I understand the concept of moral hazard. If a government guaranteed all bank deposits 100%, bank customers would simply go to the bank with the highest interest rates and rely on the guarantee that they couldn't lose anything. It guarantees 100% up to some (relatively) small limit (£85,000 in the UK) , because private individuals and very small businesses aren't in a position to judge how sound a bank may be.
However, it seems very harsh to destroy a small or start-up business should its bank fail, and the business suffer a complete loss of its capital. Also, that's not good for the wider economy, and perhaps might trigger a much wider financial crisis.
Why don't governments guarantee a fraction of larger deposits? Say 90%. It seems to me that a business which cannot survive a 10% "haircut" is a business that was probably headed for bankrupcy in the near future anyway. A better business would be able to keep going, and either modify its spending plans, or seek replacement funding for the 10% lost in the failed bank. But there would be no "moral hazard", because no business would want to risk 10% for the sake of a small fraction of a percent in interest. It would check the financial state of its banker to the best of its ability (which for a small business, is somewhat limited!)
Also, is the 100% guarantee up to a limit wise? Would making it 99% or 95% cause any systemic instability? I was once personally rescued when the Icelandic banks collapsed. I was astounded that I actually got back the interest I had been promised, as well as my capital. I'd have almost-happily accepted losing a few percent interest.
(90% is an arbitrary fraction I plucked out of the air.)
This question obviously prompted by the recent failure of SVB.
