Ron J. Feldman - Senior Financial Specialist
Arthur J. Rolnick - Senior Vice President and Director of Research, 1985-2010
Published January 1, 1998
The views expressed herein are not necessarily those of the Federal Reserve System.
Government support for depositors and other creditors of failed banks is a two-edged sword. It protects the less sophisticated depositor and helps to prevent banking panics that have historically led to economic retrenchment. But too much government protection encourages banks, often the largest in a country, to shift funds into high-risk projects that they would not otherwise fund. This effect on banks' behavior is known as moral hazard and can lead to less productive use of society's limited resources.
The challenge for policy-makers is determining how much protection is too much. Unfortunately, economic theory does not prescribe an optimal amount. Theory, however, does suggest that 100 percent coverage can lead to excessive risk taking. Yet, by the 1980s, full protection of all depositors (and in some cases other creditors) became a common practice and banks behaved as predicted, resulting in one of the worst financial debacles in U.S. history.
In 1991, Congress partially fixed the problem of 100 percent coverage by passing the Federal Deposit Insurance Corp. Improvement Act (FDICIA). Among other things, FDICIA substantially increased the likelihood that uninsured depositors and other creditors would suffer losses when their bank fails. The fix was incomplete, however, because regulators can provide full protection when they determine that a failing bank is too-big-to-fail (TBTF)that is, its failure could significantly impair the rest of the industry and the overall economy.
We think this TBTF exception is too broad; there is still too much protection. The moral hazard resulting from 100 percent coverage could eventually cause too much risk taking and poor use of society's resources. Consequently, we propose amending FDICIA so that the government cannot fully protect uninsured depositors and creditors at banks deemed TBTF.
To suggest reforming our banking laws at a time when bank failures are a distant memory for most may seem incongruous. But waiting could prove costly. The continuing consolidation in banking could lead more banks with more uninsured deposits to qualify for TBTF status. In addition, bank powers are expanding and will probably grow further, so TBTF banks will have more activities potentially benefiting from full protection. Now is also an opportune time to amend FDICIA because the robust economy and record bank earnings make it easier for banks to absorb the costs of reform.
Our proposed reform attacks the problem of 100 percent coverage head-on by requiring uninsured depositors of TBTF banks to bear some losses when their bank is rescued. We also recommend that regulators treat unsecured creditors with depositlike liabilities the same as uninsured depositors, while providing no protection to other creditors. TBTF banks would then have to pay uninsured depositors and other creditors higher rates for funds when the chance of bank default increases, thus muting their incentive to take on too much risk. To further address moral hazard, we propose that the FDIC incorporate the market's assessment of risk, including the rate paid to uninsured depositors and other creditors, into insurance assessments.
We recognize that these reforms, by increasing market discipline, will make bank runs and panics more likely. Consequently, we cap the losses that uninsured depositors and unsecured creditors with depositlike liabilities can suffer. Keeping losses relatively low also makes our plan credible because it eliminates the rationale for fully protecting depositors after a bank has failed. In addition, we call for the disclosure of more supervisory information and provide an incentive for banks to release additional information in order to help market participants evaluate the financial condition of banks.
We do not claim to have struck the perfect balance between market discipline and government protection, or to have found the only credible way to increase market discipline, but experience and theory cannot justify continuation of 100 percent protection. Moreover, alternatives to our reform that rely on regulation or the privatization of deposit insurance have much more serious drawbacks. We also recognize that our reform is unlikely to be the only action that Congress will have to take to end 100 percent coverage. Thus, we suggest an additional step that Congress may need to consider in the future.
Until the financial debacle of the 1980s, the federal government's program to stabilize banks (used broadly to include all insured depositories) had been considered highly successful. Federal deposit insurance was established in 1933 to protect small depositors and to prevent the systemwide banking runs that had plagued the U.S. economy for close to 100 years. These goals were accomplished. Small depositors at failed banks were always fully protected, and nationwide banking panics in the United States became historical curiosities.
However, the financial debacle of the 1980s made clear that depositor protectionwhich had gone well beyond the small saverdid not prevent turmoil in the banking system. Indeed, between 1979 and 1989, 99.7 percent of all deposit liabilities at failed commercial banks were protected.1 Yet, roughly 1,000 commercial banks still failed. At about the same time, while the federal government was insuring nearly all deposits at savings and loans, over half the industry failed.
This expansion to complete coverage was the result of several factors. First, the coverage rules allowed for more protection. The amount insured expressed in 1980 dollars had risen from roughly $30,000 in 1934 to $100,000 in 1980 and the FDIC insured a wider range of deposits (for example, so-called brokered deposits, which are funds that banks purchase from depositors via a broker). Second, the FDIC chose resolution techniques for failed banks that fully protected virtually all uninsured depositors and, in many cases, other unsecured creditors. In fact, in the FDIC's 1985 Annual Report, the chairman of the FDIC made it an explicit objective of the standard resolution process to fully cover all uninsured depositors. Finally, regulators indicated that they would take extraordinary steps in response to the failure of a very large bank not otherwise allowed during a standard resolution. Such steps have included full protection for uninsured depositors and other creditors, as well as suppliers of funds to the bank's holding company and potentially even shareholders, without regard to the cost to the FDIC. This practice became known as TBTF and emerged from the 1984 rescue of Continental Illinois, the seventh largest U.S. bank at the time.
We think that the 100 percent coverage and the financial debacle of the 1980s were not independent events. While other explanations for the huge number of bank failures are plausible, we view too much protection as a critical underlying cause.2 Once its depositors and other creditors are fully protected, a bank is likely to take much more risk than it would otherwise.3 This is especially true at banks where owners can diversify their risk or at banks that are seriously undercapitalized. In effect, it's heads the bank wins and tails the taxpayer loses.
Policy-makers in Congress and the Treasury Department recognized the dangers resulting from 100 percent protection and moral hazard. The Treasury's recommendations for the bank reform legislation in 1991 pointed to the "overexpansion of deposit insurance" as a fundamental cause for the exposure of taxpayers to "unacceptable losses."4 Likewise, in preparing FDICIA, Congress found that "taxpayers face a bank fund bailout today primarily because the federal safety net has stretched too far. FDIC insures more kinds of accounts than was originally intended, and also frequently covers uninsured deposits."5 With the recognition, came the legislative response.
FDICIA makes routine, full protection of uninsured depositors and other creditors at banks more difficult. However, FDICIA continues to allow full protection of depositors and other creditors at banks deemed TBTF.
Reduces Routine, Full Protection for Uninsured Depositors. FDICIA creates a new, "least cost," resolution process that makes the FDIC less likely to offer full protection. Under the 1991 law, the FDIC must consider and evaluate all possible resolution alternatives and choose the option that has the lowest cost for the deposit insurance fund. This requirement has led to many more resolutions in which acquirers only assume insured deposits.
The graph below indicates the extent to which the FDIC has reduced its coverage of uninsured depositors. In 1986, for example, the FDIC fully protected uninsured depositors of commercial banks that held over 80 percent of the assets of all failed banks. In sharp contrast, in 1995 the FDIC protected no uninsured depositors at failed banks. While there have been only a limited number of commercial bank failures since FDICIA (about 190 commercial banks failed from 1992 to 1996 and none were very large), the FDIC has established a pattern of imposing losses on uninsured depositors at small banks.
Allows Full Protection at TBTF Banks. FDICIA contains an exception to allow 100 percent protection. It allows full coverage for depositors and other creditors at banks deemed TBTF through a multiapproval process. The Secretary of the Treasury must find that the lowest-cost resolution would "have serious adverse effects on economic conditions or financial stability" and that the provision of extraordinary coverage would "avoid or mitigate such adverse effects." The Secretary of the Treasury must consult with the president in making this determination. In addition, two-thirds of the governors of the Federal Reserve System and two-thirds of the directors of the FDIC must approve the extraordinary coverage.
While these limitations appear to constrain bailouts, they are not prohibitive. Indeed, Congress appears to have codified, but not necessarily altered, the informal rescue process that was previously in place. Consider the 1984 testimony of the Comptroller of the Currency on the decision to bail out Continental Illinois:
We debated at some length how to handle the Continental situation. ... Participating in those debates were the directors of the FDIC, the Chairman of the Federal Reserve Board, and the Secretary of the Treasury. In our collective judgment, had Continental failed and been treated in a way in which depositors and creditors were not made whole, we could very well have seen a national, if not an international, financial crisis the dimensions of which were difficult to imagine. None of us wanted to find out.6
Our rationale for questioning the exception under FDICIA is clear. One hundred percent protection has proven a high-cost policy. The lack of market discipline under such a regime suggests that the current TBTF exception could encourage excessive risk taking in the future.
The need to fix this aspect of FDICIA now, however, may appear counterintuitive. The banking industry is enjoying record profits, banks have been able to broaden the activities from which they can generate revenue and the largest U.S. banks have grown to the size that some analysts believe is required to compete internationally. Yet, it is these very trends that make enactment of our reform timely.
More large banks controlling a greater share of uninsured deposits have resulted from recent bank consolidation. Hence, regulators may view more banks as requiring TBTF treatment under FDICIA. Consequently, more uninsured depositors will assume that their bank is TBTF and their deposits will be protected.
No written list of the TBTF institutions exists, but previous empirical work used the 11 largest institutions highlighted by the Comptroller of the Currency in his 1984 testimony. Those banks controlled 23 percent of all assets at the end of 1983 and had an average size, in 1997 dollars, of about $94 billion. The 11 largest banks as of the end of 1997 held 35 percent of all assets and had an average size of nearly $157 billion. The growing number of large banks also means that the TBTF list may have expanded past the 11-bank list. The smallest of the 11 TBTF banks in 1983 had assets of just over $38 billion in 1997 dollars. Using $38 billion as a cutoff suggests that regulators may view depositors at the nation's 21 largest banks as benefiting from implied deposit insurance (see Table below).
The top 21 banks that regulators may view as TBTF have increased their share of uninsured deposits from 30 percent in 1991 to 38 percent in 1997. (The top 50 banks increased their share from 44 percent in 1991 to 55 percent in 1997.) At the same time, total uninsured deposits have increased. Consequently, the taxpayers' exposure at TBTF banks has increased significantly since FDICIA.*
Banks are not only growing in size, they are growing in powers, that is, in their ability to offer nonbank financial services such as the sale and underwriting of insurance and securities. Both the Office of the Comptroller of the Currency and the Board of Governors of the Federal Reserve System have expanded the types and/or the amount of nonbank financial activities in which banking organizations can participate. Both regulators also support legislation that expands their nonbank financial and commercial activities (they disagree as to the organizational structure in which such powers will be exercised and the specific type and amount of new powers made available). Expanding powers would increase the role of banking organizations in the financial system, making it more likely that regulators will consider the failure of a large institution as destabilizing. For these reasons, we view banking deregulation before deposit insurance reform as "putting the cart before the horse," a view long held by researchers at the Federal Reserve Bank of Minneapolis.7
The most extensive reforms to the bank regulatory system have occurred after or during banking crises. Although some of these reforms were well-conceived, good times present a superior time for action for at least two reasons. First, we should put depositors and other creditors at risk now precisely to avoid a future debacle. Second, a reform may put institutions in a weaker financial position by increasing their cost of funds. We should, therefore, enact reforms when banks have more resources to absorb the higher costs.
In 1984 congressional testimony, the Comptroller of the Currency suggested that the 11 largest banks were TBTF. As of year-end 1997, the banks in the right column exceeded the minimum size required$38.2 billionto make the Comptroller's TBTF list.
Assets as of 12/83
(billions of $)
Assets as of 12/97
(billions of $)
|1983 Ranking||1983 Dollars||1997 Dollars||1997 Ranking||1997 Dollars|
|1 Chase Manhattan||
|2 Bank of America||
|3 Chase Manhattan||
|3 Bank of America||
|4 Manufacturers Hanover||
|5 Morgan Guaranty||
|5 Morgan Guaranty||
|6 First Union||
|7 Bankers Trust||
|8 Bankers Trust||
|8 Wells Fargo||
|9 Security Pacific||
|10 First Chicago||
|11 Wells Fargo||
|11 U.S. Bank||
|14 NationsBank (TX)||
|15 First Chicago||
|16 Bank of New York||
Source: Consolidated Reports of Condition and Income
We propose that Congress amend FDICIA so that uninsured depositors cannot be protected fully when a troubled bank is rescued under the TBTF policy. Congress can implement this reform in several ways described below, but the basic idea is to require some form of coinsurancethe practice of leaving some risk of loss with the protected party. Regardless of the formulation, we think all uninsured depositors should be subject to the same coinsurance plan, including banks with uninsured deposits at their correspondent. In addition, we propose treating unsecured creditors holding bank liabilities that have depositlike features the same as uninsured depositors. Also, we propose that the coinsurance plan under a TBTF bailout be phased in over several years to avoid any abrupt change in policy.
Our other key recommendation is for regulators to incorporate a market assessment of risk in the pricing of deposit insurance. In particular, after implementation of this proposal, we recommend that regulators include the risk premium depositors and other creditors receive on uninsured funds in the assessments on TBTF banks.
Lastly, to help uninsured depositors and other creditors monitor and assess bank risk, we propose that regulators disclose additional data on banks' financial condition. We think that banks will have an incentive under our proposal to disclose additional information that the market requires. Regulators should consider mandated, cost-effective disclosures only if voluntary release does not occur.
To address the potential problems created by 100 percent coverage under the TBTF exception, we turn to the conventional technique that private insurance companies have used to mitigate moral hazard. Analysis identified coinsurance about 30 years ago as a primary means for insurance underwriters to combat moral hazard.8 In that vein, we propose that uninsured depositors and other creditors face a small but meaningful loss when regulators exercise the TBTF policy.
Congress could formulate a coinsurance policy in several ways. A simple approach would set a "maximum loss rate" that uninsured depositors could face, say at 20 percent, and phase it in over time. Congress could set an initial, maximum 5 percent loss and have it rise 5 percentage points a year for the following three years. Under the maximum loss rate approach, uninsured depositors would receive no protection if they would suffer losses of less than 20 percent of their uninsured deposits, for example, after they receive proceeds from the liquidation of failed bank assets. This approach may be objectionable if the rate is set so high as to effectively eliminate TBTF coverage. To address this, the maximum loss rate could be lowered or Congress could apply the coinsurance rate to the loss that uninsured depositors would have faced if the FDIC did not protect uninsured depositors. This "loss reduction rate" would ensure that uninsured depositors always receive some coverage above what they would have received from the liquidation of the failed bank's assets.** In 1990, the American Banker's Association proposed a coinsurance formulation somewhat similar to the loss reduction approach for eliminating 100 percent coverage at TBTF banks.
Congress must address a critical trade-off when choosing a coinsurance policy. The potential loss should be set high enough so that uninsured depositors will be induced to monitor the financial condition of their bank, but not so high as to eliminate the stabilizing benefits of government protection. Certainly, the details of a co-insurance policy under this maxim will always be somewhat arbitrary. However, policy-makers do not escape the difficult decision of determining how much market discipline to impose on depositors by maintaining the status quo.
The TBTF exemption in FDICIA should also not allow full coverage of all unsecured creditors of failed banks. Indeed, Congress recently indicated a preference for imposing post-resolution losses on such creditors by passing a national depositor preference statute in 1993 (which put unsecured creditors further back in the queue for receiving revenue realized from the resolution of a failed institution). In scaling back potential coverage for unsecured creditors, we think Congress must address the same critical trade-off it faces when putting uninsured depositors at risk. Thus, we recommend that unsecured creditors holding depositlike bank liabilities should face the same coinsurance policy as uninsured depositors. All other unsecured creditors should receive no special coverage. This formulation would protect, for example, holders of very short maturity bank liabilities like the overnight loans banks make to each other, certain commercial paper and foreign deposits but not holders of longer-term liabilities or claims arising from the provision of services or court judgments.
Prior to 1993, the FDIC charged all banks the same assessment for deposit insurance regardless of their risk of making a claim against the insurance fund. Banks did not face the cost of excessive risk taking because the insurerlike the depositor with 100 percent insurance coveragedid not charge risk penalties when the probability of bank failure increased.
FDICIA required the FDIC to create a system of risk-based insurance assessments because a flat-rate assessment encourages excessive risk taking. The initial risk-based assessments turned out to be too high for low-risk banks and too low for the highest-risk banks.9 Rather than correcting this failure, the FDIC was, in essence, forced back to flat-rate assessments (due to restrictions on the insurance reserves it can hold). Since 1996 over 90 percent of banks have paid the statutory minimum assessment, which has fallen from $2,000 per year to zero.
The problem here is that, even if uninsured depositors and other creditors have the potential for bearing losses, TBTF banks may still take on too much risk if insurance assessments are not risk-based. This occurs because taxpayers would continue to bear some of the banks' risk. Thus, we recommend that any FDICIA reform to eliminate the potential for 100 percent coverage at large banks be accompanied by efforts to make their assessments more sensitive to risk.
To this end, we recommend market-based, risk-adjusted insurance assessments for TBTF banks. We suggest that the FDIC include the risk premium implicit in rates paid on uninsured deposits (as well as other market measures of risk) into insurance assessments for the largest banks. The FDIC, for example, could charge the largest banks with a risk premium above policy-makers' comfort level, say that on the A-rated corporate bond, much higher assessments in order to halt exploitation of insured status. Alternatively, the FDIC could incorporate the risk premium more gradually so insurance assessments rise or fall incrementally with changes in the risk premium.
Proposals to incorporate risk premiums on uninsured deposits into FDIC assessments date at least as far back as 1972. Critics of this reform usually argue that depositors and other market participants will not price risk correctly, either because they believe they will receive a bailout or because they do not have adequate information. As a result, assessments based on market risk premiums will not accurately price risk. Our proposal makes clear that uninsured depositors cannot receive full protection. Recent empirical reviews find that suppliers of funds to banks charge risk premiums if they will, in fact, face losses when their bank defaults.10 As for the lack of information about banks' behavior toward risk, we add one additional reform to our proposal.
The more information depositors and other creditors have on the financial and operational condition of their bank, the more the risk premium on uninsured deposits and other bank funding will reflect true underlying risk. Thus, we recommend ensuring that market participants have data that make the financial condition of banks less opaque.
Regulators, for example, receive nonpublic information on loans with late repayments that could be made public along with other information or assessments that regulators gather or produce. Some of this data may contain new information for market participants, and disclosure of such information may improve the ability of funders to evaluate their banks.11
Banks will have an incentive under our proposal to reveal more information about their business. The more germane data banks provide, the less opaque they are and the lower the interest rate they will have to pay uninsured depositors. Regulators should consider requiring cost-effective disclosure only if banks do not voluntarily disclose the information that markets need to properly assess bank financial condition.
Of course every uninsured depositor does not have the same skills or desire to analyze disclosures provided by banks and regulators. But existing firms, and firms that will develop in the future, will surely provide analysis of banks' condition for uninsured depositors just as specialized firms provide evaluations of mutual funds and the claims-paying ability of insurance firms. The lack of interest in bank conditions currently manifested by uninsured depositors and the absence of firms providing evaluations of banks for these depositors reflect current incentives, not innate features of the human or business condition.
We began this essay noting that deposit insurance is a two-edged sword. On the one hand, it protects the small saver and limits the probability of banking panics. On the other hand, too much deposit insurance leads banks to take on more risk than they would otherwise. All deposit insurance systems must face this fundamental trade-off.
Our plan clearly adds market discipline. It also addresses the concern of increased instability in four ways.
First, we put only a small percentage of uninsured depositors and other creditors' funds at risk. Limiting the amount of the potential loss should help contain spillover effects from any one large bank failure to other banks and the rest of the economy. A bank that has uninsured deposits at a large failing bank, for example, is not likely to suffer losses so great as to bankrupt it. Thus, depositors do not have cause to run all banks with deposits at large failing institutions for fear of interbank exposure.12 Moreover, the small potential loss makes it less likely that the benefit of pulling deposits out of a bank will outweigh the costs of making alternative investments.
Second, our reform should increase the information that markets have on banks' financial condition. Depositors are less likely to run sound banks if they are more transparent.
Third, by increasing market discipline, we make it more likely that banks will not take excessive risk.
Finally, we call for a gradual increase in the coinsurance rate. Policy-makers and analysts will have time to review the response of depositors and other creditors and adjust the rate. Likewise, incorporating a market-based risk premium into the insurance assessment need not occur at once.
Can we guarantee that our plan achieves the right balance? No reform plan can make such a claim. We may have too much or too little of uninsured depositors' funds at risk. Under our plan, uninsured depositors at risk of loss might pull their funds from all large banks regardless of their solvency. But one cannot reasonably judge the plan's potential costs in the abstract. Rather, interested parties must compare this proposal to the current system and alternative proposals.
Some analysts have argued that FDICIA's regulatory reformsin conjunction with existing market discipline provided by stockholders, bondholders and bank managers fearing for their jobsadequately address the potential problems that 100 percent coverage at TBTF banks can create. Yet, as we noted, stockholders are the beneficiaries of excessive risk taking and are unlikely to act as a bulwark against it. Moreover, experience over the last 15 years suggests to us that these other sources of market discipline are not sufficient to control the deleterious effects of moral hazard. And while the FDICIA regulatory reforms were a step in the right direction, reviews of these changes do not suggest that they adequately curtail risk taking.13 Moreover, we are skeptical that additional regulations can effectively substitute for putting uninsured depositors and other creditors at risk. Certainly, promulgating Draconian regulations could prevent the problems arising from 100 percent coverage, but such a strategy would impair the ability of the banking system to efficiently allocate financial resources.
Eliminating federal deposit insurance altogether offers another alternative for addressing the moral hazard of 100 percent coverage at the largest banks. We do not find this reform credible. Banking panics were not eliminated in the United States under private deposit insurance systems. Consequently, it is likely that banking regulators, in order to address the threat of such panics, would still want to fully protect depositors at large failing banks after privatization. Thus, the public would still assume that their deposits are fully protected at banks considered TBTF and moral hazard would still remain a problem.
In contrast to privatization options, we view reforms requiring TBTF banks to hold subordinated debt as differing from our own in implementation detail rather than intent or substance.14 Both plans seek to increase market discipline by putting those who supply funds to TBTF banks at risk, and both allow the FDIC to incorporate additional market data into their assessment-setting process. And, like our plan, credible subordinated debt reforms must address the trade-off between depositor safety and bank risk.
Unfortunately, our proposed reform will almost certainly not be the final action that Congress must take to eliminate 100 percent coverage. For example, uninsured depositors may divide their funds into multiple insured accounts in order to avoid the potential for loss. In response, Congress may have to curb the ability of depositors to receive more than $100,000 in insurance coverage through multiple accounts, or apply a co-insurance policy to all deposits.
Economic theory and experience both suggest that providing 100 percent government protection for bank depositors and other creditors can be extremely costly. One hundred percent coverage quashes market discipline, encourages banks to take on too much risk and can massively misallocate society's limited resources. It can lead to the very type of bank failures and costs to society that deposit insurance aims to prevent. These costs are so high that Congress should prohibit bank regulators from providing 100 percent coverage as is currently allowed at the nation's largest banks. We think that a credible reform is to amend FDICIA so that uninsured depositors and other creditors cannot be fully protected under the TBTF exception but do not suffer losses so large as to eliminate the stabilizing benefits of government protection. In another step necessary to address moral hazard, we recommend that the FDIC use market signals, from at-risk depositors and other available sources, to make insurance assessments of TBTF banks risk-related.
Our reform is unlikely to be the last that Congress will need to pass. However, the potential for future reform should not dissuade policy-makers from using the current window of opportunity to avoid the mistakes of the past. The FDIC sought to increase depositor discipline in the early 1980s through a resolution method, called modified payoff, in which uninsured depositors would receive no extraordinary coverage, but rather a proportion of their money based on the liquidation value of the bank's assets. The FDIC had "experimented" with the method and "hoped to expand the modified payoff to all banks regardless of size."15 But the failure of Continental soon after the pilot program began led to its demise. Now, Congress can establish a commitment in law to impose losses on uninsured depositors and other creditors at banks deemed TBTF. Without such a credible commitment, Congress may find itself in the uncomfortable position of conducting the post-mortem of another financial debacle.
The Minneapolis Fed Proposal
To guarantee that uninsured depositors cannot be protected fully under the too-big-to-fail (TBTF) policy, and to thereby minimize the impact of the moral hazard problem, Congress should amend the Federal Deposit Insurance Corp. Improvement Act of 1991 (FDICIA) as follows:
* In addition to potentially more TBTF banks, recent research suggests that large banks have not reduced their exposure to a significant risk since FDICIA. Specifically, the largest 10 percent of publicly traded bank holding companies had significant interest-rate risk both before and after FDICIA. If FDICIA had reduced the interest-rate risk that large banks are taking, the relationship between interest-rate movements and bank stock prices should not be as strong after FDICIA as before it. Instead, the research finds no decline in the level of interest-rate risk at large banks since FDICIA. See David E. Runkle, "Did FDICIA Reduce Bank Interest-Rate Risk?" Working Paper, Federal Reserve Bank of Minneapolis, December 1997.
** An example where an uninsured depositor suffers a $10,000 loss clarifies the difference in the two approaches. A 20 percent rate under the maximum loss formulation would provide no insurance if the $10,000 loss is less than 20 percent of the depositor's total uninsured deposits and complete coverage for any losses above 20 percent. In contrast, a 20 percent coinsurance rate under the loss reduction formulation would reduce a $10,000 post-liquidation loss to $2,000.
1 Moyer, R. Charles, and Lamy, Robert E. 1992. Too Big To Fail: Rationale, Consequences, and Alternatives. Business Economics 27 (3): 19-24.
3 Kareken, John H., and Wallace, Neil. 1978. Deposit Insurance and Bank Regulation: A Partial-Equilibrium Exposition. Journal of Business 51 (3): 413-438.
4 U.S. Treasury. 1991. Modernizing the Financial System: Recommendations for Safer, More Competitive Banks. Washington, D.C.: Department of the Treasury, pp. 8-10.
5 House Report 102-330 (November 19, 1991). U.S. Code Congressional and Administrative News, vol. 3, 102nd Congress, First Session, 1991, p. 1909.
6 Inquiry Into Continental Illinois Corp. and Continental Illinois National Bank. Hearings Before the Subcommittee on Financial Institutions, Supervision, Regulation and Insurance of the House Committee on Banking Finance and Urban Affairs, September 18, 19 and October 4, 1984, pp. 287-288.
7 Kareken, John H. 1983. Deposit Insurance Reform or Deregulation Is the Cart, Not the Horse. Federal Reserve Bank of Minneapolis Quarterly Review 7 (Spring): 1-9.
8 Dionne, Georges, and Harrington, Scott (eds.). 1992. Foundations of Insurance Economics: Readings in Economics and Finance. Boston: Kluwer Academic Publishers, p. 2.
9 Fissel, Gary S. 1994. Risk Measurement, Actuarially-Fair Deposit Insurance Premiums and the FDIC's Risk-Related Premium System. FDIC Banking Review 7 (Spring/Summer): 16-27.
10 Flannery, Mark J., and Sorescu, Sorin M. 1996. Evidence of Bank Market Discipline in Subordinated Debenture Yields: 1983-1991. Journal of Finance 51 (4): 1347-1377.
11 DeYoung, Robert; Flannery, Mark; Lang, William; and Sorescu, Sorin. 1998. Could Publication of Bank CAMELS Ratings Improve Market Discipline? Manuscript.
12 An alternative method for limiting the potential of one bank's failure to spill over to another focuses on the payment system. Hoenig, Thomas M. 1996. Rethinking Financial Regulation. Federal Reserve Bank of Kansas City Economic Review 81 (2): 5-13.
13 See Jones, David S., and King, Kathleen Kuester. 1995. The Implementation of Prompt Corrective Action: An Assessment. The Journal of Banking and Finance 19 (3-4): 491-510 and Peek, Joe, and Rosengren, Eric S. 1997. Will Legislated Early Intervention Prevent the Next Banking Crisis? Southern Economic Journal 64 (1): 268-280 for reviews of Prompt Corrective Action.
14 See Calomiris, Charles W. 1997. The Postmodern Bank Safety Net: Lessons from Developed and Developing Economies. Washington, D.C.: American Enterprise Institute for Public Policy Research for an example of a subordinated debt plan.
15 Federal Deposit Insurance Corp. 1997. History of the Eighties: Lessons for the Future. Volume I, An Examination of the Banking Crises of the 1980s and Early 1990s. Washington, D.C.: FDIC, pp. 236 and 250.