The Federal Deposit Insurance Corporation (FDIC)

Posted: August 12th, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Federal Deposit Insurance Corporation (FDIC)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Table of contents

Introduction…………………………………………………………………………3

Enactment of the Federal Deposit Insurance Corporation …………………………4

Historical background of FDIC ……………………………………………………4

Purpose for the establishment of FDIC …………………………………………….5

Functions of FDIC………………………………………………………………….6

Structure and Organization of FDIC ……………………………………………….8

Accomplishments of FDIC …………………………………………………….…..9

Challenges faced by FDIC …………………………………………………………11

Common criticisms of FDIC ………………………………………………………11

Personal criticisms of FDIC ……………………………………………………….12

Recommendations for FDIC ……………………………………………………….13

Work cited …………………………………………………………………………15

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Introduction

            An administrative agency refers to an official governmental or state body that is empowered with the authority to supervise and direct the implementation of specific acts of legislation. These agencies are also called corporations and commissions. These bodies are established by the federal constitution, USA congress, legislatures and law making bodies at the local level. They are usually established to redress crucial social problems, oversee complexities in matters that concern government concern and manage crises. There are numerous federal agencies in America. These agencies are instrumental in the management of different government objectives and aspects of public management. However, they have also come under sharp criticism in the process of service provision. One such agency is the Federal Deposit Insurance Corporation.

The agency was established in 1933 to preserve and promote public confidence in banks during the period of the stock market crash. It is an autonomous outfit of the American federal government. The Federal Deposit Insurance Corporation (FDIC) was instituted to provide insurance cover for bank deposits. The agency has undergone a significant expansion in the process of service provision. FDIC has made significant contributions to banking and insurance. However, it has been the subject of criticism because of numerous factors. The organization faces numerous challenges in implementing laws. This report offers suitable recommendations that will improve service delivery by FDIC.

Enactment of the Federal Deposit Insurance Corporation

The Federal Deposit Insurance Corporation was established under the authority of Federal Reserve Act, section12B. The law was created on 16 June 1933. The act was signed in to law by president Franklin Delano Roosevelt. The act of 1933 offered two deposit insurance plans. The two plans were both temporary and permanent. The temporary plan was to be supplied through an assessment of half of one percent of the total insured deposits. The other half was to be payable upon the admittance of the program and the remaining aspect was subjected to call by the agency.

FDIC was also authorized to levy an additional assessment that would not exceed the total values that banks had paid. In addition, the act had a provision for an additional reassessment that is based on the changes that would occur in insured deposits in the presence of the interim plan[1]. The permanent plan had a complex methodology of financing. In addition, it presented a potential burden to the banking system. The impermanent Federal Deposit Insurance Fund proved to be successful. Numerous debates were initiated in order to make the organization permanent. FDIC Chairman Leo Crowley presented a plan to the House Committee on Banking and Currency that would have a momentous influence on federal deposit insurance.

This plan had provisions that employed standards that were strict on new banks. It also made expansions on the authority over the activities of existent banks and reduced insurance exposure. The 1935 Act was incorporated and gave FDIC had the authority to borrow close to $975 million from the treasury. The Federal Deposit Insurance Act made changes for FDIC. According to the act, FDIC was to reimburse Treasury for the overall interest that was forgone. It also removed the law that governed FDIC operations and activities from the Federal Reserve Act. A separate body of law was created and aptly named the Federal Deposit Insurance Act.

Historical background of FDIC

            In the 1930s, the world was experiencing a severe global economic contraction. This period is universally known as the Great Depression. USA was not exempted from the economic crisis. This period was marked by mass unemployment and poor economic growth. The official unemployment rate in America had risen to 25 percent. The stock market had also declined to 75 percent. This was also called the stock market failure of 1929. This time also had majority of banks experiencing bank runs. Bank runs are a common occurrence within fractional reserve banking systems. Clientele withdraw their deposits from financial institutions at a similar period. These customers also transfer their funds in to government bonds (other safe institutions) or demand their total cash.

This processes destabilized banks to a crucial point they run out of finances. Ultimately, the banks became bankrupt. On the onset of President Roosevelt’s tenure, over 9000 banks had closed their doors. The Depositors were ravaged by high losses. The losses were estimated to a total cost of $1.3 billion. The banking system was left in a weakened and powerless condition. Therefore, there were increased concerns that another crisis would be the result of the acceleration in the rate of bank failures. The low levels of the earnings from banks would also pose a challenge to financing a deposit insurance system. The government had a variety of options that would remedy the crisis. However, these options were not viable.

Using tax revenues in the financing of deposit insurance scheme was viewed as widely unacceptable. This was the primary basis for the opposition to federal deposit insurance by the Roosevelt administration. Many analysts and observers therefore felt the need to establish a system and organ for federal deposit insurance. In addition, if substantive coverage was to be provided to all or majority of the banks, it could not be viable without direct support and intervention by the treasury. Legislatures therefore enacted the law that would provide a suitable system and structure of deposit insurance. Accordingly, the Federal Deposit Insurance Corporation was established.

Purpose for the establishment of FDIC

            FDIC was instituted to promote and preserve the confidence of the public in the banking industry. Banks were experiencing a crisis resulting from the great depression. Citizens were also faced by financial constraint. Individuals were continuously alarmed by the failure of the banking sector to withstand the pressures of the great depression. Therefore, bank customers across the country withdrew their money from the banks in order to secure the savings. Therefore, public confidence in the banking arena was lowered further compromising the financial situation in the country. FDIC was therefore established as an agency that would reestablish public confidence in banks.

Functions of FDIC

            The primary role of FDIC is to maintain and preserve public confidence in financial institutions. EFDIC insures deposits in thrift institutions and banks. These deposits can reach up to $100000. This is the limit that has been set by the law. This limit recognizes that many financial institutions have sizable levels of large Certificate Deposits (CDs) outstanding and this limit facilitates the retention of sections of these deposits. The deposits that are insured include deposits within national banks, state banks applying for federal deposit insurance and state banks that are found in the Reserve System. FDIC makes payments to claims by each depositor amounting to a maximum of $100000 if the bank experiences failures.

Depositors may therefore increase their insurance coverage through the maintenance of multiple accounts that are held in different kinds of legal ownership. FDIC is structured under two primary funds. The two funds are the Savings Association Insurance Fund (SAIF) and Bank Insurance Fund (BIF). The two funds are separate entities each with individual resources, expenses and members. Credit Unions are covered the National Credit Union Association. FDIC is therefore responsible for SAIF that was founded on 9 August 1989. This was under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989. SAIF is responsible for the insurance of loan associations. In addition, SAIF also insures deposits in savings.

FDIC may make loans to insured depository institutions. This is done in order to facilitate consolidations and mergers. In addition, FDIC may also purchase assets from the depository institutions. This action is purposed to protect depositors. Accordingly, risks are reduced. Threatened loss to the agency is also averted. Banks also benefit, as they do not require to be closed. This prevention of bank closure takes in to consideration the essential operations of the institution in the provision of adequate banking. For instance, the failure of IndyMac allowed for the intervention of FDIC. FDIC sold the assets of IndyMac and took over the institution.             These procedures were efforts to help the institution cover losses. In addition, the 2008 financial crisis affected 25 banks that became insolvent. Consequently, FDIC took over control of these banks.

FDIC supervises and examines the number of saving institutions and banks. Therefore, FDIC investigates unsafe and illegal banking practices. After a hearing and notice of unsafe banking procedures, FDIC may terminate the insured status of the institution. FDIC issued a cease and desist order against The First Bank of Burlingame. However, this was terminated in December 2008. The agency also regulates the methods in which depository institutions provide the required notice of the termination to depositors. FDIC is the chief federal regulator of the section of banks that are separate from the Federal Reserve System.

FDIC works with congress in legislative issues related to banking insurance policies. It has worked with congress in the process of ensuring suitable reforms in deposit insurance. Although the agency has not proposed the immediate increase of the total insurance amount from the current $100000 per account, it has made recommendations to correct the status quo. These recommendations cite that the amount needs to be indexed for the purpose of inflation with the use of Consumer Price Index. This is to de undertaken after five years. However, the limit should not decline if levels in prices fall.

Structure and Organization of FDIC

            FDIC is an independent body of the Federal government. The agency headquarters are based in Washington D.C. The management of the body was constituted under the Banking Act of 1933. The agency is governed by a Board of administrators. The board consists of five members. Three e members are appointed by the president. The senate approves the presidential nomination. The other two members are ex-officio. The appointed members serve six-year terms. The board should not have more than three members that are of similar political affiliation. The president designates one of the members appointed to become board chairperson. This is also undertaken under the consent of the senate[2]. The nominated vice chairperson also serves a five-year term. The board of directors makes final decisions on matters of FDIC administration. Under the board of directors are managers that implement the decisions of the board of directors. Three main sources fund FDIC. These are:

• Premiums that are assessed on members so as to maintain a reserve ratio.
• Interest earned from investments in insurance funds in United States treasuries.
• Recovered assets from failed banks

General FDIC activities are financed by theses three sources.

Figure 1 shows the structure and organization of FDIC.

 

           

 

 

Accomplishments of FDIC

            FDIC has been successful in the maintenance of public assurance in the banking framework. On the advent of the Great Depression, FDIC was established to contain the adverse effects of the financial crisis on the banking sector. In the period of the great depression, the Federal Reserve permitted liquidity to fall leading many banks to bankruptcy. Many depositors began to panic and withdrew their deposits. The public had lost their faith in banks[3]. More money was put out of circulation further deepening the depression. Within 20 months of the intervention of FDIC, the banking system marked great improvements. FDIC has maintained this momentum to date, and continues to instill public confidence in banking thus avoiding crisis in the banking sector. Therefore, FDIC has helped stabilize the economy.

FDIC has been successful in the formulation and proposal of strategies that can improve insurance banking. FDIC initiated a 2 year Small-Dollar Loan Pilot Program that was concluded in 2009. This was a pilot program that was designed to show how banks could provide affordable small dollar loans that would be an alternative to the high cost credit products like fee-based overdraft programs and payday loans. These procedures were also set to be profitable. The banks in the pilot program made over 34,400 small dollar loans. The principle balance was $40.2 million. The small-dollar had loan default rates that were in line with default rates that had the same type of unsecured loans. The pilot project established that most of the participant banks used small-dollar loan products as the basis for retaining or building banking relationships that are long-term. The project proved to be successful as the banks involved indicated the venture was a resourceful strategy. The banks opted to continue with the program. The affordable, safe and feasible project was replicated in other banks. The project has proven to be a success for many banks as it offers more time for the consumer to recover from a financial emergency.

FDIC has been successful in efforts to stabilize the banking sector. FDIC launched the Legacy loans Program (LLP). The initiative targeted to assist banks gets rid of the toxic assets so as to increase lending and raise new capital. During the 2008 and 2009 credit crisis, Guaranty Bank suffered insolvency and had to hand over the reigns of operations to the BBVA Compass. The sell out was aimed at helping the bank. FDIC shared the losses with BBVA on close to $1 billion of Guaranty’s assets and loans. FDIC helped stabilize other banks during the period of credit emergency. The insolvent banks are resolved by FDIC.

FDIC has also been influential in the education of the insurance banking system and the laws that govern the system of management[4]. In addition, FDIC carries out public edification on the significance of insurance banking. The agency also holds seminars and conferences that incorporate banks and clients to create awareness. It also assists in the understanding of financial laws. The public education has been essential for people who do not understand the system or the importance of insurance banking.

Challenges faced by FDIC

            FDIC faces reduced public confidence in the provision of insurance services and implementation of laws. Sections of analysts and the public want the agency disbanded as it has overstepped the mandate under which it was established.

Even though FDIC is an independent government agency, the organization faces problems of continued government intervention. Some recommendations have been instituted by FDIC to boost reforms in insurance banking. However, these reforms have sometimes been rejected by congress. FDIC also faces financial problems in the process of stabilizing banks during periods of crisis. The adequacy the financial backing of FDIC has been questionable. Sometimes FDIC may incur huge costs in the process of stabilization of the banking sector.

Common Criticisms of FDIC

FDIC’s proposal to make payouts to be faster than when a firm experiences failure has been under sharp criticism. The implications of the cost might reduce finances to many banks. Banks such as JP Morgan, Wachovia, PNC Financial services and Chase & Co. have argued that the scheme would be expensive in the process of updating the data systems. If the banks experience too many costs, the cost will be pushed further to consumers. FDIC sets stringent conditions to banks that reduce their primary role to their clientele. The laws that help FDIC find banks that are undertaking unsafe practices make it hard for banks to comply. Banks require a considerable level of independence from FDIC in order for them to offer effective and efficient services. These conditions have led to the termination of insured status of some financial institutions.

Increased government influence over FDIC is cited to affect the proper delivery of services to the public. This government influence has negative effects on the implementation of laws. In addition, some proposals by FDIC to make amendments from the initial act have been embraced by negative reactions in congress. The recommendations are finally rejected slowing the pace of reforms in the insurance banking industry. FDIC is criticized for the role it plays in the current financial system. The initial formulation of the agency was to reestablish public confidence during the Great Depression. However, FDIC is said to overstay its mandate in the insurance banking sector. Therefore, many analysts recommend the disbandment of the agency.

Personal criticisms of FDIC

Deposit insurance increases the levels of social inequalities. People are insured according to their financial capability. The finances required for the insurance mechanism may not be reached by majority of the poor people. Therefore, during the period of financial turmoil, those under the system are not adversely affected by financial constraints. However, the poor and uninsured will continue to suffer. Over the period of its administration, FDIC has not achieved much in controlling and regulating the banking sector. FDIC should have achieved more success in the process of stabilization of the 2008 and 2009 credit crunch similar to that of the great depression.

The total insurance amount is too limiting. The current amount is limited to $100000. The services are therefore not as expansive in order to cater for the increasing population that requires banking insurance. The laws that govern FDIC are too limiting for the agency to carry out crucial financial services. FDIC does not adequately involve banks and other financial organizations in the process of law and policy formulation. Though FDIC undertakes consultations with banks when establishing new laws, there is need to involve the banks extensively in the process of formulation and implementation of laws.

Recommendations

The total insurance amount should be increased from the current $100,000. The increase will make the insurance banking agency expand the services and offer effective banking insurance. The section of law that stipulates the current amount should be amended. The laws governing the FDIC should be amended to integrate the changing systems and structure of the contemporary banking sector. Amendments to the law will improve the efficiency and outreach of FDIC to the public. These laws should also consider future changes in the banking sector. The government needs to reduce its influence over FDIC. Continued government interference reduces the power and capability of FDIC. Congress is also required to pass laws that will hasten the process of insurance banking reform. The strategic plans and policies that are formulated by FDIC should not be overlooked by congress.