How secure is the FDIC?
Filed under: Banks
Recent bank failures have required the Federal Deposit Insurance Corporation to make payments to depositors. The FDIC is called in when a bank fails and can't give depositors the cash in their bank accounts. A lot of focus has been on the limits of FDIC insurance, so that depositors are protected. But there hasn't seemed to be as much focus on the actual ability of the FDIC to pay claims.Bankrate.com has a nice article about the FDIC and how it works. The agency is funded with insurance premiums paid by banks for the coverage on their deposits. Can the FDIC run out of money to pay depositors? Yes, the agency could be giving out more than it's bringing in from insurance premiums. But if that happens, the FDIC can borrow money which would be paid back via future collections of insurance premiums paid by banks.
Funds at the FDIC are currently lower than legally allowed. The law requires it to have $1.15 on hand for every $100 of insured deposits sitting in banks. Currently, it has only $1.01 for every $100 of insured deposits. How will this difference be made up? The agency is trying to raise insurance premiums for 2009, so that increase along with a hope that other banks don't fail (further depleting cash reserves) will help the FDIC bring its cash balance back up.
In my opinion, though, one other thing may cut into that reserve ratio. Consumers have become more conscious of the FDIC insurance limits available to them, and they may be more careful to ensure that their deposits are covered. So the total insured deposits could go up as a result of consumers shuffling money to make previously uninsured deposits now be insured.
The FDIC doesn't want consumers to worry, however. The economic outlook in the banking industry is not nearly as bad as it was during the savings and loan crisis of 20 years ago. Only about 2% of banks are on the FDIC's watch list right now. Back in the 1980's, there were 12% on the list. the agency has $45 billion on hand right now, and it's confident that's plenty to make it through this difficult time.
I'm not worrying about the status of our banks. I think cash in banks is secure for now, and there are bigger concerns for consumers, such as the value of their retirement accounts. Consider your cash safe, and worry about the other stuff, like how to bring in a bit more income and reduce your expenses during these uncertain times.
Tracy L. Coenen, CPA, MBA, CFE performs fraud examinations and financial investigations for her company Sequence Inc. Forensic Accounting, and is the author of Essentials of Corporate Fraud.
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Reader Comments (Page 1 of 1)
10-11-2008 @ 1:15AM
Pascal said...
I feel that all the news and discussion on the topic is ignoring a significant loophole in FDIC's insurance construct that might have a significant impact down the road. As you know, the insurance limit applies on a per bank basis. So if you had $500k, you could go to 2 banks and get your money fully insured. Similarily, if you had $50mm, you could go to 200 banks and be fully insured.
There are several middlemen in the market place that exploit this construct to profit themselves. Examples are the brokered CD desks of several investment banks, The Reserve (whose money market funds were the first to break the buck), and Promontory Interfinancial Network.
These middlemen's business model arbitrages the credit rating of a US Government Agency (FDIC) and increases FDIC's overall liability by increasing the size of insured deposits in the banking system. Wealthy and institutional customers benefit immensely because they are able to obtain Bank CD type rates on up to hundreds of millions of their money while taking US Government credit risk. Indeed, historically they have been able to pick up hundreds of basis points over Treasury rates.
The increased liability to the FDIC is paid for by the banks in the form of higher FDIC premiums. Banks, in turn, pass on the FDIC premium cost as well as the cost that the middleman charges to their customers in the form of lower interest rates and/or fees. Again, wealthy and institutional customers have more leverage with banks and are more sensitive to rates and fees, therefore the cost is disproportionately transferred to the average customer. And if FDIC runs out of its fund, then the taxpayer will be stuck with the cost.
The net result is that these middlemen significantly increase the liability of FDIC as well as transfer wealth to wealthy and institutional investors from average bank customers. Given that there are hundreds of billions of dollars in these programs, it is significantly increasing FDIC's liability and creating a substantial burden for average bank customers that don't keep more than $100,000 at banks.
The middlemen also have a significant 'moral hazard' problem because they are likely to provide funding for banks that are most desperate and thus willing to pay highest rates in the market place. However, unlike normal credit extension, there are no credit checks or collateralization because the risk is borne by FDIC. Astonishingly, these entities (except for brokered deposit desks) are not even regulated by any banking regulator.
This is another clear cut case of "Public Risk, Private Gain". Anyone remember Fannie, Freddie?
I wish this issue would be brought up in the discussions now because it has the potential to grow into a huge problem down the road.
Reply
10-11-2008 @ 11:41PM
Daniel Lovejoy said...
It is as safe as AIG.
Reply