1996 and should be addressed by the congress. the congress did intend that the fdic impose risk - based premiums, but the 1996 act limits the ability of the fdic to impose risk - based premiums on well - capitalized and highly rated banks and thrift institutions. and these two variables - capital strength and overall examiner rating - do not capture all the risk that institutions could create for the insurer. the board believes that the fdic should be free to establish risk categories on the basis of any economic variables shown to be related to an institution's risk of failure, and to impose premiums commensurate with that risk. although a robust risk - based premium system would be technically difficult to design, a closer link between insurance premiums and the risk of individual institutions would reduce moral hazard and the distortions in resource allocation that accompany deposit insurance. we note, however, that although significant benefits from a risk - based premium system are likely to require a substantial range of premiums, the fdic concluded in its report that premiums for the riskiest banks would probably need to be capped in order to avoid inducing failure at these weaker institutions. we believe that capping premiums may end up costing the insurance fund more in the long run should these weak institutions fail anyway, with the delay increasing the ultimate cost of resolution. the board has concluded, therefore, that if a cap on premiums is required, it should be set quite high so that riskbased premiums can be as effective as possible in deterring excessive risk - taking. in that way, we could begin to simulate the deposit insurance pricing that the market would apply and reduce the associated subsidy in deposit insurance. nonetheless, we should not delude ourselves into believing that even a wider range in the risk - based premium structure would eliminate the need for a government back - up to the deposit insurance fund, that is, eliminate the government subsidy in deposit insurance. to eliminate the subsidy in deposit insurance - to make deposit insurance a real insurance system - the fdic average insurance premium would have to be set high enough to cover fully the very small probabilities of very large losses, such as those incurred during the great depression, and thus the perceived costs of systemic risk. in contrast to life or automobile casualty insurance, each individual insured loss in banking is not independent of other losses. banking is subject to systemic risk and is thus subject to a far larger extreme loss in the tail of the probability distributions from which real

alan greenspan : deposit insurance testimony of mr alan greenspan, chairman of the board of governors of the us federal reserve system, before the committee on banking, housing, and urban affairs, u. s. senate, washington, d. c., 26 february 2003. * * * chairman shelby, senator sarbanes, and members of the committee, it is a pleasure to appear once again before this committee to present the views of the board of governors of the federal reserve system on deposit insurance. rather than refer to any specific bill, i will express the broad views of the federal reserve board on the issues associated with modifications of deposit insurance. those views have not changed since our testimony before this committee on april 23, 2002. at the outset, i note that the 2001 report of the federal deposit insurance corporation ( fdic ) on deposit insurance highlighted the significant issues and developed an integrated framework for addressing them. although as before the board opposes any increase in coverage, we continue to support the framework constructed by the fdic report for addressing other reform issues. benefits and costs of deposit insurance deposit insurance was adopted in this country as part of the legislative effort to limit the impact of the great depression on the public. against the backdrop of a record number of bank failures, the congress designed deposit insurance mainly to protect the modest savings of unsophisticated depositors with limited financial assets. with references being made to " the rent money, " the initial 1934 limit on deposit insurance was $ 2, 500 ; the congress promptly doubled the limit to $ 5, 000 but then kept it at that level for the next sixteen years. i should note that the $ 5, 000 of insurance provided in 1934, an amount consistent with the original intent of the congress, is equal to slightly less than $ 60, 000 today, based on the personal consumption expenditures deflator in the gross domestic product accounts. despite its initial quite limited intent, the congress has raised the maximum amount of coverage five times since 1950, to its current level of $ 100, 000. the last increase, in 1980, more than doubled the limit and was clearly designed to let depositories, particularly thrift institutions, offer an insured deposit free of the then - prevailing interest rate ceilings on such instruments, which applied only to deposits below $ 100, 000. insured deposits of exactly $ 100, 000 thus became fully insured instruments in 1980 but were not subject to an interest rate ceiling. the efforts of thrift institutions to