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How Deposit Insurance Came to be and Why It’s Necessary

If you’ve walked into the branch of a Canadian bank, you’ve probably noticed a red sticker on the window. That sticker tells the public that the financial institution is a member of the Canadian Deposit Insurance Corporation (CDIC), a government-run organization. The CDIC guarantees the deposits of member institutions in the event that there’s a bank failure.

Deposit insurance explained

Every day, Canadians put money in the bank. It might be their paycheques, it could be their Canada Pension Plan payments, or even wedding gifts. In all cases, they’re entrusting their wealth with the bank.

What does the bank do with this money? For the most part, it doesn’t just sit on it. Banks are in the business of borrowing at lower rates of interest (i.e., the interest they pay to the depositor) and then lending that money out at higher rates of interest. In this regard, the bank functions as a sort of intermediary between people who are savers and those who are borrowers.

On the one hand, this arrangement makes a lot of sense. Depositors get some interest and people are able to borrow. But for the depositor, it poses two potential problems. First, what if some of the borrowers can’t pay back their loans? Does that mean some of the depositors might not get all their money back? In addition, there’s the simple fact that because most deposits are loaned out, if every depositor wanted their money back, the bank wouldn’t have the necessary funds on hand.

Deposit insurance aims to solve both of these issues. By having a third party (usually the government) guarantee deposits, savers are given comfort that their money is protected in the event the bank fails. This way, even if the bank becomes insolvent due to borrowers defaulting, bank depositors won’t be affected. In addition, deposit insurance helps to solve the problem of bank runs. Because each saver knows that their money is guaranteed by the government, there’s no sense in withdrawing money in a panic.

The history of deposit insurance

Various forms of deposit insurance existed prior to the U.S. Civil War, but it was the Great Depression in the 1930s that really made it more prominent. In 1933, bank runs and a severely worsening economy forced the closure of thousands of U.S. banks. In response, U.S. President Franklin D. Roosevelt signed into law a bill creating the Federal Deposit Insurance Corporation (FDIC). The FDIC guaranteed the deposits of member institutions up to a set amount per customer (US$2,500 at the time, and US$250,000 today). The Canadian version of the FDIC (the CDIC) was created in 1967. Since its founding, 45 of its member institutions have failed, the last being Security Home Mortgage Corporation in 1996.

Deposit insurance and you

If you have savings at a Canadian bank, you’re almost assuredly covered by deposit insurance. If the institution is a federally regulated bank, the CDIC provides the insurance. In the case of credit unions (known as caisses populaires in Quebec), separate insurance is provided by a provincial fund.

How much are you covered for? With a credit union, it depends on the province, but according to the CDIC, depositors are insured for up to $100,000 for each of the following:

  • Savings held in one name (personal, business or other organization)
  • Savings held in more than one name (joint deposits)
  • Savings held in trust
  • Savings held in an RRSP
  • Savings held in a RRIF
  • Savings held in a TFSA
  • Money held for paying realty taxes on mortgaged properties

What counts as “savings”?

Again from the CDIC website, here’s what’s covered:

  • savings accounts and chequing accounts
  • GICs or other term deposits with an original term to maturity of five years or less
  • money orders, certified cheques, travellers’ cheques, and bank drafts issued by CDIC members
  • accounts that hold realty taxes on mortgaged properties

Note that only Canadian dollar accounts are insured. So, for example, a U.S. dollar GIC is not CDIC-backed.

Spreading your risk

Given that the CDIC guarantees each of these accounts for up to the maximum amount, it’s not a bad strategy to spread your money amongst them just in case. For example, rather than putting $200,000 in one savings account, you might consider placing $100,000 with two separate banks. It’s unlikely to be an issue, but it may help you sleep better.

From insurance to interest

If you have savings and are looking to earn some more interest, can help. You can find the best GIC rates in Canada, in addition to the best high-interest savings accounts. Deposit insurance has you covered and we do, too.

Flickr: Rob Pongsajapan