Why Deposits Need to Be Insured

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The Federal Deposit Insurance Corporation is an important institution in the U.S. It is responsible for insurance all deposits to FDIC member banks in the U.S., Of course, the legal definition of deposits reduces this number quite a bit since a lot of what we think are deposits are not. But here's why deposits need to be insured.

Picture this, imagine the day before the FDIC insured bank deposits. People put their faith in the solvency of the bank and only on the solvency of the bank. If the bank went bankrupt, the depositors lost their shirts!

Increasing confidence in the banking system, the government decided to create a system where all banks would contribute some money to an insurance fund. In return should an FDIC member bank people who deposited to the bank will get some if not all, their deposit.

In 2009 one of the biggest banks in the world went bankrupt. Many others would have gone with it if the US government had not given one of the biggest bailouts in human history.

Think of smaller banks; there is a higher risk that they would go bankrupt. Not only are they vulnerable to bankruptcy they tend to make investments that could result in their doom if they fail.

Small banks need to make money, so they need to invest in giving loans to people that larger banks will likely ignore. However, if the big banks ignored them, this probably means they are risky borrowers. With high risk comes high interest but the risk means they could lose the investment.

The 2009 Financial Crisis had shown that even conservative banks that did not invest in the dreaded Collateralized Debt Obligation (CDOs) were battered when the financial system came crashing down.

Hence even if the bank is very safe in what loans it gives out, it can suddenly get wiped out through no fault of its own. In other words, it would benefit the banks and depositors for them to have some form of insurance no matter what.

A bank run is a situation where people are withdrawing their deposits en masse from the bank. It is a terrible situation for any bank because no bank has enough money to settle its obligations to depositors should all, or even just a significant percentage of them decide to pull out their money.

Therefore, to help alleviate their fears, it is best for the bank to be insured to guarantee that depositors would not lose their money. At Brad Spurgeon Insurance Agency Inc., we aim to make our client's life easier with policies that are tailored to their needs. You can get more information about our products and services by calling our agency at (409) 945-4746. Get your free quote today by CLICKING HERE.