Criticisms of State-Sponsored Deposit Insurance
Detractors of federal deposit insurance claim the schemes introduce a moral hazard issue, encouraging both depositors and banks to take on excessive risks. Without deposit insurance, banks would compete for deposits because depositors would prefer safe banks over risky banks to guard their money. With deposit insurance, banks can take excessive risks because depositors do not fear for their deposits safety and thus do not move their money to safer banks. The risks are shared by all banks, be they safe or risky. If deposit insurance is provided by another business or corporation, like other insurance agreements, there is a presumption that the insurance corporation would charge higher rates to or simply refuse to cover banks who engaged in extremely risky behavior, thus solving the problem of moral hazard whilst simultaneously reducing the risk of a bank run.
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