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In economics, Systemic risk refers to the phenomenon that is characterized by a risk that an effect in the financial system in turn results in adverse economic impact that may lead to economic slowdown and in some cases losses or shutdown of economic institutions (Wallison, Stanton & Ely, 2004). Such events are termed as systemic risk and can be caused by surprising and adverse occurrences that makes both the investors and the market to reassess their existing associations. When a bank fails due to systemic risk, there are many chances that other banks may fail to address their economic obligations especially those that are associated with the failed bank. In this regard, the need for financial intervention has come to be considered as a way of addressing such risks and for this matter an institution like FDIC was established.
According to the Council of Economic Advisers (2010), the role of providing financial intervention is not only the role of private institution and markets alone but the government has a part in it. In fact, economist prefers the prevalence of government regulation in a market that is likely to suffer from market failures. Financial intervention is critical in the restoration and maintaining of relationships between the savers and the investors and thus a number of financial institutions have been established to take back institutions in the brink of failure or closure.
It is estimated that about 2000 banks failed in the United States between the periods of 1930 and 1933. The institutional failures experienced during this time prompted the establishment of Federal Deposit Insurance Corporation (FDCI) in 1934. This led to less bank panics, a case where investors withdrawing their investment from banks owing to the joint operation of FDCI and other related bank policies initiated during this period (Fong, 2010).
Federal Deposit Insurance Corporation
FDIC is a financial institution established in 1934 by the United States government to address the increasing number of banks failures particular after about 2000 banks failed in the period between 1930 and 1933. According to Carradine (2010), FDCI "is an independent agency of the united states government... " (p. 182). The establishment of this institution was done with the aim of offering protection to banks that have insured their deposits with it in the event that that the insured banks fail. FDIC is regarded as a wise macroeconomic regulation that seeks to offer guarantee to all banks that get insured with it, notwithstanding their conditions (Council of Economic Advisers, 2010).
Weltman (2008) confirms that FDIC runs by the funds that are accrued from funds premium made by banks and other thrift institutions that are covered by FDIC. In return, the FDIC insures funds that have been put in the deposits account it runs, checking and savings accounts, certificates of deposit and money market deposit accounts that banks seeks to have insured. Despite the novelty of insuring deposits, FDIC does not in any way insure other banks related products or services such as stocks, life insurance policies and municipal securities or any other related products (Carradine 2010).
FDIC Coverage basics
The insurance cover provided by FDIC only covers accounts in each of the insured banks, dollar-for-dollar, and includes the principal as well as any accumulated interest from the closing date of the insured bank up to the allowable limit of insurance set. The rulesand regulations for FDIC do not allow or recognize the insurance of safe deposit boxes or any content thereof. In addition, the FDIC insurance does not cover the U.S. Treasury bills, notes or bonds. However, these investments have full support and faith as well as credit accorded by U.S government.
Size of insurance cover provided by FDIC
Carradine (2009) highlights that investors need not to apply for insurance from the FDIC as coverage is guaranteed when they deposit with the institution. FDIC has set the standard deposit insurance value as $250,000 for every depositor, per insured bank and for every account ownership group. FDIC also charges $250,000 for every owner in the case of joint account, $250,000 for every IRAs as well as other retirement accounts and $250,000 for trust account for every owner per individual beneficiary. The trust account is also subject to other regulations.
On corporate clients, FDIC levies $250,000 for every corporation or partnership, $250,000 for employee benefit account plan and $250,000 per official custodian for a government account.
It is important to note that, FDIC insures deposits held by an individual in one insured bank separately from any other deposits that the same individual has in another separately chartered insured bank. Furthermore, FDIC usually provides advice to individual or entities on the need to insure their deposits with FDIC and in many cases, those who deposit with FDIC need not to be the citizens or residing in the United States. However, despite the fact that FDIC insurance covers only the depositors, in some instances there are some depositors who may be creditors or shareowners of a bank insured by FDIC.
FDIC regulatory reaction to bank failures
Dilley, (2008) confirms that the mandate of FDIC is to insure funds in that banks, loans and savings that have been deposited with insured banks. When institutions that are insured by FDIC fail, FDIC takes over and compensates those who insured their deposits with it. Banks can fail for a number of reasons such as:
i) Occurrence of economic downtown that may decrease the amount of loan or savings that the banks hold.
ii) The banks reserves falling below the minimum reserve due to poor operations or loss of assets by the bank or
iii) When a lending institution has poor management and together with fraudulent loans, the financial condition of the bank is difficult to be evaluated.
As a result of failure of institutions that is insured with FDIC, it will be the responsibility of FDIC to see that all depositors are paid full amounts for the money insured in the deposits as well as overseeing the sale of the assets of the failed bank. FDIC can also initiate investigation in attempt to find out the reasons as to why a particular bank has failed and deliver the implicated person if any, to the legal authorities. In some cases, FDIC advices on the sale of banks that are insolvent to willing banks that are solvent. Here, the insolvent banks can be reopened with new names and under new management.
Beneficiaries of FDIC take back
From its inception up to 1934, FDIC insured those who deposited with it for a value of up to $ 2,500. During the same year, about nine banks that were insured by FDIC failed and the depositors were relieved when FDIC paid them for the deposits insured by them. According to Vekshin (2009). "A total of 416 banks with combined assets of $299.8 billion failed the FDIC's grading system for asset quality,, liquidity and earnings in the second quarter". This number of failed banks is high since June 1994.
In 2009, FDIC had taken over about 81 banks that included the Guaranty Financial Group Inc. in Texas and Colonial BancGroup Inc. in Alabama. This was done amidst the worst financial situation after the Great Depression. Recently some number of banks such as bank of Bank of Wyoming, Ameribank , First National Bank of Blanchardville , Bank of Elmwood, Westsound Bank, Washington First International Bank which were put to the FDIC for receivership.
Source: FDIC Quarterly Banking Profile
FDIC solutions to Banking problems
Since the establishment of the FDIC in 1934, FDIC has helps insured institutions that have failed through its resolution process. The available resolution methods as stipulated by FDIC are:
i) Deposit payoff to the depositors
ii) Purchase and assumption (P&A) agreement,
iii) An open bank assistance (OBA) agreement.
The deposit payoff is the first step in the resolution process. This step is taken as soon as the bank or thrift becomes insolvent and is closed down. On closure of the bank or thrift, FDIC is normally decreed as the receiver of the institution and FDIC initiates the process of paying all the depositors who had insured their deposits in the bank at the time of closure. The funds are paid in full to the depositors as per the records of their insured deposits. However, those who never insured their funds are given certificates entitling them for a share from sale of assets.
Purchase and agreement process, entails the transaction with financial healthy institution normally denoted as the "assuming bank" making purchases of some part or the entire assets from the failed bank or thrift and at the same time taking over all the liabilities of the failed institution including the role of handling the insured deposits. Usually, the acquirer of the failed bank always pays a premium deposits that will in turn reduce the sum of FDIC's resolution cost necessary for the settling of the insured amount to depositors. This process has always been referred to as the 2nd resolution method. The 3rd resolution method known as an open bank assistance agreement involves the FDIC furnishing financial help to a controlling insured bank or thrift that has been found out to be in the brink of closing down. Loans can be made by FDIC in order to make purchases of the assets or in some cases make deposits in the troubled institution. In other cases, the failed institutions can be required to pay back the loans that they are advanced by FDIC. Nevertheless, this method has not been used for a long time since 1992 (Managing the crisis, n.d.)
With increasing number of challenges that has led to the closure of many financial institutions like banks among other, there were need to establish institutions that could promote confidence to depositors as well as investors in various banks. The U.S government having faced many closures of banks established the FDIC to provide insurance to depositors of banks insured with it. Indeed, with many problem ridden banks closing, many depositors have received their money back in cases where they insured their deposits and certificates of entitlement for those who never insured their deposits. Through the processes of resolutions, many failed insured banks had their depositors paid, banks taken over by receiverships and in some cases the banks have been loaned by FDIC. This has promoted confidence in making bank deposits.