2023 Options for Deposit Insurance Reform | 25 

Section 4: Objectives and Possible 

Consequences of Deposit Insurance 

Since the creation of the FDIC in 1933, more than 140 

national jurisdictions have adopted deposit insurance 

systems.74 Financial stability and depositor protection 

are the two leading public policy objectives of deposit 

insurance. However, deposit insurance can also 

change bank behaviors and lead to market distortions. 

This section reviews the objectives of deposit 

insurance and its consequences in the context of U.S. 

institutions and the regulatory framework. It highlights 

the important tools, discussed in Section 5, that may 

be used along with changes to deposit insurance 

coverage to meet policy objectives while minimizing 

undesired consequences. 

Objectives 

In addition to financial stability and depositor 

protection, deposit insurance objectives may 

include providing consistency and transparency and 

minimizing disruptions from bank resolution. This 

subsection discusses each objective, which informs 

the comparison of reform options discussed in 

Section 6. 

Financial Stability 

Improving financial stability by preventing bank 

runs is a primary objective of deposit insurance. 

Fundamentally, banks are susceptible to runs because 

they raise funding by issuing liquid deposits, usually 

available immediately upon demand, to invest in 

illiquid (or less-liquid) long-term assets such as 

loans.75 Long-term assets generally pay banks a higher 

interest rate than deposits cost the bank, so banks will 

generally be solvent and profitable if they can hold 

the loans to maturity.76 If, however, many depositors 

simultaneously demand the return of their deposits 

from a bank and it exhausts its supply of liquid 

assets (the supply of which is typically rather limited 

compared with the volume of deposit liabilities), 

the bank will be forced to sell its illiquid and longterm assets before they mature to meet depositor 

withdrawals. In selling its long-term assets, especially 

in a short timeframe, the bank must accept prices 

for the assets that may be lower than their intrinsic 

value—that is, the bank takes a loss on the sale. If the 

bank sells enough assets at a loss, losses exceed the 

bank’s cushion of equity capital and the bank becomes 

insolvent and unable to meet its financial obligations 

to remaining depositors. Depositors might withdraw 

their deposits collectively (i.e., run on the bank) 

because they fear that the bank might be insolvent,77 

but they might also run even on a bank they know is 

solvent simply because they believe other depositors 

will do the same.78 Because banks serve depositors 

in the order that they arrive,79 the first depositor to 

run on a solvent bank can withdraw their full deposit 

amount. As the bank sells more assets at a loss and 

becomes insolvent, depositors who are later to run are 

unable to obtain their full deposit amount. Thus, once 

a run starts, all depositors want to be as close to the 

front of the line as possible—the collective expectation 

of a run becomes self-fulfilling, and the bank fails.80 

Bank failures, especially failures of otherwise solvent 

banks caused by runs, impose significant costs on 

the financial system and the economy. First and most 

74 IADI, “Deposit Insurance Systems Worldwide,” 2023, https://www.iadi.org/en/about-iadi/deposit-insurance-systems/dis-worldwide/. 

75The reason banks are structured in this way has been the subject of significant academic debate, but a typical explanation is that by pooling the idiosyncratic 

(or, largely uncorrelated) liquidity needs of many depositors, a bank can provide the needed liquidity for all its depositors without holding as many liquid assets 

as the depositors would need to hold if they were to provide for their own liquidity individually. By reducing the amount of funding that needs to be held in a 

liquid form, the bank frees funds to be invested in productive but less liquid loans and projects. These illiquid projects, in turn, provide for economic growth 

and opportunity. Without banks, many of society’s resources would be tied up to provide liquidity, and economic well-being would be lower. See Diamond and 

Dybvig (1983) for more on this explanation. Alternative explanations are offered by, among others, Fama (1985), Calomiris and Kahn (1991), Diamond and Rajan 

(2011), and Kashyap, Rajan, and Stein (2002). 

76 For the purposes of this argument, we abstract from the possibility of unexpected asset losses, bank mismanagement, or other reasons besides depositor runs 

that might cause banks to become insolvent or fail. 

77 For more on informationally driven or fundamentals-based bank runs, see, for example, Gorton (1988), Jacklin and Bhattacharya (1988), Calomiris and Gorton 

(1991), and Goldstein and Pauzner (2005). 

78See Diamond and Dybvig (1983) for a theoretical explanation of this behavior. 

79This “first come, first served” type of behavior is sometimes referred to as a “sequential service constraint.” 

80See Murton (1989) for a more detailed presentation of this argument. 
26 | 2023 Options for Deposit Insurance Reform 

 

simply, bank runs, and the associated panic, can be 

contagious among depositors of different banks for 

purely behavioral and psychological reasons: a run 

on one bank can spread to others. Second, one bank’s 

funding stress can be transmitted to other banks 

through various asset prices. Distressed banks might 

raise their deposit rates to attract or retain funding, 

increasing the equilibrium rate in the market that all 

other banks must pay or attracting funds from other 

banks.81 Alternatively, banks facing deposit outflows 

may engage in asset fire sales to fund withdrawals, 

depressing market prices for those assets and 

impairing the liquidity and solvency of other financial 

institutions holding similar assets.82 Bank runs and 

bank failures also have real economic costs, especially 

arising from a loss of credit intermediation by the 

banks. Banks form relationships with, and learn 

about, borrowers in their communities, and they 

fund productive projects by these borrowers using 

money obtained from deposits. When deposits flee or 

banks fail, this credit intermediation is disrupted and 

productive projects might go unfunded, depressing 

economic activity.83 If other banks are concerned 

they might face a run, they may also forgo lending to 

profitable projects to retain liquidity for precautionary 

reasons, further limiting credit intermediation. 

Beyond general effects on the financial system or 

economy, bank failures can be painful for individual 

uninsured depositors or other creditors of failed 

banks, and for entities exposed indirectly to the 

bank. Counterparties to banks include individuals 

and households that invest their savings or maintain 

liquid funds to pay their mortgages or bills. Without 

access to their deposits, uninsured depositors may 

lack the money to make payments and access to the 

payment system to transmit their money to those with 

whom they do business. Given the $250,000 limit, the 

proportion of households unable to pay bills due to 

losses on uninsured deposits is likely to be exceptionally 

small and includes only the wealthiest households. 

As the recent bank failures showed, losses to 

uninsured deposits held in business payment accounts 

present an important concern. Payment accounts are 

critical to businesses’ ability to pay expenses and their 

employees. Because many firms’ cash flow needs are 

high, these payment accounts by necessity are often 

large and uninsured at the current deposit insurance 

limit. Thus, a disorderly bank failure can result in 

missed payments on trade credit and lost labor 

income for employees who have no direct exposure to 

the failed bank or ability to protect themselves from 

the risk of the bank.84 Losses on uninsured business 

accounts from bank runs can contribute to lost wages, 

business closures, and job losses. 

Deposit insurance removes depositor incentives to run 

on their bank, thereby preventing runs and avoiding 

the numerous costs associated with them. Depositors 

know that their insured funds are safe because the 

FDIC and the DIF, especially in combination with the 

full faith and credit guarantee of the U.S. government, 

are credible backstops for deposits. Depositors can be 

confident that if their bank fails, they will have access 

to their insured deposits without interruption. As a 

result, insured depositors have little incentive to run 

on their bank, even if they expect other depositors to 

do so or if they believe their bank to be insolvent. 

Empirically, deposit insurance is highly effective 

at preventing runs. At a high level, the rarity of 

bank runs in the United States, especially runs by 

insured depositors, since the creation of the FDIC is 

clear evidence of the stabilizing benefits of deposit 

insurance. At the level of individual depositor 

behavior, analysis on data from both the United 

States and abroad provides consistent evidence on 

the effectiveness of deposit insurance in stabilizing 

insured deposit funding.85 Banks facing funding stress 

originating from uninsured depositors and other 

creditors may be able to address this funding stress by 

increasing deposit interest rates to attract additional 

81 For example, see Egan, Hortaçsu, and Matvos (2017). 

82There exists a rich literature on asset fire sales, including Diamond and Rajan (2011), Shleifer and Vishny (2011), Tirole (2011), Brunnermeier (2009), and Allen 

and Gale (1994). 

83 For example, see Bernanke (1983). 

84See, for example, “Remarks by President Biden on Maintaining a Resilient Banking System and Protecting Our Historic Economic Recovery,” March 13, 2023, 

https://www.whitehouse.gov/briefing-room/speeches-remarks/2023/03/13/remarks-by-president-biden-on-maintaining-a-resilient-banking-system-andprotecting-our-historic-economic-recovery/. 

85Martin, Puri, and Ufier (Forthcoming) and Davenport and McDill (2006) provide evidence from the United States that FDIC insurance stabilizes insured deposits 

at the level of individual deposit accounts, especially in the face of financial market stress or when depositors have reason to question the solvency of their bank. 

Brown, Guin, and Morkoetter (2020), Iyer, Jensen, Johanessen, and Sheridan (2019), Iyer, Puri, and Ryan (2016), and Iyer and Puri (2012) provide complementary 

evidence from foreign countries, specifically Switzerland, Denmark, and India. 
2023 Options for Deposit Insurance Reform | 27 

 

insured funding.86 Generally, a higher share of insured 

deposits in bank funding structures makes banks 

individually—and the banking system as a whole—less 

susceptible to runs.87 

Depositor Protection 

Protecting small depositors, who constitute most 

deposit accounts, has been an objective of the deposit 

insurance system since its founding. In hearings 

preceding the creation of the FDIC, Representative 

Steagall argued, “The hard-earned savings of the 

majority of our people who are only able to deposit 

in one bank must be protected.”88 From the market 

crash in the fall of 1929 to the end of 1933, about 9,000 

banks suspended operation, resulting in losses to 

depositors of about $1.3 billion.89 To help reestablish 

consumer confidence in the banking system, the 

FDIC was created, and the initial deposit insurance 

limit was $2,500 per depositor. Increases in the 

deposit insurance limit have been justified based 

on “protect[ing] the small depositor.”90 There are 

several reasons to provide specific protection to small 

depositors. 

First, monitoring a bank for safety and soundness 

likely requires fixed costs, making it both impractical 

and inefficient for small depositors to conduct 

due diligence. Second, monitoring for safety and 

soundness requires financial, regulatory, and legal 

expertise that is time consuming and cannot be 

expected of small depositors. Deposit insurance 

provides small depositors a mechanism to protect 

their hard-earned savings, without placing these 

undue costs and burdens on them. 

Third, information is an important component to 

effective monitoring. Depositors, large and small, do 

not have access to supervisory information. Large 

depositors, however, can more easily justify various 

costs associated with collecting and analyzing 

financial market reports from private vendors that 

may be used for monitoring. Finally, information on 

the safety and soundness of banks is a public good: 

when monitoring by investors results in changes 

in bank risk-taking, all creditors benefit. Based on 

these factors and given the differences in expertise, 

size, and availability of proprietary information, 

small depositors are poorly situated to contribute 

to monitoring their bank for safety and soundness 

relative to supervisors or larger, institutional 

depositors.91 

For small depositors, a low-cost, viable alternative 

to monitoring is to withdraw their funds from the 

banking system, which may then affect the health of 

the economy more broadly. Thus, in providing small 

depositors a safe vehicle for saving and transactions, 

deposit insurance promotes confidence in the banking 

sector and supports the circulation of currency. 

Although larger, institutional depositors are better 

equipped than smaller depositors to perform due 

diligence, they may also use their resources to expand 

their deposit insurance coverage beyond the $250,000 

limit by using deposit services such as brokered 

deposits, reciprocal deposits, and sweep accounts. 

Use of these products shows that there is a demand 

for deposit insurance protection at higher levels. 

Further, the presence of brokered deposits, sweeps, 

and reciprocal deposits demonstrates that the current 

system already provides deposit insurance coverage 

for large depositors. However, access to insured 

deposit coverage above the deposit insurance limit 

under the current system differs across depositors 

based on depositor awareness and legal, financial, and 

regulatory expertise. 

To compare the options, this report focuses 

primarily on financial stability and consistency and 

transparency. The report does not separately discuss 

the role of the options in meeting the depositor 

protection objectives; however, depositor protection 

issues, such as prompt access to insured funds after 

a failure, are mentioned in relevant areas. 

86 For a theoretical discussion of this possibility, see Egan, Hortaçsu, and Matvos (2017). For empirical evidence, see Martin, Puri, and Ufier (Forthcoming). 

87 For theoretical support, see Egan, Hortaçsu, and Matvos (2017). 

88Hearings Before the Subcommittee of the Committee on Banking and Currency, U.S. House of Representatives, March and April 1932, p. 268, https://babel. 

hathitrust.org/cgi/pt?id=umn.31951d03595099g&view=1up&seq=272&q1=deposit. 

89 FDIC (1984), p. 3. 

90U.S. Senate Committee on Banking and Currency, Amendments to the Federal Deposit Insurance Act: Hearings on S. 80, S. 2094, S. 2307, and S. 2822 before the 

Subcommittee, 81st Cong., 2nd sess. (1950). 

91Blinder and Wescott (2001). 
28 | 2023 Options for Deposit Insurance Reform 

The arguments in favor of protecting small depositors 

may also extend to the protection of business payment 

accounts. Much like small depositors, employees 

and trade creditors of a business that uses its deposit 

accounts for payment services are poorly positioned 

to understand their exposure to failure of that firm’s 

bank. Surveys suggest that even small, relatively 

unexpected expenses as little as $400 could cause 

financial hardship for many Americans.92 Protecting 

workers from a sudden wage or job loss resulting from 

bank runs by protecting the accounts used to pay 

their wages may therefore yield significant benefits to 

consumers. 

Minimizing Disruptions From Bank Resolution 

Deposit insurance coverage has direct implications 

for the costs associated with bank resolutions. Three 

key objectives of bank resolution include paying 

insured depositors promptly, retaining franchise 

value, and minimizing costs to the insurance fund and 

banking system. 

Resolving an institution does not happen without 

considerable planning and preparation before a 

potential failure. Bank runs can shorten, or eliminate, 

the time available to the FDIC to implement an orderly 

resolution and increase the costs of the resolution. 

Severe liquidity challenges that induce a bank failure 

are likely to progress quickly and with little warning. 

To stop a bank run, and to prevent it from potentially 

spreading to other institutions, the FDIC must act 

swiftly to close the bank. Doing so hinders the FDIC 

from executing its preferred processes to prepare 

for failure.93 

When supervisory authorities conclude that an 

insured depository institution is operating in an 

unsafe condition, the FDIC undertakes preparations 

to resolve the institution should failure occur.94 These 

preparations relate directly to the key objectives 

stated above. 

The FDIC aims for a seamless experience for depositors 

and creditors. In the ideal scenario, depositors 

maintain almost continuous access to their funds, 

borrowers experience a quick transfer to another 

bank without intermediate servicing issues, and 

neither group particularly notices that ownership 

of the institution has changed. 

Providing insured depositors access to their funds may 

require the completion of an insurance determination, 

which involves the FDIC obtaining and analyzing 

bank customer and account data. Full execution 

of an insurance determination entails substantial 

manual effort to determine account ownership and 

associated insurance status. For some account types, 

full execution of an insurance determination requires 

manual review of documentation that the bank does 

not maintain. This can delay the determination of 

an account’s insurance status. Simplification of the 

system or regulation95 could reduce the costs of the 

deposit insurance determination and thus lessen 

administrative costs of the receivership. 

An abbreviated lead-up to failure also affects the 

ability of the FDIC to maximize the franchise value of 

the failed institution. The FDIC is less able to market 

the institution to potential acquirers, and interested 

parties are less able to conduct due diligence. This 

leads to increased uncertainty that may reduce 

competition in bidding for the failed bank’s assets and 

may result in lower prices or increases in the cost of 

the terms offered by the FDIC to potential acquirers, 

such as more generous cost-sharing agreements. 

These dynamics increase the cost to the DIF and, 

ultimately, the banking system that must pay higher 

assessments to recapitalize the Fund. 

Consistency and Transparency 

One objective of deposit insurance is to make 

protections explicit and to provide clear expectations 

to markets in advance.96 Differences in market 

perceptions regarding the potential for uninsured 

depositor losses can distort incentives and affect 

competition. Market perceptions may be informed 

both by bank regulatory and resolution regimes that 

differ across banks and expectations on the future 

92 Federal Reserve Board of Governors, “Report on the Economic Well-Being of U.S. Households in 2019–May 2020,” https://www.federalreserve.gov/ 

publications/2020-economic-well-being-of-us-households-in-2019-dealing-with-unexpected-expenses.htm. 

93Hoggarth, Reidhill, and Sinclair (2004). 

94See FDIC (2017), chapter 6, “Bank Resolutions and Receiverships,” and FDIC (1998), Vol. 1, chapter 2, “Overview of the Resolution Process.” 

95Some regulations are currently applied to large banks through Part 360.9 of the FDIC’s regulations, titled “Large-Bank Deposit Insurance Determination 

Modernization,” and Part 370 of those regulations, titled “Recordkeeping for Timely Deposit Insurance Determination.” 

96Garcia (2000). 
2023 Options for Deposit Insurance Reform | 29 

treatment of uninsured depositors in resolution given 

previous interventions. A well-designed deposit 

insurance system that credibly limits the need for 

government interventions during a crisis provides 

transparent protection and enables informed decisionmaking on how to allocate costs accordingly. 

Explicit deposit insurance coverage that can be 

credibly executed in a resolution may increase 

transparency and allow market participants to 

operate under fewer assumptions. In addition, 

even when they expand protection, explicit policies 

may cause a reduction in risk-taking if they correct 

distortions based on subjective beliefs about the 

potential for uninsured depositor losses.97 

Because of the constant evolution of financial 

institutions and risk exposures, explicit policies 

are unlikely to materialize as described for all 

possible scenarios. However, lawmakers and 

regulators can strengthen the financial system 

and prepare for potential shocks through explicit, 

well-designed policies. 

Possible Consequences 

Despite its potential financial and economic 

benefits, deposit insurance may create distortions 

that undermine or reduce its efficacy in meeting its 

objectives. Deposit insurance also can affect bank 

risk-taking and bank funding choices. This subsection 

examines these unintended consequences of deposit 

insurance. 

markets, including deposit insurance. Deposit 

insurance eliminates the risk of loss on deposits for 

insured depositors, which makes depositors less 

sensitive to bank risk levels, shielding banks (to an 

extent) from losing deposits. As a result, moral hazard 

can lead to risk-shifting, with the consequences of 

excessive risk-taking being borne by the deposit 

insurer. Absent deposit insurance, depositors have 

incentives to act as bank monitors. Depositors who 

are not sufficiently compensated for a bank’s risktaking are incentivized to move their deposits to a 

different bank offering a better risk-return tradeoff.98 

Thus, banks taking on excessive risk face the choice 

of increasing the rates offered to depositors or losing 

deposit funding, a mechanism known as depositor 

discipline. Deposit insurance generally weakens 

depositor discipline because insurance reduces 

depositors’ concerns for the safety of their deposits, 

though evidence is mixed on whether there is a 

measurable effect on bank risk-taking.99 

Depositor discipline may result in a proactive 

reduction in bank risk-taking or may manifest as a 

reactive punishment to bank risk, without affecting 

bank risk-taking incentives. While reductions in bank 

risk-taking from depositor discipline improve financial 

stability, discipline in the form of a sudden withdrawal 

of funding and a potential bank run decreases 

financial stability. Therefore, it is important to focus 

on the extent to which depositor discipline results 

in reductions in bank risk-taking when examining 

the potential consequences of increases in deposit 

insurance. 

Moral Hazard, Market Discipline, and Depositor 

Discipline 

Moral hazard is the incentive to take on greater risk 

as a result of being protected from the consequences 

of risk-taking. It is a common concern in insurance 

The institutional environment, such as the 

transparency of the accounting system and reporting, 

bank supervision, and well-defined legal rights, plays 

an important role in determining bank risk-taking 

and depositor incentives to monitor banks. Research 

shows that countries with strong institutional 

97Gropp and Vesala (2004), Cutura (2021). 

98Park and Peristiani (1998), Jordan (2000), Martinez Peria and Schmukler (2001), Davenport and McDill (2006), Maechler and McDill (2006), Bennett, Hwa, and 

Kwast (2015), Berger and Turk-Ariss (2015), Iyer, Jensen, Johannesen, and Sheridan (2019), and Martin, Puri, and Ufier (Forthcoming). In addition to interest rates, 

banks may compete on other dimensions (such as payment services) to attract deposits. 

99Empirically, there is both evidence that deposit insurance can increase bank risk-taking and evidence to the contrary. The relationship between deposit 

insurance and moral hazard is dependent on institutional factors that differ across time and countries. This dependence can sometimes lead to conflicting 

conclusions. Thus, drawing implications from other countries or under different sets of laws and regulations should be done with care. Examples of studies 

that find that deposit insurance increases risk-taking include Grossman (1992), Wheelock and Wilson (1995), Hooks and Robinson (2002), Demirgüç-Kunt and 

Detragiache (2002), Ioannidou and Penas (2010), Lambert, Noth, and Schüwer (2017), and Calomiris and Jaremski (2019). Studies that do not find evidence that 

deposit insurance increases risk-taking include Karels and McClatchey (1999), Gueyie and Lai (2003), and Gropp and Vesala (2004). Some studies find conflicting 

effects of deposit insurance depending on other factors like the economic cycle or the institutional environment; these include Hovakimian, Kane, and Laeven 

(2003) and Anginer, Demirgüç-Kunt, and Zhu (2014). Some studies such as Karas, Pyle, and Schoors (2013) find evidence of depositor discipline but do not 

directly establish a resulting effect on bank risk-taking ; see Bliss and Flannery (2002) for a discussion of this phenomenon in the market discipline literature 

more broadly. 
30 | 2023 Options for Deposit Insurance Reform 

environments are less likely to suffer from moral 

hazard associated with deposit insurance.100 As 

discussed in Section 5, tools such as risk-based pricing, 

regulation, and supervision can constrain bank risktaking. In addition, market discipline from non-deposit 

stakeholders at the bank can also limit bank risktaking. Given the prioritization of depositors in the 

claims structure and their sizes relative to institutional 

investors, non-depositor creditors and shareholders 

may play a larger role than depositors in exerting 

market discipline to constrain moral hazard.101 

In addition to acting as their own constraints to bank 

risk-taking, the institutional environment may reduce 

depositor monitoring incentives and the efficacy of 

depositor discipline. For example, because monitoring 

is costly, depositors may rely on bank supervisors 

or other market participants to expend monitoring 

effort. Thus, a strong institutional environment both 

mitigates concerns of moral hazard associated with 

deposit insurance and reduces the relative role that 

depositor discipline plays in affecting bank risk. 

Several factors limit depositor discipline from 

effectively controlling bank risk. First, depositors may 

face significant costs to monitor and discipline banks, 

as it requires expertise in accessing and evaluating 

bank financials. Second, savvy depositors who are 

most likely to impose depositor discipline may be 

able to eliminate their risk through other means, such 

as using cash management services to limit their 

exposure to uninsured deposits. Thus, depositors 

most equipped to monitor banks may exert little or 

no depositor discipline in practice. Third, the impact 

of depositor discipline may be reduced if banks can 

readily find substitutes for uninsured deposits.102 For 

example, if banks can use—or expect that they can 

use—other forms of funding to meet outflows, then 

potential withdrawal of uninsured deposits has a 

smaller effect on bank risk-taking incentives. 

Finally, depositor discipline can function only if 

uninsured depositors have an expectation of possible 

loss. In most bank failures since 1992, the acquiring 

bank assumed uninsured deposits in the resolution 

(Table 3.3). Consequently, absent a stress event, an 

uninsured depositor may rationally expect that it 

is unlikely both that their bank fails and that as an 

uninsured depositor they would face a loss in the 

event it did. Further, some uninsured depositors may 

expect that their deposits will be protected in the 

event of a bank failure even if not explicitly insured. 

The infrequency of bank failures with uninsured 

depositor loss weakens the depositor discipline 

mechanism in deterring bank risk-taking.103 However, 

in some cases, including some high-profile ones, 

the losses to uninsured deposits have been high. 

Therefore, although uninsured depositors may not 

monitor the bank in general, in the context of a stress 

event, uninsured depositors may choose to run. 

Despite its weaknesses, depositor discipline provides 

a market-based risk deterrent. The threat of a bank 

run may encourage banks to maintain high levels of 

transparency and financial stability to attract and 

retain deposits. To avoid the devastating effects of 

a run, bank managers may avoid risky actions long 

before there is any risk of a bank run. 

If deposit withdrawals are gradual and do not 

culminate quickly into a bank run, withdrawals 

may serve as an early-warning signal to supervisors 

and other market participants. Once a run is 

underway, it is likely too late for a bank to correct any 

mismanagement of risk. In these cases, depositor 

discipline punishes institutions already in deep 

trouble, which is likely to impede the ability of 

supervisors to impose corrective actions and prevent 

the situation from worsening. In such cases, depositor 

discipline is detrimental to financial stability.104 On 

the other hand, bank runs can end risky behaviors 

that had gone unaddressed and that could otherwise 

continue to build if they remained unrectified by 

supervisors or other market forces. Also, the bank run 

may prompt stronger controls on similar risk-taking at 

banks not subject to the run. 

Ultimately, moral hazard depends on several factors, 

of which depositor discipline is just one. Moral hazard 

associated with deposit insurance is less concerning 

100Demirgüç-Kunt and Detragiache (2002), and Hovakimian, Kane, and Laeven (2003). 

101Sironi (2003), Gropp and Vesala (2004), Anginer, Demirgüç-Kunt, and Zhu (2014), and Kandrac and Schlusche (2021). 

102Ashcraft, Bech, and Frame (2010), and Martin, Puri, and Ufier (Forthcoming). 

103 Iyer, Jensen, Johannesen, and Sheridan (2016). 

104 Flannery and Bliss (2019) distinguish between corrective market discipline and discipline that could take a “wrong turn” toward depositor runs, with little time 

for corrective action. 
2023 Options for Deposit Insurance Reform | 31 

 

when institutions are strong and when depositor 

discipline does not meaningfully drive bank risk 

management decisions. The risk of moral hazard 

arising from deposit insurance should be evaluated 

with comprehensive consideration of the existing 

institutional controls that limit bank risk-taking. 

Changes to Other Bank Funding Sources 

Because deposits are the primary source of funding 

for banks, changes in deposit insurance coverage can 

significantly affect bank funding choices. In general 

terms, increased insurance coverage is expected 

to decrease the cost and increase the availability 

of deposits for banks, leading to increased bank 

reliance on deposit funding and decreased reliance on 

alternative sources of funding. 

Domestic deposits are the largest funding source for 

banks in the aggregate.105 Other non-deposit sources 

of funding include loans from the FHLB System 

(known as advances), subordinated debt, borrowing in 

the federal funds market, discount window borrowing, 

and many other small sources of funding. Figure 

4.1 shows that as of December 31, 2022, domestic 

deposits represented about 83 percent of aggregate 

bank liabilities, foreign office deposits represented 

about 7 percent, and FHLB advances represented 

about 3 percent. At year-end 2022, bank reliance 

on domestic deposits was higher than was typical 

in the past few decades, though domestic deposits 

decreased in 2022 in association with the recent cycle 

of monetary tightening. As domestic deposits have 

declined of late, banks have increased their reliance on 

FHLB advances. Funding sources other than domestic 

deposits vary considerably across banks, especially for 

banks of different sizes. 

Changes in deposit insurance coverage are likely 

to affect the liability structure of banks in normal 

economic times and in periods of financial distress. 

105Banks also source deposits from foreign offices, though these are not eligible for FDIC deposit insurance. See CFR §330.3(e). 
32 | 2023 Options for Deposit Insurance Reform 

Increases in deposit insurance coverage may improve 

the availability and cost of domestic deposits to 

banks, reducing bank reliance on other sources 

of funding. This effect might be broadly true at all 

points in the business cycle, but perhaps especially 

so in times of turmoil. In periods of banking system 

stress in the past, bank funding has come under 

pressure as uninsured depositors and other unsecured 

creditors moved their funds out of banks and into 

assets perceived to be safe.106 An increase in deposit 

insurance coverage, by expanding the share of insured 

bank funding, may reduce the degree of funding 

stress banks face during a crisis and lessen their 

reliance on emergency sources of funding. Moreover, 

higher deposit insurance coverage has the potential 

to make banks beneficiaries of the flights to quality 

and liquidity that have historically involved funding 

flows to other financial assets perceived as liquid and 

government backed. 

Other Possible Consequences 

Deposit insurance can affect competition between 

banks, competition between banks and nonbank 

financial companies, and competition between 

deposits and other financial assets. Deposit insurance 

can affect how banks compete with one another, 

as insured depositors do not need to worry about 

bank risk. In addition, changes to deposit insurance 

coverage are likely to affect the interaction between 

banks and nonbank financials that compete with 

banks along some dimensions and partner with banks 

along other dimensions. Nonbank financials may 

compete with banks on the liability side, creating 

deposit-like savings or transaction vehicles, and on the 

asset side, making loans traditionally associated with 

chartered depository institutions. Changes to deposit 

insurance may alter the competition between banks 

and financial assets viewed as substitutes. An increase 

in deposit insurance coverage would likely make 

deposits more competitive, decreasing the demand for 

alternative assets at least to some degree. A discussion 

of the competitive effects of deposit insurance is 

beyond the scope of this report. 

106Acharya and Mora (2015) document that between the freezing of the asset-backed commercial paper market in August 2007 and the broad federal 

interventions in the banking system in October 2008, investors shifted balances away from large deposits and toward securities perceived to have stronger 

government support, such as Treasury and agency debt (and money market funds holding these securities). Facing a shortfall in deposit funding, banks increased 

reliance on the Federal Home Loan Bank System, a government-sponsored entity whose debt is perceived to enjoy implicit government support.