The last year has been particularly challenging for the FDIC. There is still another full month of 2009 to go and the bank closure list has already passed the 120 mark. In 2007 you could see details of the three bank closures in that year in a single glance at the FDIC’s Failed Bank List. Today you have to scroll a long way down this list online to view all the bank closure details.
FDIC Takes the Strain
From the FDIC’s perspective coping with this plague of bank failures has placed a heavy strain on their resources. In addition to maintaining their deposit insurance commitments, the process of winding up a bank is costly. In the best scenario, where the FDIC finds a bank willing to takeover the business of the failed bank, it still has to provide the acquiring bank with eighty percent coverage against the losses they might face from taking on the failed bank’s delinquent loans.
In June 2008, before the financial crisis had begun to have a serious impact, the FDIC Deposit Insurance Fund (DIF) held $55 billion and much of this was in liquid assets. Today, although the total size of this fund has increased to $63 billion, the portion of liquid assets has fell to $23 billion with no sign of the pressures on the DIF easing off. If no extra liquidity is added to the DIF, demands on liquidity in 2010 and 2011 will exceed assets. Therefore on November 12th the FDIC Board of Directors decided to obtain additional funds by requesting FDIC insured financial institutions to pay in advance estimated insurance assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012.
Cooperation Rather than Coercion
In a recent statement FDIC Chairman Sheila C. Bair expressed her appreciation for the way that the banks have shown themselves of one mind with the FDIC regarding the need for these pre-payments. She said that letters she received show that there is consensus in the industry that this is the preferred way to strengthen the FDIC’s cash position without impacting negatively on earnings in the industry. In her words: “… the FDIC and the industry are of the same mind: we will do whatever it takes to maintain the public’s confidence in insured institutions and we remain committed to maintaining the independence of the Deposit Insurance Fund through direct industry funding.”
The prepayments of the FDIC insurance assessments are scheduled for December 30, 2009 along with the standard assessment for the third quarter of 2009 that is also due on this day. The FDIC expects that the total amount raised is going to be about $45 billion. The banks are able to take this amount from a large reservoir of liquid reserve balances that currently stands at over $1.3 trillion. Thus Shelia C. Bair has no doubt “…we and the industry have more than enough resources” to meet all the commitments made to insured depositors.
Is This a Smart Move?
While it is understandable that the FDIC requires additional liquid assets to deal with financing bank closures anticipated over the coming year, not everyone is confident that their recent decision is the best one for the US economy. Concerns have been raised that the prepayment advance is going to put additional pressure on banks already in a fragile situation. The FDIC’s claims of banks having extra liquidity are disputed. These commentators express a preference for borrowing from the US Treasury since it would avoid putting extra pressure on the banks.
The FDIC defends their choice of financing options for two reasons. They argue that borrowing from the Treasury would be much more costly since the money would have to be repaid with interest. They also claim that they are giving due consideration to banks unable to make the prepayments by making exemptions where prepayment “…would adversely affect the safety and soundness of the institution.” Nevertheless they expect that very few institutions are going to require such special treatment.
In the survey the FDIC conducted most institutions preferred the prepayment financing option. This preference was based on the fact that the prepayments are going to be considered “a prepaid expense, which is an asset, and would not affect earnings.” An additional benefit is that the DIF is not going to incur the interest expenses involved in borrowing.