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How the FDIC pays for bank failures

Barely a day has gone by during the past several weeks without a mention in the news of the FDIC, the agency that is best known for handling the disposition of the assets of failed banks and making sure consumers receive their insured deposits.

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To date, failures due to the current crisis in the financial world haven't caused undue concern. But the size of some of these institutions, such as IndyMac, have some people wondering how much the FDIC can handle before it needs a bailout.

The FDIC doesn't receive any tax dollars; instead it's funded by the premiums paid by banks and thrifts for insurance coverage on deposits. Its deposit insurance fund is really just an accounting entry with the Treasury Department.

FDIC promises security
Christopher Whalen, co-founder and managing director at Institutional Risk Analytics, as well as a writer and former investment banker, says the FDIC will always be able to reimburse customers for their insured deposits.

"The FDIC is like any federal agency; the government runs on cash. Money comes in and money goes out and each of these little funds gets a piece of paper that says I owe you money plus accrued interest. But really, in most cases, it just evidences legal authority to spend money. In the case of the FDIC, it merely evidences funds paid in by the industry, minus losses. But it's still just a theoretical balance because it doesn't reflect at all the cash available to the agency to fund resolutions."

As long as the FDIC has a positive balance in the fund, the agency is just asking for the industry's money back. If that money is gone, the FDIC runs a tab at the Treasury because, by law, it has borrowing authority.

Unlimited borrowing authority
Traditionally, the FDIC's borrowing authority at the Treasury is limited to $30 billion, but Congress bestowed unlimited borrowing authority temporarily as part of the Emergency Economic Stabilization Act of 2008.

The deposit insurance fund is currently at 1.01 percent, meaning it has $1.01 for every $100 of insured deposits. The law requires that the fund is maintained at a level of at least 1.15 percent. The FDIC is required to submit a restoration plan detailing how it will bring the deposit insurance fund above the minimum within a five-year period when the fund slips below the required level.

The agency has just submitted a restoration plan and is proposing to raise premiums beginning Jan. 1, 2009. The premiums are risk-based and banks are currently paying anywhere from 5 basis points to 43 basis points. The agency wants to raise that uniformly by 7 basis points. A basis point is one one-hundredth of a percent.

Next: "Unsecured borrowings can ... decrease the cost of bank failures ..."
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