This is a scheme run by either a government agency or a private company which aims to insure the deposits of private investors in case a bank goes bankrupt.
The advantage of deposit insurance schemes is that they can prevent individuals and firms from losing their savings. Also, the security of having deposits insured prevents ‘bank runs’ where a panic about the solvency of banks can lead to queues of people wanting to get their money out.
Deposit Insurance and Moral Hazard
The problem with deposit insurance is that can encourage moral hazard. This involves banks taking greater risks because of the security of government bailouts. It can also encourage firms/individuals to deposit with risky (high interest bearing banks). Thus banks may have to take a riskier strategy to attract customers
Deposit Insurance in the US
The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the United States government that protects the fund’s depositors place in FDIC-insured institutions The standard insurance amount currently is $250,000 per depositor. The $250,000 limit is permanent for certain retirement accounts, which includes IRAs. The $250,000 limit is temporary for all other deposit accounts through December 31, 2013. On January 1, 2014, the standard insurance amount will return to $100,000 per depositor for all account categories except certain retirement accounts, which will remain at $250,000 per depositor.
Deposit Insurance in the UK
The financial services compensation scheme covers the first £50,000 of any claim. FSCS