FDIC insurance gives bank managers

IT IS OFTEN SAID lately that FDIC insurance gives bank managers incentives to require greater risks in operating their banks. Similar statements are made with reference to savings and loan associations insured by FSLIC. i think that there's little, if any, connection between managers' risk-taking and government insurance.

Experience shows that those that take risks without bearing consequent losses tend to require greater risks than those that are liable for the results of their decisions. This tendency to require risks when others foot the bill is named by economists a "moral hazard." Lawyers ask this tendency as breach of legal duty. Moral hazards appear when people manage other people's money, as bank managers do. Moral hazards also appear when people insure against risks which they need the facility to require. In both cases the danger takers may enjoy the danger but others may bear the loss.

The notion that bank managers take greater risks because their banks are insured by the govt is intuitively appealing. This notion draws on our observation that individuals take greater risks with their own property when that property is insured.

This observation within the area of personal insurance has been carried over to managers of FDIC-insured banks: These managers run their insured banks the way they drive their insured cars. Carrying the analogy further, there are proposals for risk-related FDIC premiums, on the idea that managers would take more care if premiums were risk-related, even as people drive more carefully if their car insurance premiums are accident-related.

I submit that the analogy to non-public insurance is misconceived. a private who takes a risk at the insurance firm's expense takes a risk regarding his own property and therefore the insurance company pays that person for the damage caused by his risky activities. The insured can thus profit at the insurance company's expense.

In contrast, neither bank managers nor their banks enjoy FDIC insurance. The depositors are the beneficiaries of FDIC insurance.

Since the bank managers aren't personally liable for the depositors' losses (unless they violate the law), FDIC insurance doesn't benefit the managers even indirectly, by covering their obligations.

In sum, managers receive no benefits from the payments of FDIC insurance. On the contrary, managers suffer an excellent deal of harm if and when the FDIC pays deposit insurance. The managers have an interest in their jobs, their prestige, and their reputations. Payment on FDIC insurance leads to the loss of those things
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