As the result of the projected approximately $8 billion loss to the FDIC associated with the IndyMac failure and the widely publicized fact that the FDIC fund is now running low, concern has turned to its capacity to handle another large bank failure. An AP article suggested that the FDIC may be running out of funds, while Institutional Risk Analytics indicates that the FDIC essentially has unlimited access to taxpayer funds through the Treasury.(2) Sheila Bair, FDIC chairperson, in a July Newsweek interview, indicated that she didn’t anticipate any unusual need for funds. However, prudent contingency planning suggests the “What if” question is a reasonable one.(3)
How can the FDIC get additional funds if it needs them? There are two different circumstances under which the FDIC might need funds. The first is when the FDIC’s designated reserve ratio (DRR) falls below the required minimum and/or its resources are insufficient to pay projected claims. The second is when the FDIC has sufficient resources but simply needs working capital, or liquidity, because it can’t get rid of assets quickly enough to obtain the necessary funds to meet its insurance obligations.
Regarding the first circumstance, the Federal Deposit Insurance Corporation Improvement Act of 1991 significantly changed the FDIC’s funding structure, placing the equity of the entire banking system as the first line of defense against losses. In particular, whenever the ratio of the insurance fund balance to estimated insured deposits falls below the statutory Designated Reserve Ratio (DRR) of 1.25%, the FDIC must raise premiums or levy a special assessment to bring the ratio above the DRR within a year, or levy premium charges that average 23 basis points until the fund has been replenished. This effectively gives the FDIC a draw on the entire equity of the insured banking system, and it is noted that 98% of the industry remains adequately capitalized. At the same time, it stretches credibility to believe that the FDIC or the government would actually exhaust the banking system’s equity before seeking other sources of funds. But right now, there is no clear indication in the law when that point is reached or when the FDIC’s borrowing rights are triggered.
Sections 14 and 15 of the FDI Act govern the extent and terms of FDIC borrowing authority. Section 14 as amended extends the FDIC’s emergency borrowing privilege from the US Treasury, with the consent of the Secretary, from $5 billion to $30 billion when funds are needed to meet its insurance needs.(4) Funds are to be advanced at an interest rate no less than that for a Treasury obligation of comparable maturity. The Corporation may also borrow from (issue debt) from insured depository institutions, but such borrowings count against the $30 billion that the FDIC is authorized to borrow from the Treasury, presumably on the fact that the FDIC’s debts are backed by the full faith and credit of the government..
Finally, the FDIC is also authorized to borrow both from the Federal Home Loan Banks and, most significantly, from the Federal Financing Bank, subject to certain limits. Borrowing from either organization may not exceed the sum of the $30 billion line of credit from the Treasury, the estimated value of the Corporation’s cash, cash equivalents and investments, and 90% of the fair market value of any assets resulting from its case activities.
The practical implication of these provisions is that the FDIC has the ability, by judiciously managing its borrowing authority, effectively to obtain the operating funds it needs from the US Treasury, the Home Loan Banks, and the industry. As the number of failed banks and the assets the FDIC acquires increases, so does its borrowing authority, subject to the 10% haircut. In addition, the taxpayer is protected from losses to the extent that the banking industry is able to fund any losses incurred by the fund as reflected in the 10% haircut. What remains unclear is (a) what circumstances would trigger borrowing from the Home Loan Banks, (b) how great the losses would have to be before borrowing from the Treasury would be required, (c) what practical limits exist to the capacity of the banking industry to absorb the losses imposed upon it, and (d) what happens when the losses imposed upon the banking industry impair the capital adequacy of a significant number of banks.
As for the difference between the views expressed in the aforementioned AP article and those in the Institutional Risk Analytics commentary, the capacity to borrow is clearly much greater than the $30 billion draw on the Treasury; but there are also critical limits – at least under existing law – to that borrowing, which ultimately are contingent upon the willingness of the government to impose and the ability of the banking system to absorb losses.
(1) Helpful comments were offered by Diane Ellis and Mathew Green from the FDIC, but any errors or omissions belong to the author.
(2) (This link is no longer available on the original website) AP STORY IS WRONG — THE FDIC IS NOT RUNNING OUT OF MONEYwww.rcwhalen.com
(4) See http://www.fdic.gov/regulations/laws/rules/1000-1600.html.