The Flip Side of Raising the FDIC's Insurance Limits

The 13 banks that have folded this year have done a lot to spook American consumers when it comes to the safety of their cash. While the latest bailout legislation, which awaits passage by the House of Representatives, should bring consumers some peace of mind, it may end up costing them more.

The bailout package proposed by the Bush Administration promises to raise the amount of deposits that the Federal Deposit Insurance Corp. insures at banks and credit unions from $100,000 to $250,000. The hope is to boost depositor's confidence and assuage any fears that their bank accounts will run dry in the midst of the ongoing banking industry fallout. (The bill was passed by the Senate Wednesday evening and now awaits the approval of the House of Representatives on Friday).

“To address this crisis of confidence, I do believe that it would be helpful for the FDIC to have the temporary ability to raise deposit insurance limits," said FDIC Chairwoman Sheila Bair on Tuesday. (In another move to instill confidence, the FDIC recently assured the public that its insurance fund is in “a strong financial position to weather a significant upsurge in bank failures.” If needed, it says, the FDIC would be able to borrow from the Treasury for what it calls working capital, used to provide funding between the time a bank fails and when its assets are sold; these funds are eventually paid back.)

At first blush, the higher FDIC insurance limits appear to be beneficial for consumers -- after all, more of their money is guaranteed to be safe -- but the new limits may not be everything they're cracked up to be. Here's what consumers need to know:

Sure, raising the FDIC insurance limits to $250,000 will inspire more confidence in consumers -- but only in those who have a lot of money in their bank accounts, says Bob Glovsky, president of Mintz Levin Financial Advisors, a fee-only wealth management firm in Boston. The bigger question is: How do you get people who have less than that [$250,000] to feel confident? “My bottom line is it’s a plus, but not a panacea,” he says.

Should the bill get passed by the House, the increase in insurance limits are only a temporary solution -- the higher limits would be in effect through December 2009, says Peter Garuccio, spokesman for the American Bankers Association. Much like the Treasury Department’s move on Sept. 19 to insure money-market mutual funds, this is more or less a stop-gap measure aimed at stemming any significant outflow of capital spurred by panicky depositors.

However, James Abbott, a banking analyst at Friedman Billings Ramsey, believes the insurance increase may just stick beyond the January 2010 expiration. “Sometimes Congress makes moves that start out as temporary and become permanent because they’re rational. I suspect that will be the case here,” he says.

The FDIC’s insurance fund is paid for entirely by the nation’s banks – in the form of premiums paid to the FDIC. And even though the proposed legislation specifically prohibits the FDIC from charging banks higher premiums to cover the increased insurance limits, the FDIC will have to get the money from somewhere.

Long before the current upheaval in the financial sector, the FDIC had already proposed raising premiums. “So banks knew an increase in premiums was going to happen,” says Garuccio.

The question now is whether the FDIC will be forced to raise premiums by a larger amount than they originally intended, says Rob Strand, senior economist at the American Bankers Association. When another bank failure occurs, the FDIC will have to pay out more. “It has to cost the banks in premiums; they have to pay the extra cost of these failures,” he explains. Friedman Billings Ramsey's Abbott agrees: “There will have to be an increase to cover the additional risk,” he says

If banks are forced to pay higher premiums, they will most likely turn to customers to help foot the bill, says Strand. As he explains, customers may get charged higher interest rates or receive lower interest rates on their deposits. And shareholders may receive reduced dividends -- if they weren't already. “It’s some combination of those,” Strand predicts.

Still unknown is how exactly these changes will impact consumers. But "given the fact that before there was a crisis, banks have been willing to charge exorbitant fees for all sorts of things, the thought of them charging even higher fees to cover a legitimately higher expense is certainly plausible,” says Ruth Susswein, deputy director of national priorities for Consumer Action, a consumer advocacy group.