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The Banking Act of 1933 established The Federal Deposit Insurance Corporation (FDIC). At that time, the United States was coming out of the Great Depression and restoring faith and confidence in a battered banking system was paramount.

The FDIC is a supposed independent entity structured to insure bank deposits. Beyond this primary role as insurer, the FDIC works in conjunction with the Federal Reserve Board and Office of the Comptroller of the Currency to regulate banks.

Diffusing Financial Panic

Liquidity is the engine oil that greases the machinery of global commerce. U.S. Dollars and other industrialized, fiat currencies are backed by the full faith and credit of federal governments, and not by gold or any real assets.

Financial intermediaries match investors, creditors, and institutions in need of capital together. Banks take in deposits to ultimately lend out money to finance real estate deals, capital projects, and securities investments. Banks profit on “the spread,” or the difference between interest paid on deposits and interest collected upon loans and investments.

Bankers and depositors maintain a symbiotic, yet fragile relationship. Customers demand liquidity, or the ability to access cash at all times, while bankers operate best with a steady and reliable deposit base for making loans.

The financial system seizes up amid financial panic. Banks will then refuse to make loans in order to preserve capital to honor customer withdrawals. Customers will line up for a run on the bank – to drain the few remaining reserves at the institution. Bank deposits are now insured to mitigate systemic risks of total collapse.

Define Bank Deposits

The FDIC defines deposits as conventional banking products, such as certificates of deposit (CD), checking, savings and money market deposit accounts. The FDIC categorizes account types into single, joint, corporate, government, employee benefit and trust. The FDIC insures the principal and interest earnings for these bank deposits, which might also include particular retirement accounts.

The FDIC will not insure stock, bond, and mutual fund investments. Be further advised that a money market mutual fund is separate and distinct from a money market deposit account. Financial intermediaries are legally obligated to declare to the public that investment products are not FDIC insured and may lose value.

FDIC Insurance Coverage

In 2008, the Federal Government passed the Emergency Economic Stabilization Act, which temporarily increased FDIC insurance coverage limits from $100,000 to $250,000 per depositor, per bank. This Act also triggered a series of bank bailouts legislated to stabilize the financial system through the Great Recession.

Now, in 2024, the FDIC $250,000 limit is still in force and appears to be permanent. Wealthy savers will split one large lump sum between multiple banks to maximize FDIC coverage. For example, you may divide $1,000,000 in cash into five separate $200,000 deposits at five separate banks to insure the entire amount.

FDIC Banking Regulations and Funding

The FDIC has direct jurisdiction over insured branches of foreign banks and state-chartered banks outside of the Federal Reserve System. FDIC guidelines regulate bank mergers, credit card issuing, payday loans, and community reinvestment. As a last resort, the FDIC will seize failed and non-compliant banks to make good on depositor and creditor claims.

Member banks, not Congress, fund the FDIC through deposit insurance assessments, or premiums. The FDIC rolls these insurance premiums into U.S. Treasuries to collect interest and strengthen reserves.

The FDIC insurance fund itself is relatively small in proportion to bank deposits covered. The reserve ratio, or percentage of insurance funds compared to insured deposits, is typically only one percent.

FDIC deposit insurance, of course, is backed by the full faith and credit of the United States government, which means that taxpayers will make up for any shortfall. No depositor has ever directly lost money upon any FDIC insured product.

Financial Risks and Strategies

All investors are familiar with the risks versus rewards clichés. Expect real returns of zero on FDIC insured bank deposits, at best. Real returns account for inflation risks, which devastate purchasing power. Inflation runs white hot in this post pandemic world, with the Bureau of Labor Statistics Consumer Price Index approaching 10% in annual price increases.

Intelligent savers may consider CD laddering, or taking out certificates with different maturity dates to mitigate interest-rate and inflation risks. Expect money market deposit account interest rates to move in lockstep with the federal funds rate, which in turn, tracks inflation. The federal funds rate is now 5.5%.

Bank deposits are best used to meet immediate day-to-day expenses and to establish an emergency fund. From here, savers may work towards medium term goals, such as financing a start-up business or home down payment. Over time, it is a diversified investment portfolio of stocks and bonds that will power real growth.