Each depositor insured to at least $250,000 per insured bank

The story of banking in the U.S. is fast becoming a tale of two industries. At one end are the dozen or so large complex banking organizations whose size is measured in the hundreds of billions. At the other end are thousands of community banks, typically less than one billion dollars in assets. Since 1985 the number of community banks declined by half, from over 14,000 to just over 7,000 today. In 1985, the top ten banking organizations held 16 percent of industry deposits. Today, their share is 40 percent.

This consolidation trend suggests the largest institutions may grow even larger and community banks will continue to decline in number. This trend will ultimately pose some significant questions for policymakers, and will have a profound impact on how we administer the safety net for the regulated financial services industry.

It seems appropriate to explore a "two-tiered" approach to bank regulation, supervision, and safety-net arrangements. Elements of a two-tiered approach are already in place, with Basel II capital rules, regulations that provide exemptions or require less reporting for smaller banks, failure-resolution rules that allow for extending safety-net protections for banks that pose systemic risks, and so forth. The question is, should we go farther?

The FDIC has long argued that building a deposit insurance fund in advance of problems is beneficial, since it ensures that financial resources are available and thereby makes forbearance less likely when problems arise. It's not clear that this argument is valid when applied exclusively to the largest banks, since it seems unlikely we could build a fund large enough to address severe problems at any of these institutions.

One option is to consider an ex post funding arrangement for the largest institutions. Instead of an insurance fund, this approach would result in a pre-specified set of rules and obligations for the members of this group to fund any insurance losses going forward.

Another option is to recast deposit insurance for the largest institutions so that it applies to just a subset of the overall organization. The notion is to limit the scope of deposit insurance protection by linking up the insured deposits in an organization with an appropriate subset of assets. This carve-out from the larger organization (Narrow bank) becomes the insured institution, and all other parts of the organization would be disconnected from deposit insurance as well as the associated costs and constraints.

Finally, we might explore the role for market instruments in measuring and managing FDIC risk exposure, especially large-bank exposure. Private sector firms handle this in different ways. Some purchase catastrophe insurance. Banks and insurance companies use market instruments like credit derivatives, catastrophe bonds, and reinsurance contracts. The pricing of similar instruments used by the FDIC has the potential to provide us with valuable information on the market's view of deposit insurance risks.