In theory a higher ceiling implies greater prevention accompanied with an increase in moral hazard. The tradeoff means that raising the deposit insurance ceiling to create more confidence induces bank managers to take on greater risks. Because of this, the FDIC must continually set up incentive compatible insurance structures. Other tasks of the FDIC include bank supervision and monitoring with respect to the regulatory dialect and resolution or liquidation of failed banks. FDIC failure prevention policies and procedures are subject to several criterions. These criterions include the FDIC's treatment of insured depositor's verses uninsured depositor's keeping the confidence of the people in the banking system, and choosing methods that ensure market discipline. Taking this into account, the FDIC currently uses two methods for liquidating failed banks. Under a purchase and assumption transaction the FDIC will auction off a failing institution to a healthy one to restore stability in the banking industry. When this is not possible the FDIC will just use a deposit payoff to reimburse insured depositors.
Originally, deposit insurance was financed though a flat-rate premium. This premium structure meant that all banks paid the same premium for FDIC coverage regardless of the risk it brought to the fund. Theoretically, this type of structure would give rise to moral hazard increasing the chance of bank failures. Since weak banks pay the same premium as healthy banks the have more incentive to make risky investments to increase profit. This was not really a problem though until the 1980's. Before the Depository Institution's Deregulation and Monetary Control Act of 1980, banks were heavily regulated in the activities they could engage in. For example, Regulation Q put interest-rate ceilings on many deposits and banks also had portfolio restrictions prohibiting them from holding securities.