Deposit Insurance Leads to Moral Hazard

Precious Metals

The fractional reserve banking system is a system that is doomed to fail, it’s just a matter of when, not if. Governments throughout history have taken steps to prop up that system, but in the long run nothing has ever worked. You just can’t loan out deposits while telling depositors they can retrieve their money at any time without eventually running into problems. The introduction of deposit insurance has helped to prevent bank runs that periodically plagued the banking system, but it’s not a long-term fix. In fact, over the long term it only makes the problem worse because it breeds moral hazard that will exacerbate the underlying structural problems.

While most people think of deposit insurance as protecting bank depositors, it really acts as a subsidy to banks. With deposit insurance, a bank doesn’t have to worry as much about the quality of the loans it makes. If the bank misjudges or makes too many risky loans and goes out of business, it may be sold to another bank but its depositors will be made whole by the Federal Deposit Insurance Corporation (FDIC). That means that banks can engage in riskier lending than they otherwise would be able to in a free market, which amplifies the already dangerous nature of fractional reserve banking.

That also encourages bank depositors not to do their due diligence when opening a bank account. How many people look at a bank’s balance sheet and income statement before opening a bank account? How many look at the bank’s loan structure and look at how many non-performing loans the bank has? More likely, they open a bank account based on how convenient the bank’s branches are to their home or office, whether they offer free checking accounts, or how widespread the bank’s ATM network is.

People are so used to the idea that their money is safe in banks that they think of it as a risk-free asset, even though it’s not. In reality, a bank depositor is a creditor to the bank, and the bank is a debtor. Depositing money in the bank is as risky as any other loan, particularly when you realize that the federal Deposit Insurance Fund doesn’t have anywhere near enough money to make depositors whole in the event of a systemic banking crisis, only enough to cover 1.2% of deposits.

Even worse, because of deposit insurance many investors have seen banks as a safe place to park their money, thinking that it is completely insured. They couldn’t be any more wrong. Not only that, but money in the bank isn’t an investment that brings any returns. Because of inflation, you’re guaranteed to lose money.

That’s why gold is always far superior to “money in the bank.” In the days of specie money people used to rush to the bank to exchange their paper money for gold if a bank was rumored to be going under. Gold has kept its value over time and has been trusted by investors for centuries as a store of wealth. And with new financial innovations you can invest your retirement savings in gold with the same ease as investing in stocks and bonds, with all the same tax advantages. So if you’re looking for a safe haven for your savings, skip the banks and take a look at gold.

This article was originally posted on Goldco.

Leave a Reply

Your email address will not be published. Required fields are marked *