Main Page | See live article | Alphabetical index

Federal Deposit Insurance Corporation

The Federal Deposit Insurance Corporation (FDIC) was created by the Glass-Steagall_Act of 1933. The vast number of bank failures had spurred Congress into creating an institution which would guarantee banks. The FDIC currently guarantees checking and savings deposits in member banks upto $100,000 per depositor. 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

When a bank becomes under capitalized 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 under capitalized the FDIC declares the bank insolvent.

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 mortages 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 the 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 inadequate reserves to make depositors of failed S&Ls whole. It had clearly been shown, when seriously tested for the first time, to be inadequate to its task.

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.

See also: Financial supervision, Financial institutions