Does the Federal Reserve insure the money of all depositors?

Question

Banking institutions in the United States are required to hold reserves‍—‌amounts of currency and deposits in other banks‍—‌equal to only a fraction of the amount of the bank's deposit liabilities owed to customers. This practice is called fractional-reserve banking. As a result, banks usually invest the majority of the funds received from depositors. On rare occasions, too many of the bank's customers will withdraw their savings and the bank will need help from another institution to continue operating; this is called a bank run. Bank runs can lead to a multitude of social and economic problems. The Federal Reserve System was designed as an attempt to prevent or minimize the occurrence of bank runs, and possibly act as a lender of last resort when a bank run does occur. Many economists, following Nobel laureate Milton Friedman, believe that the Federal Reserve inappropriately refused to lend money to small banks during the bank runs of 1929; Friedman argued that this contributed to the Great Depression.[28]

https://en.wikipedia.org/wiki/Federal_Reserve

The Wikipedia article says that there can still be a bank run even with the Federal Reserve, and then even imply that it may not lend money to all banks if all banks were to suffer a bank run, and the Federal Reserve will not repay some depositors if they were to lose money in a massive bank run crisis where everyone would retire their money. Is this true? I thought the system was set up to prevent bank run of any kind no matter the scale.

Answer 1

The Federal Deposit Insurance Corporation is insuring deposits up to $250,000 per owner. A bank run can still happen (still did happen, in the recent case of the SVB) when large customers are starting to pull their deposits out because they are not fully covered. Small customers are still covered from direct results of a bank failure. They may be affected by the indirect results.

Answer 2

It depends on what you mean by "bank run". It's generally understood to mean a situation where depositors make withdrawal demands that exceed the assets of the bank that are sufficiently liquid to meet those demands. If we exclude the FDIC insurance from "assets", then this is quite possible. However, a bank having FDIC insurance is, in some sense, an asset (albeit one not generally included in this context), and that asset covers withdrawal demands of up to $250k per eligible depositor. In that sense, a bank run is possible. A bank run is also possible with regard to amounts greater than $250k, and for deposits that are not eligible for FDIC insurance. A bank run is also quite possible in the more general sense of simply "a significantly larger amount of withdrawal demands than usual".

A bank run, however, also has a connotation of a feedback loop in which there is an unusually large amount of withdrawal demands, which causes people to fear that the bank will fail, which cause people to withdraw their money so that they get it out before the bank fails, which causes even more fear of failure. FDIC paying out insurance is really the last resort to address bank runs. The main mechanism of the FDIC avoiding bank runs is to cut short this feedback loop: if depositors feel secure that they will get their money back, they won't withdraw their money, and so the existence of the insurance will in most cases make it unnecessary. It also keeps bank runs from spreading to other banks; previously, all it took for a run on one bank to cause a run on another was enough people believing that it would do so, and that belief would then become a self-fulfilling prophecy. So while the FDIC is intended to decrease the probability of a bank run, it is not intended to make them impossible, only to remove the consequences of them (namely, people losing all their money), and by removing the consequences of runs, make the runs themselves much less likely.

As for why the FDIC didn't pay out in the 1929 crash, that is simply because the 1929 crash was what lead to the FDIC being established; it didn't come into being until 1933, and so wasn't available to stop the crash. Also, the FDIC and the Federal Reserve are separate entities. The FDIC insuring deposits doesn't mean the Federal Reserve is obligated to extend loans to cover losses.

Answer 3

The Federal Reserve in its role as lender of last resort will lend money to a solvent bank that’s suffering a bank run and having temporary cash flow problems. But it appears that SVB was insolvent — its liabilities exceed its assets — and that means that such loans would probably never be repaid. The question of how the regulator let it get into this position is one that will certainly need to be answered.

Answer 4

Does the Federal Reserve insure the money of all depositors?

No. The Federal Reserve doesn't insure the money of any depositors. The Fed doesn't make any promises of that kind. But it can make emergency loans that have the practical effect of preventing banks from defaulting on their deposits by establishing loan payment requirements that the bank can meet (as opposed to the demand loan status of bank deposits).

The Federal Reserve System was designed as an attempt to prevent or minimize the occurrence of bank runs, and possibly act as a lender of last resort when a bank run does occur.

The statement above from Wikipedia overstates the role of the Fed in preventing bank runs as a primary or sole motivation for establishing it.

Preventing bank runs was one consideration among many in the formation of a Federal Reserve system in 1913.

Providing a central bank to manage interest rates and inflation, and to coordinate the national payment system between banks, and to act as the chief banker of the federal government, were all more important reasons for it that were discussed as far back of Alexander Hamilton's proposal to create a national bank was was a key partisan issue in the United States in the early 1800s.

Nonetheless, the Fed is also something of a "utility infielder" of the financial regulatory system that can step in with economic power to address a financial crisis by making emergency loans when no other agency is in a position to do so.

But, loans from the Fed were a blunt instrument, couldn't be relied upon by depositors, and weren't very effective in the face of widespread bank runs in the Great Depression, which is why the FDIC was created.

The FDIC, unlike the Fed, made a promise to depositors that they could rely upon and could impose financial solvency requirements and practices on FDIC banks which prevented runs from arising in the first place. The FDIC also shifted by risk of loss on payments to banks facing runs from the general U.S. taxpaying public to the pool of covered banks as a whole.

Preventing bank runs by creating confidence in bank deposits is primarily the responsibility of the Federal Deposit Insurance Corporation (FDIC) and parallel federal agencies for types of banks other than the commercial banks covered by the FDIC system, like savings and loans institutions and credit unions.

The Fed has the authority to make large emergency loans to financial institutions (and in principal, other kinds of businesses) to prevent the contagion of a financial crisis from flowing from one troubled institution to others in the financial system, usually when there are large volumes of uninsured deposits. The Fed utilized that authority during the 2007-2008 financial crisis.

But, this authority is purely discretionary and is nothing something that entities facing a potential bank run or depositors are entitled to rely upon.