The Procyclicality of FDIC Deposit Insurance Premiums

Abstract

A broad awareness exists about the potential procyclical effects of FDIC deposit insurance premiums. Despite the importance of the topic, however, empirical study on the link between procyclical insurance premiums and bank performance has been limited due to identification challenges. In this paper, we examine empirically the procyclical effect of FDIC insurance premiums by exploiting unique changes to premium rate schedules set by regulatory agencies during the financial crisis. Using confidential FDIC data on bank risk to remove the effect of premium changes driven by bank endogenous factors, we examine the effect of changes in deposit insurance premiums that are plausibly exogenous to the performance of an individual bank. Using credit unions as a control group, which are not subject to the same deposit insurance premium regulations as banks, we estimate the effect of deposit insurance premiums on bank lending. We document empirically a procyclical effect of deposit insurance premiums on bank lending during the crisis and show that community banks are disproportionately affected by this mechanism. Our study provides some of the first, large-scale evidence on the procyclical effects of deposit insurance premiums while also highlighting the importance of countercyclical deposit insurance policy.

Keywords: FDIC, deposit insurance, procyclicality