What is the purpose of FDIC insurance and do you think it is effective in reducing the fears of depositors?
The purpose of Federal Deposit Insurance Corporation (FDIC) is protection of banks and their customers in the face of 3 very serious possibilities.
- Robbery. This is the most common protection of the FDIC. People deposit their money in banks so it will be safe against threats like burglaries and home fires. But what if the bank they are using gets robbed? Before the FDIC, there wasn't anything that the customers could do, and that's why "hanging" was a common punishment for Bank robbery.
- "Run on the bank." In the 1800s, and early 1900s this was a bank's worst nightmare. A run typically begins when a financial institution either becomes insolvent, or greedy (won't give people their money back). People begin "running" to the bank to get all their money out before it's all gone. When this happens the bank has two options 1) hope to ride it out or 2) temporarily close. The problem with riding it out is that it's not an option in a case of insolvency, even if the insolvency is temporary. The other problem is that the bank could run out of cash before the run is over, and that could lead to the bank going out of business. Temporary closure has its own problems: it is horrible PR because it reinforces the notion that the bankers are greedy fat cats and that will lead to loss of current and future customers, and it can also incite a riot. The existence of the FDIC has largely eliminated the phenomenon of a "run on the bank" as people don't have to worry about losing their money, they will be allowed to withdraw it all before the bank closes.
- Bank insolvency: even though this usually triggered a "run on the bank" it sometimes occurred more slowly and could still leave depositors penniless. FDIC protects against losses that could result from the bank running out of money, so people don't have to worry about losing their savings.
Since Bank Robbery now only draws sentences of 10-20 years, a "run on the bank" is practically unheard of, and most people didn't lose their bank-held savings during the Great Recession, it is safe to believe that FDIC is successful in allaying most depositor fears.