Establishment of the Federal Deposit Insurance Company - Case Study Example

Establishment of the Federal Deposit Insurance Company Table of Contents Introduction 3 Causes 3 Consequences 4 The Board of Directors 8 FDIC Funds9 Present Condition 10 Works Cited 12 Name of the Student: Name of the professor: Course Number: Date of the Paper: Establishment of the Federal Deposit Insurance Company Introduction The Federal Deposit Insurance Corporation (FDIC) is a United States (U.S.) government corporation, which was created by the Banking Act of 1933 (Walker 34) and runs independently. It had come into existence because of widespread bank failures that took place during the Great Depression. Since incorporation of the company, it started to insure the financial deposits of banks in return of certain amount of fees. This ensured the banks that even if they fail, customers would not get affected and their funds will be safe. Causes Federal Deposit Insurance Company came into existence after the Banking Act of 1933 and from that point onwards, it helped to solve various banking crises caused as a result of the Great Depression in 1930s as well as the savings and loan crisis of 1990s. The other problems that the Great Depression and saving and loan crisis had triggered were downfall of the banks, which can be described as follows: Financial crisis of 2008 which had led to insolvency of 25 banks. The most detrimental among them, in terms of dollar value, was when Washington Mutual Fund had to face a 10 day bank run on the deposits (Schooner and Taylor 45). Again on August 2009, FDIC increased the number of troubled banks in the second quarter to 416. The number increased to 552 at the end of the third quarter and FDIC declared 140 banks as insolvent at the end of 2009. This period saw the largest number of bank failures, since 1992 (Williams 56). In 2010, FDIC Chairman, Sheila Bair, rightly warned that the number of failures of banks in that year had chances of surpassing the level of 140 banks, which were taken over earlier. In 2010, 157 banks were seen to fail. In the same year, a new division of FDIC, called the Office of Complex Financial Institutions, was formed so that risk related to the largest financial institutions could be assessed. Therefore, these are certain financial events and causes for downfall of the banks, which were handled by FDIC to their best of ability (Kaufman and Seelig 78). Consequences During the period of 1930s, the whole world experienced a Great Depression, which was a severe economic contraction. In United States (U.S.), the stock market declined by 75% and the rate of unemployment was officially 25% from 1929. Banks were in a situation where there was no insurance on deposits and customers were all withdrawing their funds simultaneously. They demanded their money back in the form of government bonds, precious stones or transferred in an institution that is safe as they presumed that the current institution might get insolvent. Therefore, bank runs were too common during that period. The customers were in a situation of trouble because they were aware that their deposits were not insured (“Consumer Protection”). Thus, in order to cope up with the problem, President Franklin D. Roosevelt on June 16, 1933, signed the Banking Act of 1933 (“Consumer Protection”). This act helped FDIC to be the temporary government corporation (“Consumer Protection”). FDIC became a permanent agency after the Banking Act of 1935 was formulated. This Act helped FDIC in the following manner: It helped the company to provide insurance on deposits of the banks. It made the company a permanent government agency and allowed it to insure deposits of various banks to a level of $5000. At the same time, it gained authority to supervise and regulate non-member banks of the state. As per the Banking Act 1935, the insurance company was funded with loans amounting to $289 million through the Federal and Treasury reserve. Later on, FDIC returned the whole amount with interest to these reserves. It was even responsible for operating the commercial banks (“Consumer Protection”). Therefore, this Act helped FDIC to provide great relief to the banking sectors as well as their customers. FDIC had got the first scale of test during the Great Depression in the 1930s and then again, in the year 1990 when the loan and savings crisis took place. The saving and loan crisis made this industry insolvent and at the same time, affected multiple banks. It increased the trouble of large banks. The crisis had parallel affect on the Federal Savings and Loan Insurance Corporation (FSLIC), which was created to insure all deposits of the savings and loan institutions. FSLIC had to face the brunt of the crisis of these S&L institutions. It led to insolvency of FSLIC and hence, was abolished in 1989. Finally, it had to be replaced by the Resolution Trust Corporation (RTC) and later was merged with FDIC on 1995. After this merger, FDIC had to resolve all the failed thrifts of FSLIC. This is how FDIC resolved problems of the Great Depression and the savings and loan crisis of 1930s and 1990s, respectively. Furthermore, there was a financial crisis in 2008, which led to insolvency of twenty banks of U.S. The largest bank failure took place on September 26 when Washington Mutual, which had an asset of $307 billion, experienced bank run for 10 days on the deposits it had. It was a huge bank failure in terms of value of their dollar, as the company lost a large part of their deposits in giving the money back to depositors. Therefore, to encourage liquidity and strengthen the banking system, FDIC played a huge role by creating Temporary Liquidity Guarantee program (TLGP), thereby guarantying all freshly issued unsecured debts, thrifts of banks and few holding companies. At the same time, TLGP provided total coverage for transaction accounts related to non-interest bearing deposits, irrespective of the dollar value of institutions. The limits for insurance of these deposits were raised from $100000 to $250000 for that period of crisis (“Regulations and Examinations”). In 2009, another incident of non-performance of banks took place. More than one fifty publicly traded banks of United States had severe non-performing loans, over and above 5 % of their total holdings. It was a level considered to threaten any banks’ survival and wipe out all the equity. This situation was not harmful for the banks only if they had additional capital and proper amount of reserves to safeguard them from this low phase. These banks had neither reserves nor additional capital to save them from this situation, which called for immediate FDIC intervention. As a result of all these failures, on August 21, Guaranty Bank in Texas became completely insolvent and was taken over by BBVA Compass, the second largest bank of Spain. Additionally, FDIC gave full agreement to share loses of Guaranty Bank with BBVA. Loses made by the bank was $11 billion of its loans and assets. The transaction cost for sharing the money for loses alone amounted to $3 billion for FDIC Deposit Insurance Fund (“Regulations and Examinations”). In the second quarter of 2009, on August 27, the number of troubled bank that FDIC funded increased to 416. The number gradually jumped to 552 in the third quarter. At the end of this year, the number of banks which became insolvent presented a drastic figure of 140. This was the second highest figure of insolvency of banks, after the year 1992 where the rate was 179. FDIC played a huge role in supporting these banks from the time of incorporation (Parke 145). The year 2010 saw another drastic failure of banks. About 157 banks with a total asset of $92 billion failed successively (“Industry Analysis”). A new division of FDIC called the Office of Complex Financial Institutions was created as a division of FDIC, so that it can handle all expanded responsibilities that FDIC had to face till then. This division was formed as per the Dodd-Frank Act so that risk related to largest and most important financial institutions could be assessed (“Regulations and Examinations”).. FDIC played a vital role to bring in the required stability in deposits of the financial institutions. It not only helped banking and other institutions to recover from their worst situations, but at the same time, also provided investors the much-needed assurance in form of insurance cover for their deposits. FDIC made its existence fruitful by supporting the financial institutions at time of their depression. It helped U.S. in the past with full effort to overcome worst financial situations. The Board of Directors Presently, the board of directors of FDIC forms the governing body of the company. The board consists of five members; where three are appointed by President of the United States with proper consent from two ex officio members and the United States Senate. Each of the three appointed members serves six years term. It is a necessity that at the most three members serving the board can be from similar political part. With the due consent of the Senate, the President also appoints one member as the chairman and one as the vice chairman of the board for a time period of five years. The Comptroller of Currency and director of the Consumer Financial Protection Bureau (CFPB) are considered as the two important ex officio members. From 1st January 2013, members of the Federal Deposit Insurance Corporation who acted as the boards of director were: Thomas J. Curry, who was the Comptroller of the Currency, Thomas M. Hoenig , who acted as Vice Chairman of the Board, Martin J. Gruenberg , acted as the Chairman of the Board, Jeremiah O. Norton, Richard Cordray acted as the Director of Consumer Financial Protection Bureau. FDIC Funds Former Funds There were two funds of FDIC during the period of 1989 to 2006. These are the Bank Insurance Fund (BIF) and Saving Association Insurance Fund (SAIF). SAIF came into existence after the crisis of savings and loan during the period of 1980s (“News and Events”). The maintenance of separate funds by FDIC for similar purpose helped the corporation to shift to each fund as per the benefit and solution provided by them. This resulted in the difference in their rates of premium, which helped participants present in the market to arbitrage this difference. Thus, the chairman of Federal Reserve, Alan Greenspan rightly revolted against this practice. Deposit Insurance Fund In 2006, Federal Deposit Insurance Reform Act of 2005 (FDIRA) and an amendment act was signed by President George W. Bush. The act contained conforms and technical changes, which needed to implemented on a number of survey and study requirements and at the same time, to bring in necessary reforms in deposit insurance. This law also highlighted the merger of the BIF and SAIF into a fresh new fund, which is the Deposit Insurance Fund (DIF). The change was made effective soon in the month of March of that year. Through this fund, FDIC assessed the insurance premium on deposits for each institution. The institutions are evaluated based on their balance of deposits, which are insured and at the same time, the degree of risk they possess on insurance funds (“News and Events”). Present Condition FDIC still provides guarantees on security deposits made by the public banks. Presently, FDIC insures an amount of $250000 for each bank and the account it holds of depositors (“Federal Deposit Insurance Corporation”). Hence, depositors have a guarantee that their entire deposited money will be refunded in case of insolvency of their respective banks. FDIC provides full security to the deposits made by citizens in different banks. This law is applicable to only those banks, which form a part of the corporation as their member. To counteract incidents, like, Great depression, this law was formulated. Before formulation of this law, the period of 1980s and 1990s witnessed great loses that occurred to citizens due to insolvency of various banks. It helped to insure the citizens against the deposits they have kept with the banks. Presently, the Federal Deposit Insurance Corporation successfully insures deposits of at least 8000 banks and other financial institutions of United States. After incorporation of FDIC and formulation of various acts, there were no depositors since 1934 as they had lost their funds when the banks went insolvent, creating a deplorable phase for the United States (“Federal Deposit Insurance Corporation”). It is not difficult to check whether a certain financial institution or bank is a member or not, given that banks now post their emblems in each of their branch so as to confirm their FDIC membership. Therefore, the first major challenge faced by FDIC was in the time period of 1980s and 1990s. The loan crisis was also prevalent at that point in time, which affected the commercial and savings banks. The preventive measures taken to control this situation were in the form of Recovery and Enforcement Act and Financial Institutions Reform of 1989 as well as other acts. This situation led to burdening of the tax payers as they had to pay around $150 billion to battle this crisis successfully (“Deposit Insurance”). The next big challenge was the global downturn. As a result of this crisis, 25 banks went insolvent in 2008 and were finally taken over by FDIC. The corporation then implemented the legacy loan program. This program was conducted so as to get the banks out of their liabilities; to increase their power to lend; and raise new capital. FDIC maintains a list of failed banks now and regularly updates it. This list includes quite a large number of banks, namely Atlantic Southern Bank, Mountain Heritage Bank, United Western Bank, First Georgia Banking Company and many more (“Deposit Insurance”). The member banks have to comply with certain liquidity and reserve requirements of the Federal Deposit Insurance Corporation as they are funded by it. There are examiners who visit these member banks regularly so as to ensure that they follow the guidelines as laid down by FDIC. In case a bank is unable to abide by the guidelines, the corporation immediately issues a warning. If the bank fails to act as per the guidelines and problems created by it are not solved within a given time, then FDIC have the right to force that particular institution to take corrective actions in form of change in the management. Though this has rarely happened in past, FDIC can take immediate measures that result in closure of the bank. The basic reason for such a measure by the Federal Deposit Insurance Company is to retain the citizens’ confidence in banking institutions and partly in themselves (“Bank Regulatory Database”). Thus, FDIC fulfils this objective by offering insurance to the right amount of deposits kept by depositors and through various other measures for lowering the risk of failure of banks, as per its guidelines. Therefore, right from the time of initiation, FDIC has intensively helped to improve the banking scenario of United States. The corporation performed to the best of its ability for bringing in the required stability to existing unstable condition of various banking institutions. It has allowed citizens of United States to restore their faith in the banking institutions and feel more secure about keeping their insured deposits with the latter. Works Cited “Bank Regulatory Database.” Baker Library Bloomberg Centre. Bloomberg Centre, 2014. Web. 1 March. 2014. “Consumer Protection.” Federal Deposit Insurance Corporation. Federal Depository Insurance Corporation, 2013. Web. 1 March. 2014. “Deposit Insurance.” Federal Deposit Insurance Corporation. Federal Depository Insurance Corporation, 2013. Web. 1 March. 2014. “Federal Deposit Insurance Corporation.” Bloomberg. Bloomberg L.P., 2014. Web. 1 March. 2014. “Industry Analysis.” Federal Deposit Insurance Corporation. Federal Depository Insurance Corporation, 2013. Web. 1 March. 2014. Kaufman, George and Steven Seelig. Post-Resolution Treatment of Depositors at Failed Banks. Washington D.C.: International Monetary Fund. 2001. Print. “News and Events.” Federal Deposit Insurance Corporation. Federal Depository Insurance Corporation, 2013. Web. 1 March. 2014. Parke, David. Closing a Failed Bank: Resolution Practices and Procedures. Washington D.C.: International Monetary Fund. 2011. Print. “Regulations and Examinations.” Federal Deposit Insurance Corporation. Federal Depository Insurance Corporation, 2013. Web. 1 March. 2014. Schooner, Heidi and Michael Taylor. Global Bank Regulation: Principles and Policies. California: Elsevier. 2010. Print. Walker, George. International Banking Regulation: Law, Policy, and Practice. Netherlands: Kluwer Law International, 2001. Print. Williams, Harding. Federal Banking Law and Regulations: A Handbook for Lawyers. California: American Bar Association. 2006. Print. Read More