The Reform of Federal Deposit Insurance

2009

The US deposit insurance system (managed by the Federal Deposit Insurance Corporation – FDIC) has been established in 1933 to ensure the safety of deposited money and the overall stability of the banking sector. Although over decades the system proved to be successful in accomplishing those goals, there were some discussions and efforts in the 2000s to reform it further. And indeed, it was reformed twice – in 2005-2007 and 2008-2009. But there was a fundamental difference between those reforms: the former had been carried out at a time of very good economic and financial conditions (strong economic growth, wealthy banking system, etc.) while the latter was prompted by a serious crisis situation (similarly like the reforms following the 1920-30s and 1980-90s crises). The paper is mostly related to the United States. It first outlines the main features of the US deposit insurance system prior to the recent reforms. Then, the paper presents the reasons and results of the 2005-2007 refo...

Carnegie-Rochester Conference Series on Public Policy, 1993

The current system of deposit insurance has a basic structural problem because *We thank the Carnegie-Rochester Conference participants, and especially 1 For a general overview of deposit-insurance reform, see Barth and Brumbaugh (1992), Barth, Brumbaugh, and Litan (1992), and Brumbaugh (1993). The specific analytical framework of our paper is developed in Merton (199213) Merton and Bodie (1992a,b and c). In the banking literature, the analytical approaches of Black (1985), Black, Miller, and Posner (1978), Gorton and Pennacchi (1992a), and Pierce (1991) are most closely aligned with the development here. 2We have discussed elsewhere deposit insurance as it relates to thrifts. See Merton and Bodie (1992b,c, Section 6). More generally, see J. Barth (1991) and Brumbaugh (1988). 3The thrust of policymaker thinking is often reflected in the titles given to government reports. Thus, the U.S. Treasury entitled its February 1991 detailed proposals for financial system reform, Modernizing the Financial System: Recommendations for Safer, More Competitive Banks. *As here, Diamond and Dybvig (1986) f ecus on the functions of banks. They, however, identify three core functions: (i) asset services, which is making loans; (ii) liability services, which is transaction clearing, providing currency and other means of payment (checks, cash cards); (iii) transformation services, which creates liquidity by buying illiquid loans and issuing liquid deposits. The role of banks in liquidity creation is discussed in Section 3. 5According to the Federal Reserve, at the end of 1990 the breakdown of the loan portfolio of U.S. commercial banks was: commercial and industrial loans 30%, real-estate loans 37%, consumer loans 19%, all other 14%. 'jFor discussion of the role of banks in the intermediation of asymmetric information, see Diamond (1984), Fama (1985), and James (1987). 7We use the term "opaque" here in the sense developed in depth by Ross (1989). "The trend in the recent past is for banks to invest in marketable debt instruments including securitized loans of other banks. To the extent they do so, they are becoming less like the institution we define as commercial banks. The bank assets that lend themselves to being securitized are the ones that are least opaque, such as credit-card and automobile loans. Corporate, commercial real-estate, and sovereign loans are not generally acceptable for securitization and, therefore, tend to stay on the balance sheet of the firm. For an extensive discussion of asset securitization, see the Fall 1988 issue of Journal of Applied Corporate Finance.

Journal of Financial Services Research, 1987

Unrecognized and deferred losses at insured deposit institutions currently impair the capacity of the nation's principal deposit insurers (the FDIC and FSLIC) both to discipline failing institutions and to discipline or take over insolvent ones. These agencies' accrued but unreported losses far exceed their explicit financial resources. Moreover, their backlog of unresolved problem cases far exceeds the workload that their existing staffs can handle. What holds the deposit-institution system together is financial-market participants' so-far-unshakable faith that politicians and bureaucrats cannot afford to let the FDIC and FSLIC renege on the obligations that they and their predecessors have permitted these agencies to assume. Underlying this belief is a conjectural economic assessment of the strength and constancy of incentives that direct elected politicians to bail out politically sensitive enterprises. This article addresses three tasks: (1) to clarify the defects in the information, monitoring, regulatory-response, and incentive sub-systems of federal deposit insurance that, by subsidizing institutional risk-taking, led so many deposit institutions and their insurers into economic insolvency; (2) to identify a generic mix of reforms that could in principle put the system right again; and (3) to explain how far proposals for reform that hold a place on the active legislative and regulatory agenda fall short of this ideal.

Proceedings, 1998

Conventional wisdom holds that the enactment of federal deposit insurance helped small rural banks at the expense of large urban institutions. This paper uses asymmetricinformation, agency-cost paradigms from corporate-finance theory and data on bank stock prices to show how deposit insurance could and did help stockholders of large banks. The broadening stockholder distribution of large banks during the stock-market bubble of the late 1920s undermined the efficiency of double liability provisions in controlling incentive conflict among large-bank stakeholders. Federal deposit insurance restored depositor confidence by asking government officials to take over and bond the task of monitoring managerial performance and solvency at U.S. banks. WHEN CONGRESS ENACTED federal deposit insurance in 1933, scholars understood it to be a tool for helping small banks and for restoring the liquidity of bank deposits. Still, Calomiris and White (1994, p. 164) note that by late 1931, representations of urban constituencies in "eastern states that had not supported deposit insurance for decades introduced federal deposit insurance bills." These authors argue that the severity of losses experienced in the early 1930s caused this switch, energizing small depositors into a political force strong enough to overcome unvarying large-bank opposition to deposit insurance. In their view, "small, rural banks and lower-income individuals (with small deposit accounts) were clear winners, while large, big-city banks, wealthy depositors and depositors in failed banks were losers." It was, of course, recognized that deposit insurance could also have incentive effects. At the outset, Emerson (1934) explained that deposit insurance would intensify risk-taking incentives at banks unless it was properly priced and principles of sound banking were consistently enforced. In the late 1960s, scholars began to argue that deposit insurance was mispriced (Scott and Mayer 1971) and had in fact fueled a massive reduction in stockholder-contributed bank capital (Pelzman 1970). But it was not until the onset of the 1989 FSLIC debacle that the profession came to appreciate the many and perverse ways that this substitution of subsidized government guarantees for stockholder-contributed capital at insured institutions shifted risks from owners to taxpayers. Valuable comments on an earlier draft were provided by Charles Calomiris, James Thomson, Larry Wall, and an anonymous referee.

Here the author proposes the Mutual Insurance Model with Incentive Compatibility (MIMIC). MIMIC is a model for deposit insurance that mimics the incentives and practices of a private-sector, mutual, insurance organization. The main features of MIMIC are: fully risk-based premiums, payments by the Federal Deposit Insurance Corporation (FDIC) to the U.S. Treasury Department (the Treasury) for its line of credit and "catastrophe insurance," rebates to banks when the reserve ratio exceeds a risk-based ceiling, surcharges on banks when the reserve ratio dips below a risk-based floor, dilution fees on deposit growth to maintain reserve ratio, and refunds to banks to maintain reserve ratio when their deposits shrink.

Journal of Banking & Finance, 1986

Journal of Financial Services Research, 1989

The federal insurance funds were designed to cover all insured deposits but lacked a rule specifying how these deposits would be covered if a crisis occurred that swamped either insurance fund. The Congress apparently accepted the argument that strict enforcement and regulation could be used to reduce the probability of failure and thereby avoid large losses to the insurance fund. This flaw in the federal deposit insurance system has permitted insolvent institutions to remain open. The very poor performance of these institutions has skewed aggregate thrift performance in recent years, masking the performance of solvent institutions. A protracted debate has ensued centering on the cost of resolving troubled thrifts and whether healthy thrifts can pay these costs. This debate has drawn attention away from the potential value of the thrift charter.

The Journal of Finance, 1981

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected].