Why is Canada's deposit insurance lower than the U.S.?
It would be very difficult for Canadian banks to feel the same issues as U.S. regionals: Paul Harris
Amid the fallout from the Silicon Valley Bank (SVB) failure, experts say the discrepancies in deposit insurance seen across Canada and the U.S. are indicative of the different banking environments.
In the U.S., bank deposits are protected through the Federal Deposit Insurance Corporation (FDIC). The FDIC insures bank deposits up to US$250,000 per account ownership category for each depositor at an insured institution.
In Canada, bank deposits are protected by the Canada Deposit Insurance Corporation (CDIC), which is a federal Crown corporation that safeguards over $1 trillion in bank deposits. The CDIC insures bank deposits at member institutions up to $100,000 per each issued category.
Laurence Booth, a professor of finance at the University of Toronto, said in a phone interview Wednesday that deposit insurance serves two main purposes. The first is to reduce the risk of a bank run.
“By a run, we mean depositors just pulling their money out and putting it in another bank. So that can destabilize the financial system, [and] that risk is greater in the United States than it is in Canada because they've got thousands of banks,” Booth said.
“In Canada, we're talking about six big banks, basically having a systemic risk to the economy.”
The second purpose is that deposit insurance provides incentives for people to use smaller banks, according to Booth, which spurs competition in the banking industry.
“A lot of the smaller banks in the United States probably wouldn't be able to access that much capital in deposits, unless there was deposit insurance. So it encourages the creation of small banks in the United States and encourages competition amongst those banks,” he said, adding that this is not a concern for Canada.
“We don't have either of the two major reasons that are usually given for deposit insurance.”
Booth added that the U.S. has a “vastly different” banking system than Canada.
Trevor Tombe, a professor of economics at the University of Calgary, said in a phone interview Tuesday that Canada has changed its deposit insurance threshold “at several points in our history.”
The current CDIC deposit insurance threshold of $100,000 was initially put in place in 2005.
According to Tombe, there is no “right or wrong” amount of funds that should be protected, only trade-offs.
“The trade-off here is that deposits are a way for banks to borrow money rather than selling bonds or the regular way that you would access credit markets. If you had no limits, then you would have a way for banks to effectively borrow money that is to the lender entirely risk-free,” he said.
The intent behind deposit insurance is to counteract that “risk-free” method for banks to effectively borrow through deposits and to protect bank customers, Tombe said.
“The higher you make that limit, the more you're creeping away from its core mission,” he said.
This story has been updated to clarify the CDIC's insurance coverage.