Silicon Valley Bank’s spectacular failure demonstrated a fatal flaw in the U.S. system of deposit insurance: The Federal Deposit Insurance Corp.’s coverage limit of $250,000 appears insufficient to prevent bank runs. But raising or eliminating this cap, as some commentators suggest, would create incredible moral hazard. Instead, the FDIC should reduce risk like an insurer would, by pricing it and spreading it around.

Deposit insurance is foundational to the American financial sector. In our fractional reserve system, banks lend out nearly all deposits. If depositors all show up demanding their money at the same time, there isn’t going to be enough on hand to satisfy everyone. Even a rumor could start a run, particularly given how quickly ideas can spread in the Twitter age.

Insuring bank deposits makes runs less likely by providing covered depositors peace of mind. But many depositors hold funds in excess of the FDIC’s deposit insurance limit. Businesses, in particular, will often need to keep more than $250,000 in a bank at any one time to meet payroll and pay other bills. If their bank seems unsteady, these depositors have every incentive to pull their money out.

Read more at The Wall Street Journal