Deposit Insurance Creates a Need for Bank Regulation

Many bank managers and owners have long complained that they are over-regulated by a plethora of government agencies. The thrust of their complaint is that they could do a better job - i.e. become more profitable or increase their bank’s market value - if left unencumbered by regulations limiting portfolio choice, capital adequacy, holding company formations, deposit rates, and so forth. They are doubtless correct. Yet banking in the US possesses institutional characteristics that require at least some of the regulations currently in place. In particular, Federal deposit insurance gives insured bankers an artificial incentive to undertake more risk than they would in an unregulated and uninsured free market. Bankers insured by the Federal Deposit Insurance Corporation (FDIC) can benefit privately by undertaking risks that the society as a whole consider excessive.