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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.

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  • $\begingroup$ A business can presumably afford to buy insurance against bank failure, right? $\endgroup$
    – user253751
    Mar 15, 2023 at 18:43
  • $\begingroup$ @user253751 Can all businesses obtain such insurance? I'm thinking of start-ups and small businesses, not large ones. I haven't heard of it, but I'm not running a business. $\endgroup$
    – nigel222
    Mar 15, 2023 at 18:46
  • $\begingroup$ I'm told that insurance companies will insure you against all sorts of things, for a price. As an individual you are mostly buying pre-packaged options but if enough money is involved, they'll run the numbers and quote a price for a custom contract just for you. $\endgroup$
    – user253751
    Mar 15, 2023 at 18:52
  • $\begingroup$ No business has the majority of its assets in deposits. Many medium sized companies anyhow have accounts at different banks. There is also little risk for a wider financial crisis if some small startups fail because one bank fails. It's the same if a business fails because it's largest trading partner fails. At the end of the day, you cannot and shouldn't guarantee everything for everyone. $\endgroup$
    – Alex
    Mar 16, 2023 at 8:12
  • $\begingroup$ @Alex I believe start-ups may have a significant part of their assets in cash. They've raised cash by selling equity, and intend to live off the cash while developing and/or marketing the product. $\endgroup$
    – nigel222
    Mar 16, 2023 at 16:27

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Usually the government effectively guarantees 100% of deposits anyway when push comes to shove. For example, with SVB, the US government quickly came out with a statement that depositors will be made whole, even though the FDIC only formally guarantees a certain amount.

Why the de jure guarantees can differ from de facto guarantees can have multiple reasons, including budgetary limits and political considerations. The trade-off between bad long term effects of moral hazard and bad short-term effects of self-fulfilling bank runs could also play a role, though I think this is not the main reason.

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