In American depository institutions, two major agencies are concerned with the provision of deposit insurance to depositors. They are the Federal Deposit Insurance Corporation and the National Credit Union Administration. While the former is a corporation established by the U.S. government to offer deposit insurance to depositors in American commercial banks and savings banks, the latter is designed to regulate and insure credit unions.
The Federal Deposit Insurance Corporation, FDIC for short, was launched in 1933 by the Banking Act that was enacted during the Great Depression to restore trust in the American banking system. Before introducing the FDIC, over one-third of banks had failed, and bank runs were rampant. However, since its launch, no depositor has ever lost a penny of funds insured by the FDIC because it is fully backed by the full faith and credit of the U.S. government.
Since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2011, the FDIC-insured deposits in member banks have increased rapidly from its initial $2,500 per ownership category to up to US$250,000 per ownership category. The major source of the FDIC’s reserves is the insurance dues of member banks. Interestingly, the FDIC also has a $100 billion credit with the United States Department of the Treasury. By the end of September 2019, the FDIC had already provided about 5,256 institutions with deposit insurance.
The FDIC performs several other essential functions, including examining and supervising various financial institutions to ensure safety and soundness, performing specific consumer protection duties, and managing the receiverships of failed banks.
There are various ownership categories, and they include the following:
- Single accounts
- Certain retirement accounts
- Joint accounts Revocable trust accounts
- Irrevocable trust accounts
- Employee Benefit Plan accounts
- Corporation/Partnership/Unincorporated Association accounts
- Government accounts
For the ownership categories above, a depositor’s total sum in accounts at a particular bank is added and insured up to $250,000. Therefore, a depositor’s money in any ownership category is insured independently of the insurance limit at each bank. For instance, if a depositor has $250,000 in each of the three ownership categories at each of two banks, he will have six different insurance limits of $250,000 each. Hence the total insurance covering would be 6 × $250,000 = $1,500,000.
You can trace the history of the FDIC to the Panics of 1893 and 1907 and the Great Depression of 1893-1933. From 1893 to the FDIC’s creation in 1933, 150 bills were submitted in Congress proposing deposit insurance. In 1933, President Franklin Delano Roosevelt signed the Banking Act of 1933. The Banking Act of 1935 made the FDIC a permanent government agency and provided permanent deposit insurance maintained at the $5,000 level, amongst other benefits. The insurance limit continued to grow from $2,500 in 1934 to $250,000 in 2008.
In 2010, a new division within the FDIC, the Office of Complex Financial Institutions, was created to focus on the expanded responsibilities of the FDIC by the Dodd-Frank Act for the assessment of risk in the largest, systemically important financial institutions (SIFIs). Interestingly, 2018 saw the goal of the FDIC to increase to 1.35% of total insured deposits become a reality.
Two different FDIC funds — the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) — were in operation between 1989 and 2006. Since these funds served the same purpose, there was a tight competition between them as banks juggle between the two depending on the one that offered better benefits, thus driving their prices overly high sometimes.
This uncontrolled rise in prices prompted the Chairman of the Federal Reserve at the time, Alan Greenspan, to criticize the system. They emphasized that the attempt to use government to implement two different prices for a single item can give rise to a situation where such price difference can only create efforts by market participants to make profits from the difference in prices — arbitrage trading. This critic resulted in the signing into law of the Federal Deposit Insurance Reform Act of 2005 by President George W. Bush in February 2006.
The FDIRA law became effective on March 31, 2006, and contains several technical and conforming changes to enforce deposit insurance reform, as well as several study and survey requirements, including the merging of the Bank Insurance Fund and Savings Association Insurance Fund into a single fund known as the Deposit Insurance Fund.
The FDIC is responsible for regulating the insurance funds; this is done by placing a premium on all the member institutions. The amount allocated to each institution is dependent on the balance of the insured deposits and the institution’s risk level. The FDIC uses the funds up for every failed institution in paying depositors their insured balances. This loss of funds is meant to be replenished using the failed institution’s or member premium banks’ assets. However, in a situation where the FDIC cannot meet the obligations after exhausting the insurance fund, it is offered a statutory $100 billion line of credit from the federal Treasury.
There are specific liquidity and reserve requirements that must be met before a member bank could benefit from insurance funds. To understand this, let us briefly classify banks according to their risk-based capital ratio, thus:
- Well capitalized: 10% or higher
- Adequately capitalized: 8% or higher
- Undercapitalized: less than 8%
- Significantly undercapitalized: less than 6%
- Critically undercapitalized: less than 2%
From the above, it can be deduced that a bank becomes undercapitalized at a risk-based capital ratio of less than 8%. The result is that the institution’s primary regulator would issue a warning to the bank. At below 6%, the primary regulator can change management and mandate the bank to take other corrective measures. Finally, at less than 2%, when the bank becomes critically undercapitalized, the chartering authority closes the institution and appoints the FDIC as the bank’s receiver.
Resolution of insolvent banks
When the state banking department or the U.S. Office of the Comptroller of currency ascertains that a bank has gone insolvent, they will close it and appoint the FDIC as its receiver. To perform the function of a receiver, the FDIC is obligated to protect the depositors and optimize the process of recovering funds for the failed bank’s creditors. This gives the FDIC a dual functionality — as a receiver and a deposit insurer — with unique rights, duties, and obligations.
As a receiver, the FDIC is required to market the failed institution’s assets, liquidate them, and distribute the proceeds to the institution’s creditors. It has the legal right to merge a failed institution with another insured depository institution and transfer its assets and liabilities without the consent or approval of any other agency, court, or party with contractual rights. Additionally, the FDIC may also form a new institution, such as a bridge bank, to take over the assets and liabilities of the failed institution. Finally, it may sell or pledge the failed institution’s assets to the FDIC in its corporate capacity.
Generally, to carry out its role as a receiver, the FDIC employs two methods, namely: Purchase and Assumption Agreement (P&A) and Deposit Payoff.
The Purchase and Assumption Agreement (P&A) involves the assumption of deposits by an open bank that buys the failed bank’s assets. These assets are sold via various means, including online and using contractors. On the other hand, the Deposit Payoff allows the FDIC, as the receiver, to pay off the failed institution’s depositors with the total amount of their insured deposits using insured funds. However, depositors without insured funds and other general creditors of the failed institution cannot receive instant or full reimbursement. Instead, they are given a receivership certificate that entitles them to a portion of the receiver’s collection of the failed institution’s assets.
Covered Insured Depository Institutions Resolution Plans
To resolve an insolvent bank, the FDIC requires the following resolution plans:
- Bank Holding Company (“BHC”) resolution plans required under the Dodd-Frank Act under Section 165
- Covered Insured Depository Institution (“CIDI”) resolution plan for U.S. insured depositories with assets of $50 billion or more.
- Resolution plan for the BHC that includes the BHC’s core businesses and its most significant subsidiaries and one or more CIDI plans depending on the number of U.S. bank subsidiaries of the BHC that meet the $50 billion asset threshold.
The CIDI guidance issued by the FDIC in December 2015 offers clarifies the assumptions that are to be made in the CIDI resolution plans and issues to be analyzed in the CIDI resolution plans.
The FDIC insures the following deposit accounts:
- Demand deposits and negotiable order of withdrawal
- Savings accounts and money market deposit accounts
- Time deposits, including certificates of deposit (C.D.s)
- Outstanding cashier’s checks, interest checks, and other negotiable instruments drawn on the accounts of the bank
- Accounts denominated in foreign currencies
Items not insured
The following products are uninsured, whether or not they are purchased through a covered financial institution:
- Stocks, bonds, and mutual funds, including money funds
- Investments backed by the U.S. government, such as Treasury securities
- The contents of safe deposit boxes.
- Losses due to theft or fraud at the institution.
- Accounting errors.
- Insurance and annuity products, such as life, auto, and homeowner’s insurance.