The Federal Deposit Insurance Corporation (FDIC) was created by the Glass-Steagall Act of 1933. The vast number of bank failures in the Great Depression spurred the United States Congress into creating an institution which would guarantee banks, inspired by the success the Commonwealth of Massachusetts experienced with Deposit Insurance Fund (DIF). The FDIC currently guarantees checking and savings deposits in member banks up to $100,000 per depositor.
Insurance requirements
In order to receive this benefit member banks must follow certain liquidity and reserve requirements. Banks are classified in 5 groups according to their risk-based capital ratio :
- Well capitalized: 10% or higher
- Adequately capitalized: 8% or higher
- Undercapitalized: less than 8%
- Significantly undercapitalized: less than 6%
- Critically undercapitalized: less than 2%
When a bank becomes undercapitalized the FDIC issues a warning to the bank. When the number drops below 6% the FDIC can change management and force the bank to take other corrective action. When the bank becomes critically undercapitalized the FDIC declares the bank insolvent.
Insured deposits
Deposits that are covered by insurance are deposits that are not invested in bonds or stocks. In reality the bank will invest the deposited money for its own business. But accounts like money market funds and mutual funds that invest in bonds and stocks for the sake of the customer are not insured.
(Some banks offer a form of savings instrument confusingly called a Money Market Deposit Account (MMDA); these are insured savings accounts, intended to compete with the uninsured money market funds offered by brokerages).
While the basic federal insurance amount is $100,000, you can receive more than $100,000 of coverage if your funds are maintained in different ownership categories, according to the FDIC. For example, you can have coverage of up to $100,000 for your individual accounts at the bank, another $100,000 for your share of joint accounts at the same bank, and yet another $100,000 for your retirement accounts there.
You can also protect more than $100,000 by dividing the money among different financial institutions, with no more than $100,000 in any of them.
What is insured by the FDIC
Here is what is covered by FDIC insurance:
-
Checking accounts, Negotiable Order of Withdrawal , also called NOW accounts (checking accounts that earn interest), and Money Market Deposit Accounts , also called MMDAs (savings accounts that allow a limited number of checks to be written each month.)
-
Savings accounts that you can add to or withdraw from at any time.
-
Certificates of deposit (CDs), which generally require you to keep funds in the account for a set period - the maturity.
What isn't
Here is what is not covered by FDIC insurance:
-
Stocks, bonds, mutual funds, and money market funds.
- Investments backed by the U.S. government, such as Treasury securities and Savings Bonds .
- The contents of safe deposit boxes. Even though the word deposit appears in the name, under federal law a safe deposit box is not a deposit account - it's a well-secured storage space rented by an institution to a customer. If you are concerned about the safety or replacement of items you put into a safe deposit box, ask your insurance agent whether your homeowner's or renter's insurance policy covers your safe deposit box against damage or theft.
- Losses due to theft or fraud at the institution. These situations are often covered by special insurance policies that banking institutions buy from private insurance companies.
- Errors made in your accounts. In these situations, there may be remedies for consumers under state contract law, the Uniform Commercial Code, and some federal regulations, depending on the type of transaction.
-
Insurance and annuity products, such as life, auto and homeowner's insurance.
Deposit insurance in action
Deposit insurance received its first large-scale test in the late 1980s and early 1990s during the Savings and loan crisis, with mixed results.
It was not the FDIC that was tested, but a parallel institution, the Federal Savings and Loan Insurance Corporation (FSLIC), created by Glass-Steagal to insure savings and loan institutions (S&Ls). (Ordinary individuals in the U.S. do their personal banking at a commercial bank, savings and loan, or savings bank, usually unaware that these are distinct kinds of financial institution, providing virtually identical ranges of personal banking services but operating under different regulatory regimes).
S&Ls were intended to be (and for over a century were) thrift institutions whose primary lending activity was the extension of mortgages to finance homebuilding. In 1982, government regulations were changed to permit S&Ls a far wider range of investment opportunities. S&Ls promptly and enthusiastically took advantage of these opportunities, aware that the regulatory framework gave them significant protection against the consequences of bad decisions. This and other causes led to widespread problems. By 1989 20% of S&Ls were hopelessly insolvent, 20% were marginal, and only 60% were sound.
To consumers in 1990, bank failures were ancient history—something they had heard of in a boring school lesson on the depression, or something seen in a flickery old black-and-white documentary. (Oddly enough, intergenerational tradition had passed on a sense of unease about the stock market, but not about banks). In 1974 the failure of the Franklin Square National Bank due to fraud made headlines, at least in the financial section of the newspaper, but attracted little public notice. But in the late 1980s and early 1990s savings and loans began to fail on a large scale, and these were not isolated cases of mismanagement, but a systemic problem.
FSLIC was strained to the breaking point and, in fact, went bankrupt. Deposit insurance for S&Ls was hastily shored up by the government, which created new regulations and transferred S&L deposit insurance to a branch of the FDIC. In this sense, deposit insurance was a failure. The regulatory framework had not given FSLIC adequate reserves to make depositors whole.
On the other hand, deposit insurance itself and the way in which bank regulators managed bank failures was, from the point of view of bank depositors, a total success. S&L failures became so common that many ordinary people experienced them—but from their point of view it was almost a nonevent. Federal regulators would quietly arrange for the acquisition of insolvent institutions by solvent ones. Transitions in ownership were accomplished quietly and skilfully, usually over a weekend. A depositor might take his paycheck to the bank on Friday, and the familiar sign would still be over the door; when he came in to withdraw cash on Monday, he would see a new sign above the door, and bank personnel would hand him a reassuring leaflet. The insurance limit of $100,000 was far more than enough to protect the average depositor. Customers of failed S&Ls usually experienced only the most minor irritations, no different in degree or kind from the ones resulting from the wave of bank mergers and consolidations a decade later.
The S&L crisis made headlines and politicians made speeches about it, but unlike the bank failures of the depression, S&L failures remained an abstract problem, like the deficit or the balance of trade. Not a penny was lost in FSLIC-insured savings accounts, and the public belief in the total safety of "money in the bank" remained (and remains) unshaken.
Criticisms of deposit insurance
Not all economists think that the FDIC is a good idea. The main fear of its critics is that the government will, for very large banks (which they consider "too big to be allowed to fail"), use the FDIC fund money to "bailout" a large bank, rather than letting it fail and paying the up to $100,000 amount per depositor. These economists believe that free market political decision making in this matter will lead to the best net result, and that there is not enough money to adequately use FDIC funds to "prop up" banks. Some advocate privatizing the FDIC insurance money, with the caveat of not allowing the "too big to fail" system. These critics mostly believe that the current FDIC insurance would fail as did the FSLIC, and would require a bailout from the government.
See also
External links
Last updated: 10-21-2005 01:49:17
