FDIC losses in bank failures: Has FDICIA made a difference?

Banks are generally failed and placed in receivership when the value of their assets declines below the value of their deposits and other debt, so that the value of their capital (net worth) becomes negative. As a result, some of their creditors and in the United States also the FDIC, which stands in the shoes of, at minimum, the insured depositors up to the insurance coverage ceiling, are likely to suffer losses. Because the FDIC is a federal government agency, if losses from bank failure resolutions are sufficiently high to exceed both the FDIC’s reserves and its ability to collect additional revenues by levying sufficient premiums on insured banks to replenish the reserve fund, the losses may need to be paid by the government and thereby the taxpayers. Indeed, taxpayers were required to pay some $150 billion when losses incurred by the former insurer of deposits at savings and loan associations (S&Ls) – the Federal Savings and Loan Insurance Corporation (FSLIC) – in resolving the large number of failures in the S&L crisis of the 1980s exceeded its financial capacity to protect all insured deposits at these institutions against loss. Thus, the FDIC loss rate in resolutions is of concern to the banks that pay insurance premiums, to the taxpayers that are widely perceived to have backup liability, and to the uninsured depositors and other bank creditors who share in the loss with the FDIC. It is in the best interest of all of these parties that the FDIC minimize its losses in failure resolutions. Indeed, it is the losses from bank failures more than the bank failures themselves that are most damaging to both the stakeholders of the failed banks and the FDIC, so that it is more important to minimize this loss rate than the number of bank failures. Inefficient or unlucky banks that become insolvent should be permitted if not encouraged to exit, but with minimum losses. This paper reviews both the causes of resolution losses to the FDIC and recent legislative and regulatory initiatives intended to reduce such losses, computes the loss rates experienced by the FDIC from 1980 through 2002, and compares and analyzes the losses before and after the enactment of the FDIC Improvement Act (FDICIA) at yearend 1991, which, among other things, was intended to minimize such losses. The paper concludes that although the number of bank failures declined sharply after the implementation of FDICIA in 1993, the FDIC’s loss rate increased significantly. This disturbing conclusion holds even after adjustment for changes in the size distribution of failed banks in the two periods. Only when the high-loss larger banks in the second period are also removed from the observations does the loss rate in the post-FDICIA period decline below that of the pre-FDICIA period. The paper concludes with speculation on why the FDIC’s loss rate may have failed to decline and makes recommendations for enhancing the likelihood of loss reductions in the future.UnpublishedNon Peer ReviewedBarth, James R., “Testimony,” Task Force on the Resolution Trust Corporation on the Structure of the Savings and Loan Bailout, Committee of Banking, Finance, and Urban Affairs, U.S. House of Representatives, July 1991. Barth, James R., Philip F. Bartholomew, and Michael G. Bradley, “Determinants of Thrift Institution Resolution Costs,” Journal of Finance, July 1990, pp. 731-754. Bartholomew, Philip, F., The Cost of Forbearance During the Thrift Crisis, Washington, D.C., Congressional Budget Office, June 1991. Bartholomew, Philip, F., Resolving the Thrift Crisis, Washington, D.C., Congressional Budget Office, April 1993. Benston George J. and George G. Kaufman, “ The Intellectual History of the Federal Deposit Insurance Corporation Improvement Act of 1991” in George Kaufman, ed., Reforming Financial Institutions and Markets in the United States, Boston: Kluwer Publishers, 1994, pp. 1-17. Benston, George J. and George G. Kaufman, “FDICIA: After Five Years,” Journal of Economic Perspectives, Summer 1997, pp. 139-158. Benston, George J. and George G. Kaufman, “Deposit Insurance Reform in the FDIC Improvement Act: The Experience to Date,” Economic Perspectives (Federal Reserve Bank of Chicago), Second Quarter 1998, pp. 1-20. Blackwell, Rob, “The Resolution of NextBank: Did FDIC Make Costly Blunder?” American Banker, December 26, 2002, pp. 1, 4. Committee on Banking, Housing and Urban Affairs, United States Senate, The Failure of Superior Bank, FSB, Hinsdale, Illinois (S. Hrg. 107-698), September 11 and October 16, 2001. Washington, D.C.: U.S. Government Printing Office, 2002. Eisenbeis, Robert A. and Paul M. Horvitz, “The Role of Forbearance and Its Costs in Handling Troubled and Failed Depository Institutions,” in George Kaufman, ed., Reforming Financial Institions and Markets in the United States, Boston: Kluwer Academic, 1994, pp. 49-68. Eisenbeis, Robert A. and Larry D. Wall, “The Major Supervisory Initiatives Post- FDICIA: Are They Based on the Goals of PCA? Should They Be?” in George Kaufman, ed., Prompt Corrective Action in Banking: 10 Years Later, Oxford: Elsevier Science, 2003, pp. 109-142. Ely, David P. and Nikhil P. Varaiya, “Opportunity Costs Incurred by the RTC in Cleaning Up S&L Insolvencies,” Quarterly Review of Economics and Finance, Fall 1996, pp. 291-310. Federal Deposit Insurance Corporation, Office of Inspector General, Issues Related to the Failure of Superior Bank, FSB, Hinsdale, Illinois (02-005), Washington, D.C., February 6, 2002. Federal Deposit Insurance Corporation, Office of Inspector General, The Division of Resolutions and Receiverships’ Resolution and Management of Credit Card Portfolios (03-029), Washington, D.C., April 17, 2003. Kane, Edward J., “Principal-Agent Problems in S&L Salvage,” Journal of Finance, July 1990, pp. 755-764. Kaufman, George G., “The U.S. Banking Debacle of the 1980s,” The Financier, May 1995, pp. 9-26. Kaufman, George G., “Reforming deposit insurance – Once again,” Chicago Fed Letter (Federal Reserve Bank of Chicago), November 2001. Kaufman, George G., “FDIC Reform: Don’t Put Taxpayers Back at Risk, “ Policy Analysis (Cato Institute), April 16, 2002. Kaufman, George G., “Too Big to Fail: Quo Vadis” in Benton Gup, ed., Too-Big-To- Fail: Policies and Practices, Westport, CT: Praeger, 2004 (forthcoming). Kaufman, George G. and Peter J. Wallison, “The New Safety Net,” Regulation, Summer 2001, pp. 28-34. U.S. Department of the Treasury, Office of Inspector General, Material Loss Review of The First National Bank of Keystone (01G-00-067), Washington, D.C., March 10, 2000. U.S. Department of the Treasury, Office of Inspector General, Material Loss Review of NextBank, NA (01G-03-024), Washington, D.C., November 26, 2002a. U.S. Department of the Treasury, Office of Inspector General, Material Loss Review of Hamilton Bank, NA (01G-03-032), Washington, D.C., December 17, 2002b