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Who Pays for Bank Failures? You Do, of Course

By Hans Parisis
Tuesday, 12 Aug 2008 11:13 AM Current | Bio | Archive

Bank failures are popping up across the map. Historically, it's a small number so far, but regulators already are preparing to raise the rates they charge banks to insure depositors.

The Federal Deposit Insurance Corporation (FDIC) has been sending its chairman, Sheila Bair, on the rounds to media outlets, explaining how the FDIC is an insurance fund, not a publicly financed backstop, and that the banking industry would have to cover its own losses.

"There will be increased failures, but it will be within range of what we can handle," Bair said in an interview not long after the failure of IndyMac. "People should not worry."

Putting aside for the moment that the FDIC can, in fact, borrow billions from the public purse if necessary, a serious question remains:

Can the FDIC handle the coming banking bust?

This week, the FDIC said it plans to increase premiums, although no new fee has been set. If necessary, the agency can also tap a $30 billion line of credit at the Treasury Department and borrow up to $40 billion from the Federal Financing Bank to cover assets at failed banks.

Eight banks have failed so far. Bair expects more to fail. There are 8,455 banks insured by the fund.

Christopher Whalen, managing director of Institutional Risk Analytics, figures 8 percent of all FDIC-insured institutions are "stressed" as of the first quarter, and roughly that same number are headed in that direction. That 8 percent is 700 banks, although just 90 unnamed banks are on the FDIC "problem" list.

IndyMac, by the way, was added to the problem list just before it was shut down.

The failure of IndyMac will sap $4 billion to $8 billion from the fund, up to 15 percent of the fund's total assets. In the case of asset disposal, IndyMac has to repay $10 billion of received advances from the Federal Home Loan banking system first.

The government estimates that the IndyMac failure alone could shave 18 basis points off the FDIC reserve ratio, lowering it to 1.01 percent. By law, it must hold 1.25 percent.

That would trigger a big premium increase as early as September, because the FDIC is required by law to rebuild the fund once it tips below $1.15 for every $100 of insured deposits

Premiums could rise to 10 cents to 15 cents per $100 of domestic deposits from the current 5 to 7 basis points premium for most institutions, according to analysts.

So how does all this compare to the S&L crisis, when more than 2,000 banks and thrifts were taken over? Then, all remaining institutions had to pay 23 basis points to make up the losses.

Relatively speaking, so far so good. But there is no guarantee that things won't get worse, and nothing about rising insurance rates for banks is "free" to the economy or consumers.

After a decade of premium-free insurance, all banks and thrifts began paying premiums in June 2007. That was when the agency implemented a pricing plan mandated by a 2006 law aimed at maintaining the fund's ratio at its traditional target of 1.25 percent.

The FDIC said then that the insolvency risk to the fund has increased "significantly" due to industry consolidation and is mainly due to the concentration of deposits in the 10 largest U.S. banking companies.

FDIC representatives warned that deposit insurance reforms would cause "only a marginal reduction in the risk" of fund insolvency. That's because, according to the agency, the increased risk associated with a concentrated industry structure "simply dominates the reform effect."

So, the banks are paying for the first time in years, and they are paying more than they expected to pay, and they might well end up having to pay much more if many more banks fail.

Guess who will pick up that tab? Bank customers, of course. And, to a degree, bank stock shareholders.

And, in broader but very serious way, the economy itself. If banks must cover rising premiums, they will lend even less in already tough credit conditions.

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Bank failures are popping up across the map. Historically, it's a small number so far, but regulators already are preparing to raise the rates they charge banks to insure depositors.The Federal Deposit Insurance Corporation (FDIC) has been sending its chairman, Sheila Bair,...
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