This post was authored by Salvatore M. Capizzi, Dunham's Chief Sales & Marketing Officer. If you have questions concerning today's topic, please call us at (858) 964 - 0500. Hold us to higher standards.

Key Takeaways

• FDIC insurance reduces panic—but it can also create moral hazard when depositors stop evaluating bank risk.
• Banks may take greater risks when they believe failures will be managed or absorbed through government intervention.
• Most bank failures protect insured deposits, but uninsured balances still face real risk.
• Financial advisors play a critical role in helping clients manage cash concentration and understand FDIC limits.

Does the Government Help or Hinder Moral Hazard

Have you ever considered how your client’s trust in the government could inadvertently fuel risky behavior—from them and from the very institutions “safeguarding” some of their assets?

As depositors, your clients’ confidence in government-backed insurance may encourage both depositors and banks to take on more risk than they otherwise would. Over time, this behavior can threaten the stability of the broader financial system.

There is a name for this dynamic: moral hazard.

In finance, moral hazard occurs when people take greater risks because they believe they will not bear the full consequences if something goes wrong.

And that brings me to why I am writing this article.

A Recent Bank Failure Puts Moral Hazard Back in Focus

On Friday, April 26, 2024, the Federal Deposit Insurance Corporation (FDIC) announced the seizure of Philadelphia-based Republic First Bank. Fulton Bank, headquartered in Lancaster, Pennsylvania, agreed to assume nearly all deposits and acquire virtually all of the failed bank’s assets.

Once again, the FDIC found a solution that resulted in no losses for insured depositors.

There were five bank failures in 2023, and Republic First became the first in 2024 - all with relatively clean resolutions. That stability is reassuring. But it’s also where caution is warranted.

This is where moral hazard enters the conversation.

Moral Hazard for Depositors: How FDIC Insurance Can Encourage Risk

For depositors, moral hazard shows up when they believe their money is fully protected—either through FDIC insurance or through the assumption that the FDIC will always find another bank to step in.

That belief can reduce vigilance.

In practice, this often leads depositors to:

• Concentrate large cash balances at a single institution
• Pay little attention to a bank’s balance sheet or risk profile
• Assume protection extends beyond formal FDIC limits

It’s similar to believing that eating one more slice of pizza has no downside because “nothing bad has happened before.” Moral hazard is the assumption that consequences don’t apply—even when risks are clearly present.

Moral Hazard for Banks: When Risk-Taking Has Fewer Consequences

On the flip side, banks themselves can face moral hazard.

When executives believe failure will be softened through mergers, guarantees, or intervention, it can encourage excessive risk-taking. That might include:

• Reaching for yield in longer-duration or illiquid assets
• Loosening underwriting standards
• Taking liquidity risk under the assumption it can be managed later

When decision-makers don’t fully internalize the downside, short-term gains can take priority over long-term stability—ultimately putting both depositors and the system at risk.

Adem Tumerkan wrote an outstanding article about the headwinds some banks face today. It is required reading if you want a perspective on this potential crisis developing.

FDIC Insurance Reduces Panic - but Not All Risk

Please understand I am not trying to create unnecessary alarm or panic. It is important to provide a fair and balanced perspective. According to MoneyWatch, the likelihood of losing money held at a bank is exceptionally low. They report that less than 7% of bank failures since the beginning of 2007 have resulted in losses for uninsured depositors.⁽³⁾

In my view, 7% is a reassuring number only when it is not your deposit over the FDIC limits that were not covered by FDIC insurance. Based on my research, there have been 567 bank failures since 2001, and 19 banks with no knight in shining armor saving depositors above the insurance limits.⁽⁴⁾

When the FDIC Can’t Find a Buyer

Now imagine being a depositor at a failed bank and reading this paragraph from an FDIC press release:

“The FDIC received no bids for the bank’s deposits. As a result, the FDIC will mail checks to customers for the amount of their insured deposits…”

If you hold balances above FDIC limits, this is not an abstract risk.

Deposit Flight: How Confidence Can Turn Into a Bank Run

Moral hazard and panic are closely linked.

When confidence is high, depositors stop paying attention. And when confidence breaks, deposit flight begins.

Deposit flight occurs when depositors rapidly withdraw funds from institutions they perceive as risky, which can:

• Drain liquidity quickly
• Force asset sales at unfavorable prices
• Turn a contained issue into a broader crisis

A Historical Reminder: How Moral Hazard Shaped Past Banking Crises

If, like me, you were in the business during the 1980s, you might recall the banking crisis that spanned from 1980 to 1994. The FDIC reports that during this period, 1,617 commercial and savings banks were affected and these institutions held $206.2 billion in assets. It led to the very first operating loss for the FDIC.⁽⁶⁾

The banking crisis spanning from 1980 to 1994 is a glaring reminder of the deep impact of moral hazard on the financial system's stability. This period saw numerous banks give in to risky lending practices and speculative investments, worsened by depositors' belief that all their funds were insulated from loss.

The lesson is that these events do happen and can happen again in the future.

What This Means for Financial Advisors Managing Client Cash

Moral hazard is not about predicting which bank will fail next.

It’s about structure.

As a financial advisor, your role is to help clients:

• Understand FDIC coverage limits and ownership categories
• Avoid excessive cash concentration at a single institution
• Maintain liquidity access outside any single point of failure
• Distinguish between feeling safe and being structured safely

One day, there may not be a bank willing to absorb a failed institution. And the FDIC may not extend protections beyond insured limits.

You do not want your clients learning that lesson from a press release.

How The Dunham Insured Marketplace Can Help

Help clients find bank programs that offer multi-millions of FDIC insurance, like the Dunham Insured Deposit Marketplace (IDM). This program has up to $50 million in FDIC Insurance and what we consider a highly competitive APY. It allows your client to spread their deposits among various banks, saving time for them to research and find several banks that will fully protect their banking assets. Learn more by clicking here.

Sources:

(1)    Bank Failure 2023 in Brief, by The FDIC, n/d, https://www.fdic.gov/resources/resolutions/bank-failures/in-brief/bfb2023.html#:~:text=There%20are%205%20bank%20failures,a%20month%20within%20the%20graph.

(2)   Bank Failures in 2024, by The FDIC, n/d https://www.fdic.gov/resources/resolutions/bank-failures/in-brief/bfb2024.html

(3)   Don’t worry too much about losing your bank cash. Bank-failure data don’t support panic over uninsured deposits, by Elanor Laise and Katie Marriner, April 21, 2023, https://www.marketwatch.com/story/dont-worry-too-much-about-losing-your-bank-cash-bank-failure-data-dont-support-panic-over-uninsured-deposits-219fc64

(4)   Bank Failures in Brief – Summary, by The FDIC, n/d, https://www.fdic.gov/resources/resolutions/bank-failures/in-brief/index.html

(5)   FDIC Approves the Payout of Insured Deposits of NextBank, National Association, Phoenix, Arizona, by The FDIC Press Release, February 7, 2002, https://archive.fdic.gov/view/fdic/2217

(6)   Banking Crisis of the 1980s, by John Summa, updated October 6, 2021 https://www.investopedia.com/articles/financial-theory/banking-crisis-1980s.asp#:~:text=According%20to%20the%20FDIC%2C%201%2C617,the%201980s%20and%20early%201990s.&text=The%20cost%20of%20the%20crisis,U.S.%20General%20Accounting%20Office%20estimated.

(1)(7) The Banking Crisis of the 1980s and Early 1990s : Summary and Explanation, by The FDIC, n/d, https://www.fdic.gov › bank › historical › history PDF

Disclosure:

This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance. All examples are hypothetical and are for illustrative purposes only.

If you participate in the IDM offered by Dunham Trust Company (“DTC”), DTC is acting as your agent. DTC also serves as custodian of the Custom Asset Allocation Programs and is an affiliated entity of Dunham & Associates Investment Counsel, Inc., (“DAIC”), a Registered Investment Adviser and Broker/ Dealer. Member FINRA/ SIPC. DAIC is the sponsor of the Dunham Asset Allocation Program.

The FDIC insurance limit for all insurable capacities in the IDM is $250,000 per program bank. The IDM program banks may be excluded from receiving program deposits in the event that total assets at a program bank (including assets that are held with the bank outside of DTC’s IDM) exceed the FDIC insurance limits. For example, if you have deposits in a bank through the program and also have made deposits at that bank outside the program, all of these deposits will count toward the FDIC limit. It is your obligation to monitor your account(s), your FDIC coverage and your FDIC insurance eligibility. See www.fdic.gov for more details regarding FDIC coverage. For more information on DTC’s IDM, please refer to the IDM Disclosure Booklet. If you would like to opt out from certain program banks, please speak to your advisor or contact Dunham at customercare@dunham.com .

Excluding a bank from holding your Insured Bank Deposit balances may result in a lower available program limit for FDIC insurance. The bank list is subject to change.

See the IDM Disclosure Booklet for details, limitations, and eligibility requirements to participate in the IDM.

*The Annual Percentage Yield (APY) and interest rate shown is available in IDM and is part of the Asset Allocation Program (“AAP”). It is subject to a program fee of 0.25% (“Program Fee”) charged to DAIC as the program sponsor of AAP and is an asset-based advisory fee ranging from 0.00% to 2.00% (“Asset-Based Advisory Fee”). The actual interest rate received will vary and is based on the actual advisory fee charged. The APY and interest rate quoted, with a minimum balance of $0.01, is current as of the date shown. This rate is variable and may change daily without notice. Interest rates paid on deposits held at DTC are determined at the discretion of DTC. The APY is a rate based on monthly compounding of interest and assumes interest is not withdrawn from the deposit account and no changes to the interest rate for one year. The interest rate may change at any time at the discretion of DTC.

For the IDM, the program interest rate is impacted by several factors, including the total amount paid on deposits by the program banks, the fee paid to DTC and a fee paid to a third party that assists DTC in operating the program. DTC determines the portion of revenue it receives as a fee. The fee paid to DTC will affect the interest rate and may exceed the amounts paid to clients in the form of interest. Neither the program banks nor DTC is required to offer the highest rates available or rates comparable to money market mutual fund yields. In contrast, money market mutual funds generally seek to achieve the highest rate of return consistent with their investment objectives, which can be found in their prospectuses.

DTC, at its discretion, may determine that your account is ineligible to participate in the IDM. IDM provides up to $50 million of FDIC insurance.

The deposit rates and annual percentage yields are variable and may change at any time at DTC’s discretion. They are effective as of the date shown above. Interest will be accrued daily and credited monthly.

Unlike the IDM, non-deposit investments held by your broker-dealer (such as DAIC), are NOT FDIC INSURED / NOT BANK GUARANTEED / MAY LOSE VALUE.

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