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.

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.

The sting of those premium increases will be offset to some extent by the Federal Reserve’s announcement that it will pay interest on the reserve funds that banks are required to maintain. The Fed had been slated to start paying interest on reserves Oct. 1, 2011. The Stabilization Act moved that date up to Oct. 1, 2008.

Furthermore, in the second quarter of 2009, the FDIC wants to increase assessments to institutions that rely heavily on secured liabilities and brokered deposits.

“It would include charging banks more if they have brokered deposits or secured borrowings, and then possibly giving banks a little extra credit if they have unsecured borrowing,” say David Barr, FDIC spokesman. “Unsecured borrowings can actually decrease the cost of bank failures because the losses associated with the failure are shared with the unsecured debtors.”

In addition to raising premiums and the previously mentioned borrowing authority which is, essentially, a line of credit at Treasury, the FDIC has a second line of credit at Treasury that can be called upon, Barr says.

“We have a separate borrowing authority for what we call working capital. When banks fail, the FDIC retains assets from those banks. These tend to be illiquid assets such as physical properties or hard-to-sell loans. Since a lot of our money could be tied up in these illiquid assets, we have borrowing authority from the Treasury for working capital. It’s meant to be short-term borrowing and it would be repaid as the FDIC sells the assets.”

Not the worst banking crisis

As awful as the overall financial picture is today, the situation in the banking industry was considerably more dire 20 years ago during the savings and loan crisis.

There are 117 banks on the FDIC’s current “watch list;” about 2 percent of the FDIC-insured banks nationwide. In 1987 there were 2,165 institutions, or 12 percent, on the list. There have been 13 bank failures so far this year. In 1989, 534 institutions failed.

Institutions on the watch list are in financial trouble and are receiving increased scrutiny by the regulatory agencies. It’s important to note that, historically, only about 13 percent of the banks on the list have failed.

“We were in triple-digit bank failures for four or five years (back then) and we’re still here,” says Barr. “The FDIC, and the banking industry, is facing this economic downturn from a position of strength. Ninety-eight percent of the banks are well capitalized. That’s the highest level of capital in the regulatory arena.

“At one point we had $52 billion in our insurance fund. That’s the most we’ve ever had to help resolve troubled institutions. It’s down to $45 billion but that’s taking into account Indy Mac, Washington Mutual, and Wachovia (original agreement with Citi). So, getting those behind us and still having $45 billion, that’s a strong position and we’re going to bolster it by proposed premium increases. We’re here to protect depositors — it’s what we’ve been doing for 75 years. Not a single customer has lost a penny of insured money and they never will.”

The moral to this is, don’t worry about the FDIC. Just make sure that your deposits are insured.