Is deposit insurance the real problem in banking?

Former Citibank CEO Sandy Weill garnered headlines last week when he said that the megabanks (one of which he created) should be busted up into smaller units.  Two WSJ columnists (Zweig and Jenkins) point out that size may not be the real problem -- instead, they argue, we need to take a closer look at deposit insurance. 

Currently the FDIC insures deposits up to $250,000.  Zweig quotes Rutgers economist Eugene White, who thinks the insurance could be cut back to a limit of $100,000.  This would protect the deposits of middle class investors, while forcing those with larger balances to pay more attention to the security of their deposits.  Bankers -- of all shapes and sizes -- would be less willing to take risks if they knew they could not count on the FDIC to bail them out with their depositors. 

Of course it would be hard, without full disclosure of compensation formulas and balance sheets, to know how risky a bank might be.  But maybe such info should be disclosed?

Bank runs coming to Europe?

A definite possibility, says Fortune columnist and former FDIC director Sheila Bair.  If withdrawals massively overwhelm deposits over a short period, bank reserves are depleted and, in the absense of deposit insurance, the last depositors in line are left with nothing.  Deposit insurance is designed to mitigate that risk and in the US it has largely served its purpose.  However, each country in Europe runs its own deposit insurance system and the ability of the Greek, Italian or Spanish governments to take on more debt to bail out their citizens is limited at best. 

A further complication: if a country such as Greece decides to leave the euro, it will end up converting all accounts to drachmas which will no doubt be worth much less than the euros they would be replacing.  Fear of such a currency conversion could in and of itself launch a bank run as Greeks move their assets to safer countries. 

Bair endorses the creation of a EU-wide deposit insurance fund.  We will see how this plays out over the coming weeks.