FDIC – Likely will need to raise rates for bank insurance
August 16, 2009 by admin
The FDIC is burning through depository insurance coverage at an alarming pace. This week, the FDIC announced another round of bank closings, including the largest bank of the year with the collapse of Colonial BankGroup of Georgia. The latest group of bank failures brings the total number of banks taken over by the FDIC to seventy eight for the year.
The FDIC, is a government sponsored agency that is responsible for helping to regulate banks and plays a key role as they oversee the insurance protection offered to banking consumers who deposit money with FDIC approved institutions and products. The FDIC, is an acronym known as Federal Depository Insurance Corporation. It was created, following the great depression as part of the Glass-Steagall act, in order to provide confidence in the banking system and allow for banks to accept deposits to build their financial balance sheets and utilize this capital to lend out to the community, helping to grow the economy.
The role of insuring deposits is critical to the banking industry. The FDIC temporarily increased the amount eligible for insurance from $100,000 to $250,000 late last year in an effort to preserve the banking system and prevent a phenomenon known as “run on the bank”, where customers line up in mass and begin withdrawing funds, essentially create a panic that escalates into a bank failure. Banks, which are a critical component of the economy, lend money only on the basis of their depository or capital base. Regulators, typically allow for a bank to lend out money at ratios between 8-10% of their capital ratio. For example, for every dollar deposited, a bank essentially can lend out between eight to ten dollars. Banks offer incentives (interest) to consumers in exchange for their deposits, and consumers likewise enjoy the protection of near risk free investments. The FDIC, is compensated by banks that offer insurance, and use these premiums to build a pool of money, which is utilized on the rare occasion that a bank were to fail and the FDIC is forced to cover the insured deposits of the institution.
The string of bank failures over the last twenty four months, ranging from IndyMac Bancorp (largest to date), to Bank United and Colonial all faced similar problems. These companies were paramount in lending in the real estate market for both the residential and commercial markets, in some of the worst performing markets in the country (California & Florida). These markets have experienced historic rates of home foreclosures as property values have dropped sharply during the economic recession. The rapid rise in foreclosed properties, significantly impacted the balance sheets of these banks which held billions of dollars worth of loan securities that were losing value at a record pace. Ultimately, the banks were not able to secure enough adequate capital to remain viable and keep their required ratios in line with the FDIC and government banking requirements, which led to their FDIC seizures.
The FDIC role in supporting the banking industry is becoming threatened by the billions of dollars worth of insurance losses they have experienced in the last twenty four months. When the FDIC increased the coverage amount to $250,000 late last year, they also raised the premiums charged to banks for offering this, in a move to help restore their insurance loss reserves to cover future bank failures. Experts vary on the total number of banks they expect to fail in the near future, as the banking industry struggles to deal with record home foreclosures and job losses continue to escalate. The FDIC is likely to turn to the Treasury department for a capital injection to help rebuild its insurance coverage fund and could explore additional rate increases this year.
