Small Banks Should Not Use Deposit Insurance to Mug Bigger Banks

It is wrong when one part of the business sector uses government power to enrich itself and mug its competitors. It is even worse when that effort is sold as a plan to protect ordinary people.

The “Main Street Depositor Protection Act,” S. 4198, fits that pattern. The bill sounds like it protects small businesses, but it would expand government-backed deposit insurance, weaken market discipline, and let smaller banks shift the cost of their preferred subsidy onto larger competitors. CFE opposes this bill because deposit insurance should protect financial stability, not become another Washington tool for picking winners and losers in the banking system.

The Bill Expands a Government Backstop

Senator Bill Hagerty and Senator Angela Alsobrooks reintroduced the bipartisan “Main Street Depositor Protection Act” with Senators Jim Banks, Catherine Cortez Masto, Cindy Hyde-Smith, and Ruben Gallego. Representative Frank Lucas introduced companion legislation in the U.S. House. The bill would direct the Federal Deposit Insurance Corporation to create additional deposit insurance coverage for noninterest-bearing transaction accounts, with a new cap of up to $5 million.

Supporters describe the bill as a way to protect small businesses that keep payroll and operating funds in transaction accounts. That pitch sounds narrow and reasonable, but the bill would do much more than protect depositors. It would expand a government guarantee and change the competitive landscape for banks.

Deposit insurance is not free. The FDIC’s Deposit Insurance Fund is funded by bank assessments, and if the fund is ever insufficient, the FDIC has borrowing authority from the U.S. Treasury. CEI’s Steve Swedberg explains that this structure shields insured depositors from loss while shifting risk into the broader financial system.

Small Banks Should Not Get a Subsidy at Big Banks’ Expense

The most revealing part of the bill is not the new insurance cap, but the way the bill shifts costs.

The bill says that, during the transition period, insured depository institutions with $10 billion or less in assets would not be required to pay special assessments or assessment increases tied to the new coverage for noninterest-bearing transaction accounts.

Smaller banks want expanded deposit insurance because it helps them compete for large transaction accounts, but they do not want to pay the full cost of the expanded government guarantee they are asking Congress to create. That is not free-market competition. It is a political transfer.

A community bank should compete by offering better service, stronger relationships, better lending judgment, and sound balance-sheet management. It should not compete by asking Washington to expand government-backed deposit insurance while pushing the cost onto larger banks.

Deposit Insurance Already Weakens Market Discipline

Deposit insurance has a clear purpose: preventing bank runs and preserving confidence in the banking system. But every expansion of that guarantee comes with a cost. The more Washington shields depositors from risk, the less reason depositors have to evaluate where they keep large balances. The less depositors care about bank risk, the less market discipline banks face.

CEI’s analysis makes this point directly. Government-backed deposit insurance creates moral hazard because banks and depositors are insulated from the consequences of risky decisions. When customers assume all banks are equally safe, they are less likely to pay attention to bank management, capital strength, liquidity, or risk-taking.

The “Main Street Depositor Protection Act” would push that problem further by encouraging more depositors to treat bank risk as Washington’s problem. It would give banks a government-backed tool to attract funds instead of requiring them to earn confidence through sound management.

Silicon Valley Bank Is the Wrong Excuse

Supporters point to the collapse of Silicon Valley Bank and the run on large uninsured deposits as the reason Congress should act. That argument misses the lesson.

Silicon Valley Bank did not fail because Washington failed to insure enough deposits. It failed because of bad risk management, poor supervision, and a depositor base that was unusually concentrated and sensitive to rapid withdrawals. Expanding deposit insurance after that failure treats the symptom while ignoring the disease.

Congress should not respond to every banking failure by expanding federal guarantees. If lawmakers want a safer banking system, they should strengthen market discipline, improve transparency, reduce regulatory barriers for new banks, and make sure bank shareholders and managers bear the consequences of bad decisions.

Higher Guarantees Mean Higher Risk

Supporters say expanded coverage would help small businesses make payroll and preserve confidence in smaller banks. Those are real concerns because businesses need access to their operating cash, and a bank failure can create serious disruption. But a serious concern does not justify a bad solution.

More generous deposit insurance can reduce pressure in the moment while increasing risk over time. CEI points to research showing that deposit insurance can distort bank behavior, reduce market discipline, and contribute to greater financial fragility. CEI also notes that higher insurance premiums can reduce lending, especially when banks face higher costs during economic stress.

The bill could hurt the same economy it claims to protect by encouraging more risk-taking, raising systemwide costs, reducing credit availability, and distorting competition through political carveouts. If the Deposit Insurance Fund falls short, taxpayers can be left closer to the hook for risks that private banks and large depositors should manage themselves.

CFE Takeaway

Congress should reject the “Main Street Depositor Protection Act.” Protecting depositors should not become an excuse for expanding moral hazard, shifting costs, and turning deposit insurance into a subsidy fight between banks. Free-market banking requires competition, accountability, and risk discipline, not another Washington-backed guarantee.