DEFINITION of 'Risk-Based Deposit Insurance'

Deposit insurance with premiums that reflect how prudently banks behave when investing their customers' deposits. The idea is that flat-rate deposit insurance shelters banks from their true level of risk-taking and encourages poor decision-making and moral hazard. Although not all bank failures are the result of moral hazard, risk-based deposit insurance is thought to prevent bank failures. Banks that have a higher risk exposure pay higher insurance premiums.

BREAKING DOWN 'Risk-Based Deposit Insurance'

The Federal Deposit Insurance Corporation (FDIC) Improvement Act of 1991, passed in the aftermath of the Savings and Loan crisis, required the FDIC to switch from a flat-rate deposit insurance program to a risk-based deposit insurance program by 1994 (it actually made the switch on January 1, 1993). The FDIC uses the deposit insurance premiums it collects from banks to fund the Federal Deposit Insurance program. This program protects consumers by insuring deposits of up to $250,000 at member banks in the event of bank failure.

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