Deposit Insurance Outline

Deposit Insurance

1. In General

   1. Deposit insurance shifts to the government huge potential risks - risks that the private sector would otherwise bear.

      1. By inhibiting market discipline of banks, deposit insurance creates incentives for excessive risk-taking and impels government to protect the taxpayers through safety and soundness regulation

   2. Purposes:

      1. (1) Protect depositors and (2) systemic risk (i.e., protect the financial system)

   3. Basic Principles re Design of Deposit Insurance

      1. (1) Deposit Insurance should enhance macroeconomic and financial stability

      2. (2) Deposit Insurance should prevent most bank runs

      3. (3) Deposit Insurance should be designed to minimize microeconomic distortions (other than the incentive to run)

      4. (4) A publicly-funded deposit insurance system should neither subsidize nor tax the banking system

      5. (5) Deposit insurance should minimize the risk to the taxpayers

      6. (6) Deposit insurance should relieve small depositors of the burden of monitoring their banks

2. Basics of Deposit Insurance

   1. Insurance Coverage

      1. Deposit insurance currently covers $250,000 per depositor per bank in each category of legal ownership:

         • (1) Single account: deposits owned by one person

         • (2) Qualifying retirement accounts: (e.g. individual retirement accounts)

           • NOTE: the book is outdated and stated that Deposit Insurance covers only $100,000 per depositor. Under this category, it states that this particular type of account is an exception to the general rule and receives $250,000 in coverage. Thus, after the increase to $250,000, this type of account may have even higher coverage

         • (3) Joint account: accounts owned by two or more individuals, each of whom has signed the signature card and has equal rights to make withdrawals from the account

         • (4) Revocable trust accounts, under which the trustor can revoke the trust relationship and reclaim the assets

         • (5) Irrevocable trust accounts, under which the trustor makes a final binding transfer of assets in trust form for the benefit of the beneficiaries

         • (6) Employee-benefit plan accounts: includes deposits of a pension profit-sharing or other employee-benefit plan (FDIC insures up to $250,000 for each participant's interest in the plan)

         • (7) Accounts of a corporation, partnership, or unincorporated association

         • (8) Government accounts

           • But, quirky rules apply to these accounts (e.g. a separate dollar limit applies to each official custodian)

      2. Limit applies only bank by bank

         • Thus, you can just have accounts at multiple different banks and have the coverage up to $250,000 for each account)

      3. When a bank fails, the FDIC decides whether to pay insured depositors in one of two ways: (1) by opening accounts for the depositors at another FDIC-insured bank, from which depositors can withdraw money OR (2) less commonly, by mailing a check to each depositor.

      4. Federal banks, federal thrift institutions, and federal credit unions must have federal deposit insurance

      5. States require their state commercial-banks and thrift institutions to have deposit insurance

         • Most, but not all states require that state credit unions obtain federal insurance

   2. Insurance Premiums

      1. The FDICIA requires the FDIC to key a bank's insurance premiums to the risk the bank poses to the insurance fund: the probability that the bank will cause a loss to the insurance fund and the likely amount of any such loss. 12 U.S.C. § 1817(b)(1)(A), (C).

      2. Pursuant to that requirement, the FDIC has adopted a risk-based premium system centered on banks' capital and examination ratings. 12 C.F.R. §§ 327.09-327.10

         • The system classifies banks into three capital groups (well-capitalized, adequately capitalized, and undercapitalized) and three supervisory groups (A, B, C) and looks at the matrix to determine the appropriate premium (in cents per $100 in U.S. Deposits) - HIGHER RISK = HIGHER PREMIUM

           • The three capital groups correspond to prompt corrective action

             • Well Capitalized

               • Leverage Ratio 5%

               • Total RBCR 10%

             • Adequately Capitalized

               • Leverage Ratio 4%

               • Total RBCR 8%

             • Undercapitalized

               • Leverage Ratio < 4%

               • Total RBCR < 8%

           • The three supervisory groups are as follows

             • Group A

               • CAMELS Composite rating of 1 (0.4% Five-year failure rate) or 2 (1.0% Five-year failure rate)

             • Group B

               • CAMELS Composite rating of 3 (3.8% Five-year failure rate)

             • Group C

               • CAMELS Composite rating of 4 (14.6% Five-year failure rate) or 5 (46.9% Five-year failure rate)

         • FDIC Risk-Based Premiums: Base Rates - SEE pg. 317

         • FDIC Risk-Based Premiums: 2008 RATES - SEE pg. 317

           • The 2008 include an across the board 3 increase to the base rates

         • Historical 5-Year Failure Rates

           • Well-Capitalized

             • Group A: 0.8%

             • Group B: 2.7%

             • Group C: 6.8%

           • Adequately Capitalized

             • Group A: 2.0%

             • Group B: 5.5%

             • Group C: 14.4%

           • Undercapitalized

             • Group A: 2.3%

             • Group B: 7.1%

             • Group C: 28.8%

      3. The FDIC collects premiums in insured banks' U.S. deposits; it neither charges on nor insures deposits booked offshore. 12 U.S.C. § 1817(b).

      4. Congress has directed the FDIC to manage the fund such that it keeps between $1.15 and $1.50 per $100 in deposits. 12 U.S.C. § 1817(b)(3)(B).

         • The insurance has historically maintained $1.25 in reserves for every $100 of insured deposits.

   3. Definition of "Deposit" - SEE pg. 320 for Statute (12 U.S.C. § 1813(l)(1))

      1. 12 U.S.C. § 1813(l)(1) provides that "deposit" means:

         • "(1) the unpaid balance of money or its equivalent...

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