FDICIA is a major step in reforming the banking regulatory system. How well will it
work to solve the adverse selection and moral hazard problems of the bank regulatory
system? Let’s use the analysis in the chapter to evaluate the most important provisions
of this legislation to answer this question.
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A P P E N D I X T O C H A P T E R
11 Evaluating FDICIA and
Other Proposed Reforms of
the Banking Regulatory System
STUDY GUIDE
Before looking at the evaluation for each set of provisions and proposals in this appli-
cation, try to reason out how well they will solve the current problems with banking reg-
ulation. This exercise will help you develop a deeper understanding of the material in
this chapter.
Limits on the Scope of Deposit Insurance
FDICIA’s reduction of the scope of deposit insurance by limiting insurance on brokered
deposits and restricting the use of the too-big-to-fail policy might have increased the
incentives for uninsured depositors to monitor banks and to withdraw funds if the bank
is taking on too much risk. Because banks might now fear the loss of deposits when
they engage in risky activities, they might have less incentive to take on too much risk.
Limitations on the use of the too-big-to-fail policy starting in 1992 have resulted in
increased losses to uninsured depositors at failed banks as planned.
Although the cited elements of FDICIA strengthen the incentive of depositors to
monitor banks, some critics of FDICIA would take these limitations on the scope of
deposit insurance even further. Some suggest that deposit insurance should be elimi-
nated entirely or should be reduced in amount from the current $100,000 limit to, say,
$50,000 or $20,000. Another proposed reform would institute a system of coinsurance
in which only a percentage of a deposit—say, 90%—would be covered by insurance. In
this system, the insured depositor would suffer a percentage of the losses along with the
deposit insurance agency. Because depositors facing a lower limit on deposit insurance
or coinsurance would