(1) small depositors, in general, aren't in a very good position to evaluate the risk of a bank very well. So they won't be exerting much positive force on banks anyway.
(2) even if they could evaluate risk well they still wouldn't exert much pressure because that requires an organizing force (even if the aggregate amount of deposits is high)
(3) Understand that the FDIC is a nation-wide program and that the funds the FDIC pays out do not come from tax payers. They come from premiums paid by member banks. Banks get the money for the premiums by reducing the terms they offer depositors. That is, the banks directly, and depositors indirectly pay for the risk taken on by the banks directly and the depositors indirectly.
This breaks down at higher dollar amounts though because banks and depositors aren't really uniform, but at lower levels of money it's a good approximation. At higher levels of money, depositors and banks will apply increasingly sophisiticated measures to shift reward toward themselves and risk away. That is, they will find ways to work the system. At some level the insurance program becomes a way for more sophisticated players to profit less sophisticated players. A cap of $250K puts everyone at approximately the same level of sophistication and makes it harder to run some con at scale.
BTW, insurance for amounts higher than $250K is available. It's not that popular, though, because it's expensive. It's expensive, of course, because of the risk.
That all makes sense, though I would argue that many companies with an order of magnitude more than the FDIC limit aren't really that much more sophisticated, and certainly not enough to evaluate risk of catastrophic failure (as we have seen with SVB).
It seems then the logical alternative to insurance for these companies is to concentrate deposits at large, "too big to fail" type institutions. I'm not sure if that is something that would be good or bad for the economy as a whole, but definitely seems bad for smaller banks?
(1) small depositors, in general, aren't in a very good position to evaluate the risk of a bank very well. So they won't be exerting much positive force on banks anyway.
(2) even if they could evaluate risk well they still wouldn't exert much pressure because that requires an organizing force (even if the aggregate amount of deposits is high)
(3) Understand that the FDIC is a nation-wide program and that the funds the FDIC pays out do not come from tax payers. They come from premiums paid by member banks. Banks get the money for the premiums by reducing the terms they offer depositors. That is, the banks directly, and depositors indirectly pay for the risk taken on by the banks directly and the depositors indirectly. This breaks down at higher dollar amounts though because banks and depositors aren't really uniform, but at lower levels of money it's a good approximation. At higher levels of money, depositors and banks will apply increasingly sophisiticated measures to shift reward toward themselves and risk away. That is, they will find ways to work the system. At some level the insurance program becomes a way for more sophisticated players to profit less sophisticated players. A cap of $250K puts everyone at approximately the same level of sophistication and makes it harder to run some con at scale.
BTW, insurance for amounts higher than $250K is available. It's not that popular, though, because it's expensive. It's expensive, of course, because of the risk.