Overview
The Federal Deposit Insurance Corporation was established by Congress as a measure to combat the negative effects created by a run on a bank. Liquidity is a key concern of banks. Banks need to have enough enough liquid assets to meet the redrawal requests of its depositors. However, to be profitable, a bank must invest some of its deposits in assets that are not liquid, such as customer houses or busiesses.
When fear grips a community about the bank's solvency, depositors may rush to withdraw their money from the bank. This create the condition known as a run on the bank. Even solvent banks cannot survive a run, the rumor alone can cripple the bank.
The FDIC was created to provide insurance for bank customers for their deposits. That is, the federal government guarantees the depositors money, up to a certain limit. This tends to prevent a run on the bank.