What is deposit insurance?
In general terms, deposit insurance is a system put in place to protect a depositor’s money during a bank failure. Many countries have some form of deposit insurance implemented into their financial system. Deposit insurance promotes trust and economic stability within a country by acting as a safety net for deposits. This, in turn, helps stimulate a country’s economy and boosts growth.
In the United States, two federal agencies administer deposit insurance:
- Federal Deposit Insurance Corporation (FDIC)
- National Credit Union Administration (NCUA)
The FDIC is responsible for insuring deposits made to banks, while the NCUA insures deposits made to credit unions. Both agencies will insure deposits up to $250,000 and are backed by the full faith and credit of the United States government.
Deposit insurance explained
On the surface, deposit insurance is put in place by a country’s government to protect a depositor’s money. However, if you look below the surface, you’ll find that deposit insurance does more—it protects banks from collapsing.
There was little confidence in the American banking system before the FDIC was established in 1933. In fact, between 1921 and 1929, there was an average of 600 bank failures every year. American’s didn’t trust banks and were sensitive to rumors, even if those rumors weren’t true.
The moment people were scared they’d lose their money, they would withdraw it. This would create a chain reaction, which caused more people to withdraw their money.
As a result, the bank rumors became a self-fulfilling prophecy because too many people removed their money at once, thus depleting the bank’s reserves. This was also known as a “bank run.”
However, since the FDIC’s inception in 1933, not a single American has lost even a penny in insured deposits. Nowadays, American’s are very confident in the American financial system.
You’re much less likely to withdraw your money every time you hear a rumor because you know your money is secured. Furthermore, a “run on the bank” is far less likely to happen, which means the odds of a bank failing are nearly eliminated.
Deposit insurance example
If you are opening a new bank account, you always want to make sure the account is FDIC insured. If the account is with a credit union, it should be NCUA insured for you even to consider depositing your money.
The FDIC and NCUA both insure your deposit’s up to $250,000 per deposit, per insured bank, and for each account ownership category. For example, if you have both a savings account and a retirement account with $250,000 each, your entire $500,000 nest egg would be insured.
However, if you have $300,000 in a savings account and $250,000 in a retirement account, only $500,000 out of $550,000 would be insured. If the bank holding your savings account failed, you will lose $50,000 since the FDIC only insures up to $250,000.
It’s also possible to spread out your deposits across multiple banks if your savings exceeds $250,000. For example, say you have $350,000 in savings and want it all to be insured. You could deposit $250,000 into one bank, and the remaining $100,000 into another bank that is FDIC insured.
One thing to be cautious about is not spreading out your deposits across banks that fall under the same umbrella organization. For instance, you might spread $350,000 across two different financial institutions, but both are part of JPMorgan Chase, which is only one bank.