst, 

Division of Insurance and Research 

mcraig@fdic.gov 

The authors are indebted to Kenneth D. Jones 

and Daniel A. Nuxoll of the FDIC and Marshall 

Reinsdorf for their extensive earlier work on privatization which served as a basis for this article. 

FDIC QUARTERLY 31 2007, VOLUME 1, NO. 2 
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