Banking Law Prof Blog

The Cambridge University Chest - Better Than Keeping Your Money Under the Mattress

 

Having begun my career as a banking lawyer with FDIC's Washington, D.C. office, I have a keen interest in how banks originated and in how they assured the safety of their funds long before deposit insurance.  Another part of my past is a year spent at Cambridge University writing a thesis on European Community law and monetary policy.  So, I was doubly fascinated by the July 2009 calendar photo and text published by "Cambridge in America:"

"Before the days of banks, all the monies belonging to Cambridge were placed in the University Chest.  Until the fourteenth century, all of the University's books were housed in the chest as well, often as security against loans.  Though the University's money is now held in banks, the budget process is still known as the 'allocations from the Chest.'"

"The current Chest is in the Registrary's office and is 600 ears old.  The existing Chest replaced one burnt when participants in the Peasants' Revolt attacked the University in 1381.  Serious efforts were made to protect the contents of the new chest -- a total of seventeen locks were added to guarantee its security!"

--Source:  University Press Office.

(ag) July 7, 2009, in Deposit Insurance

Extending Full FDIC Coverage for Payroll Accounts

FDIC is proposing two alternatives for phasing out the Transaction Account Guarantee Program, originally set to expire December 31, 2009.

Option One:  The program, which provided full FDIC coverage of non-interest-bearing accounts such as payroll accounts (which often exceed insured limits just before payday), would be terminated on December 31, 2009, as originally scheduled.

Option Two:  The TAG Program would be extended for an additional six months, until June 30, 2010.  Insured depository institutions currently participating in the TAG Program would be offered a one-time opt-out opportunity.  Those that opt-out would have to disclose the fact that they are no longer participating.  Those that continue coverage would be subject to increased fees.

Background Info:  FDIC originally extended insurance coverage of these non-interest-bearing accounts for participating institutions that paid additional fees because of analysis that indicated that the financial crisis was causing uninsured depositors to remove their funds from any institution that might be troubled.  FDIC's analysis showed that, "A five percent reduction in uninsured deposits
would reduce Gross Domestic Product growth by 1.2 percent per year in a normal economy and 2.0 percent per year in a stressed economy. With U.S. economic growth currently stressed, a run of this magnitude could result in, or deepen and prolong, recession. FDIC data indicate rapid and substantial outflows of uninsured deposits from institutions that are perceived to be stressed. The systemic nature of this threat is further evidenced by the increasing number of bank failures."

Link to Proposal, which has a 30-day comment period which is now open:  http://www.fdic.gov/news/board/june2309no6.pdf

(ag) June 28, 2009, in Deposit Insurance

Privatizing Deposit Insurance

The question of whether the U.S. should privatize deposit insurance is a recurring one.  Academics talk about the "moral hazard" that results from FDIC insurance, particularly at the level of $100,000 per depositor.  Moral hazard is the tendency of those who are insured to engage in more risky behavior than they would if they were not insured and bore all potential loss themselves.  Insureds know that they can shift the risk to the insurer, and as a result, they don't exercise the degree of care they would otherwise.  This creates more loss overall.

With Federal Deposit Insurance, depositors know they are protected and don't monitor the financial condition of their banks as well as they would if there were no insurance.  Therefore, banks can attract deposits, almost regardless of their true condition.   Banks have reduced incentive to strengthen their financial positions.  The result is a misallocation of resources to weaker banks than if banks truly had to compete for deposits on the basis of financial strength. 

Banks that are on the verge of insolvency have an incentive to "bet the bank", knowing that the deposit insurance fund will cover the depositors -- and their risky investments might just pay off and rescue the bank.  Nine times out of ten, of course, these gambles don't pay off and the desperate bank has simply managed to dig a deeper hole, incurring even more losses in the end.

The Deposit Insurance Fund and the taxpayers may be the ultimate losers, unless deposit insurance can be fully priced according to risk.  We have made strides in that direction, but risk-based deposit insurance is not perfectly priced.

FDIC's current study concludes, as did a prior 1998 study, that privatization is not the answer to problems of arising from federal deposit insurance:
1.  Privatization will not eliminate moral hazard. 
2.  FDIC has better tools to manage moral hazard than it did in the 1980s, including risk-based insurance premiums, risk-based capital requirements, and prompt corrective action.
3. Privatization of deposit insurance would not significantly reduce regulatory burden for banks.
4.  The problem of "too big to fail" has been addressed.
5.  Inadequate private capital sources exist  which could or would supply private insurance.  Undiversified risk and inadequate liquidity would plague a private insurer.  (Anybody remember state insurance funds like Maryland?  Ohio?)
6.  The bottom-line consideration is depositor confidence in the banking industry.  Our economy is dependent on maintaining the safety and continued availability of deposits in our banks to fund loans  and "create money" (as we learned in Money & Banking 101).

LINK: http://www.fdic.gov/bank/analytical/quarterly/2007_vol1_2/index.html

(ag) Oct. 3, 2007, in Deposit Insurance

Wondering About the Strength of the Deposit Insurance Fund?

FDIC's Board of Directors met today and considered a Memorandum on the Outlook for the Deposit Insurance Fund (DIF).  The target goal is for the Designated Reserve Ratio (DRR) to reach 1.25 -- expected to be achieved at least by year-end 2009.  As of Dec. 31, 2006, the DRR stood at 1.21.

Check out the full analysis:  http://www.fdic.gov/news/board/may8no2.pdf

(ag) May 8, 2007, in Deposit Insurance

FDIC & the ILC Applications: Decision by January?

FDIC Chairman Sheila Bair indicated in response to questions at Monday's ABA Convention that she hopes to have a decision on the pending Industrial Loan Company applications by the time FDIC's six-month moratorium expires in January 2007.  FDIC continues to be beseiged by comments.  The WalMart application in particular has generated strong opinions.

So, which way is the wind blowing?  The October 2006 issue of Independent Banker, ICBA's monthly magazine, carries an extensive interview of FDIC Chairman Sheila Bair by ICBA's Kelly Pike.  In a wide-ranging discussion of the issues facing FDIC and the banking industry, Chairman Bair identified the ILC applications as one of the most controversial issues her agency faces.  About the pending ILC applications, she said, "I can't guarantee what that decision will be.  It may be a decision they don't like, but we need to move forward and make it."

In the same article, Chairman Bair discussed Deposit Insurance Reform, Regulatory Burden, and Basel II.

Link to a report about Bair's Oct. 16, 2006, remarks:  http://www.nafcu.org/Template.cfm?Section=News&template=/contentManagement/contentDisplay.cfm&contentID=21643

Link to Independent Banker article:  www.icba.org/files/ICBASites/PDFs/coverstory1006.pdf

(ag) Oct. 19, 2006, in Industrial Loan Companies, Deposit Insurance, Basel II, Federal Banking Agencies - FDIC

FDIC Chairman's Current Issues: Deposit Insurance Reform, Capital Reform, and Economic Inclusion

FDIC Chairman Sheila C. Bair gave two speeches this week that merit attention.  Chairman Bair addressed the American Bankers Association Convention on Oct. 16, 2006, and America's Community Bankers Convention on Oct. 17, 2006.

In her recent remarks, Chairman Bair highlights the following topics of current focus:  1.  Deposit Insurance Reform, including merger of the BIF and SAIF funds, the one-time assessment credit, and the new proposed assessment rate structure (to be set in early November -- check out the rate calculator on FDIC's website for a preliminary idea of what this could mean for your bank); 2.  Capital Reform, meaning Basel II -- although Chairman Bair indicates that this is not just a big bank issue.  FDIC supports a capital structure that does not place community banks at a disadvantage; and 3.  Economic Inclusion.  Providing financial services to the unbanked is a key issue for this new Chairman.

In the speech to America's Community Bankers, Chairman Bair covered the topics discussed above and added discussion about Commercial Real Estate.  She also discussed the role of Community Banks. 

Link to ABA Speech:  http://www.fdic.gov/news/news/speeches/chairman/spoct1606.html

Link to ACB Speech:  http://www.fdic.gov/news/news/speeches/chairman/spoct1706.html

(ag) Oct. 18, 2006, in Federal Banking Agencies - FDIC/Capital/Basel II/Deposit Insurance

Maximizing Deposit Insurance with "Cedars" - Former Banking Regulators with a Good Idea

On Sept. 25, 2006, Promontory Interfinancial Network, LLC, announced that it now possesses the capacity to offer FDIC insurance coverage up to $30 million per depositor.  Previously, the maximum coverage offered by Promontory was $25 million per depositor. 
Link to Press Release: http://www.promnetwork.com/pressreleases.html

Image is Eugene Ludwig, Former Comptroller of the Currency and one of the founders of Promontory Interfinancial Network.

Promontory Interfinancial’s business model centers around its proprietary Certificate of Deposit Account Registry Service (“CDRS” – pronounced “Cedars”).  Promontory serves more than 1,350 members.  CDRS allows these members, which are FDIC insured depository institutions, to retain “high dollar” depositors and earn fee income or access funds.  When a financial institution subscribes to the CDRS, it can accept a deposit over $100,000 (the basic insurance limit) and place the excess through the CDRS program with other network member institutions.  This program does not change FDIC’s basic coverage set by Congress, but it does allow institutions to work together through the CDRS network so that an individual depositor continues to do business with his original bank or other financial institution, yet his deposit insurance coverage is increased as if he had placed $100,000 at Bank A, $100,000 at Bank B,  $100,000 at Bank C, and so forth.
Link to Promontory Home Page:  http://www.promnetwork.com/index.html

As all banking law profs and financial institution new accounts officers know, the basic FDIC Insurance is $100,000 per depositor (in the same right and capacity) per insured institution.  By using joint accounts and “Payable on Death” accounts, bank customers can effectively increase coverage to a certain extent.  Congress has recently raised the maximum coverage for self-directed retirement accounts to $250,000.
Link to FDIC’s Deposit Insurance Coverage information:  http://www.fdic.gov/deposit/deposits/index.html

As the subheadline for this posting indicates, Promontory was founded by a stellar cast of former federal banking agency officials, including: Eugene Ludwig (former Comptroller of the Currency); Dr. Alan S. Blinder (former Vice-Chairman of the Federal Reserve); Marc Jacobsen (former Chief of Staff at both FDIC and the OCC); and Alfred H. Moses (formerly a partner in the Washington, D.C., law firm of Covington & Burling).
Link to Bios:  http://www.promnetwork.com/founders.html

(ag) Sept. 25, 2006, in Deposit Insurance