Bank Insurance Fund Research Articles

The effect of industry consolidation and deposit insurance reform on the resiliency of the U.S. bank insurance fund

We examine the effects of structural change in the U.S. banking industry, as well as key regulatory changes, including recently enacted deposit insurance reform legislation, on the resiliency of the FDIC-administered bank insurance fund (BIF) by estimating and comparing the probability of BIF insolvency over time. We do this using a Markov-switching model that relies on historical patterns of BIF disbursements to define the probability of switching among three “states” of the banking industry's financial health. Monte Carlo simulations are then performed to project the financial condition of the BIF over a 50-year period. Our results indicate that the insolvency risk to the bank insurance 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. We also find that recent deposit insurance reforms will cause only a marginal reduction in the risk of BIF insolvency. The increased risk associated with a more concentrated industry structure simply dominates the reform effect.

The Effect of Industry Consolidation and Deposit Insurance Reform on the Resiliency of the U.S. Bank Insurance Fund

We examine the effects of structural change in the U.S. banking industry, as well as key regulatory changes, including recently enacted deposit insurance reform legislation, on the resiliency of the FDIC-administered bank insurance fund (BIF) by estimating and comparing the probability of BIF insolvency over time. We do this using a Markov-switching model that relies on historical patterns of BIF disbursements to define the probability of switching among three states of the banking industry's financial health. Monte Carlo simulations are then performed to project the financial condition of the BIF over a fifty year period. Our results indicate that the insolvency risk to the bank insurance fund has increased significantly due to industry consolidation, and is mainly due to the concentration of deposits in the ten largest U.S. banking companies. We also find that recent deposit insurance reforms will cause only a marginal reduction in the risk of BIF insolvency. The increased risk associated with a more concentrated industry structure simply dominates the reform effect.

Study of banking sector design from risk perspective to minimise social costs

A comprehensive review of the US banking sector design is currently underway with debates among bankers, trade, consumer groups and regulatory agencies on pricing, The Federal Deposit Insurance Corporation (FDIC) bank insurance fund maintenance and coverage levels for new deposit insurance initiative. A macro design framework is proposed as an input to planned improvements. The objective of the proposed conceptual banking sector model is to seek a design where each bank self-monitors its own risk level and controlled by the market forces/discipline. The agency providing risk-based depositors' insurance should break even, at minimal, and the stockholders should make an adequate rate of return. In this way, the need for regulations is decreased, the banking sector becomes more stable and the social cost is decreased.

Should the FDIC Worry About the FHLB? The Impact of Federal Home Loan Bank Advances on the Bank Insurance Fund

Does growing commercial-bank reliance on Federal Home Loan Bank (FHLBank) advances increase expected losses to the Bank Insurance Fund (BIF)? Our approach to this question begins by modeling the link between advances and expected losses. We then quantify the effect of advances on default probability with a CAMELSdowngrade model. Finally, we assess the impact on loss-given-default by estimating resolution costs in two scenarios: the liquidation of all banks with failure probabilities above two percent and the liquidation of all banks with advance-to-asset ratios above 15 percent. The evidence points to non-trivial increases in expected losses. The policy implication is that the FDIC should price FHLBank-related exposures.

Should the Fdic Worry About the Fhlb? The Impact of Federal Home Loan Bank Advances on the Bank Insurance Fund

Does growing commercial-bank reliance on Federal Home Loan Bank (FHLBank) advances increase expected losses to the Bank Insurance Fund (BIF)? Our approach to this question begins by modeling the link between advances and expected losses. We then quantify the effect of advances on default probability with a CAMELS-downgrade model. Finally, we assess the impact on loss-given-default by estimating resolution costs in two scenarios: the liquidation of all banks with failure probabilities above two percent and the liquidation of all banks with advance-to-asset ratios above 15 percent. The evidence points to non-trivial increases in expected losses. The policy implication is that the FDIC should price FHLBank-related exposures.

The implied reserves of the Bank Insurance Fund

Option models of deposit insurance pricing view assessment rates as put option premiums. However, such models ignore the risk of guaranty fund default. This paper attempts to link risk-based premiums with guaranty fund reserves in a partial equilibrium setting, by employing a methodology based on options with credit risk. The value of full insurance per coverage period is expressed as a standard options premium and is decomposed into two parts. The explicit part is due to the available assets (reserves) of the guaranty fund, while the implicit part comes from federal support, contingent on the adequacy of reserves at the end of the coverage period. Implied reserves are derived under an exogenous insurance coverage rate as a policy parameter. The method is illustrated on a sample of 40 large bank holding companies and an extension to the case of several insured banks is provided.

Of Free Trade and Debt Bondage

Years from now, economic historians studying the 1990s will likely pinpoint Mexico as the birthplace of a new and devastating sort of financial crisis. In a sequence of events that scholars of Thailand, Malaysia, South Korea, and Indonesia will now find familiar, Mexican leaders' announcement in December 1994 of a controlled currency devaluation created a financial panic of devastating proportions. Set off by market jitters over a presidential succession and a negative balance of payments, ten days of manic sell-offs of peso holdings, Mexican treasury bonds, and corporate shares erased every bit of employment and income progress made since a halting recovery from depression-level conditions in the middle and late 1980s. For months prior to the crisis the disaster had been imminent. Speculation, gross political corruption, unsound economic policy, and bad investment bets hinging on the stability of an overvalued peso were hollowing out the financial system from within. In early 1995, a hurried U.S.$50 billion rescue package cobbled together from the International Monetary Fund, the World Bank, the Inter-American Development Bank, and the U.S. Treasury bailed out foreign investors but left the bill with Mexican farmers, workers, and middle classes in the form of a severely restricted money supply, buying power cut in half or more, government budgets slashed, and exorbitant interest rates. Three years later, at the end of 1998, Mexicans were further punished by the crisis when legislators converted U.S.$60 billion in bad loans bought by the government's bank insurance fund to public debt, thereby leaving the remaining cost of the debacle to taxpayers. The sum owed by the Mexican people on this count today tops U.S.$100 billion as interest capitalizes and more bad debts surface. The news that filtered into the North American media about the Mexican crisis and its aftermath generally centered on the impact it would have on immigration and the U.S. economy and on what measures ought to be taken

Merging the BIF and the SAIF: Would a merger improve the Fund's viablity?

During the 1990s, the differences between BIF-insured and SAIF-insured institution have declined. Due to mergers, over one-third of the deposits insured by the Savings Association Insurance Fund (SAIF) are now being held by Bank Insurance Fund (BIF) member institutions. This paper examines the SAIF's ability to remain solvent using a Monte Carlo model, under various levels of industry concentration. It shows that industry consolidation has served to reduce the vulnerability of the SAIF, as several large BIF-memeber insitutions have increased their SAIF-insured holdings. Nontheless, the SAIF continues to be somewhat more vulnerable to insolvency risk than the BIF. The paper also examines a merger of the BIF and the SAIF. The results show that a larger, combined insurance fund would be less risky than either the BIF or the SAIF separately. In other words, both the BIF and the SAIF would benefit from a merger of the funds. In addition, the results show that probability of either the BIF or the SAIF becoming insolvent is significantly higher that the probabilty of a merger fund becoming insolvent.

Effects of Bank Consolidation on the Bank Insurance Fund

During the 1990s, mergers of large banks have changed the industry dramatically, with the concentration amoung the 100 largest banking organizations increasing from 54.6 percent as of year-end 1990 or 72.6 percent as of mid-1990. This paper examines changes in the BIF's ability to remain solvent using a Monte Carlo model, under various levels of industry concentration. To better examine the effects of consolidation, the top 100 banking organizations were simulated individually while other banks were simulated in aggregate. The results show that, based on historical loss and failure rates, the consilidation that took place between 1990 and 1997 increased the risk of BIF insolvency by approximately 50 percent, and that megamergers that took place or were announced during the 18 months between year-end 1997 and mid-year 1999 increased the risk of insolvency further. Moreover, unlike the BIF of 1990, the solvency of the BIF of today is inseparably tied to the health of the largest banking organizations.

The federal deposit insurance fund that didn't put a bite on U.S. taxpayers

Unlike the Federal Savings and Loan Insurance Corporation and the Bank Insurance Fund, the National Credit Union Share Insurance Fund (NCUSIF) survived the 1980s without falling into a state of accounting insolvency. This paper analyzes how differences in incentive structure constrain the attractiveness of interest-rate speculation and other risk-taking opportunities to managers and regulators of credit unions. Despite these better incentives, robust present-value calculations establish that NCUSIF fell into economic insolvency during the mid-1980s. Besides calculating the extent of this insolvency, the paper also seeks to explain why, after NCUSIF became insolvent, it could rebuild its reserves without an explicit or implicit taxpayer bailout. Our explanation turns on cross-industry coinsurance responsibilities and the shallowness of the fund's observed insolvency relative to industry net worth. We identify forces in the decisionmaking environment tending to limit the depth and duration of unresolved insolvencies at individual credit unions. Managerial opportunities to benefit personally from taking risks that would flow through to NCUSIF are constrained by difficulties in converting a credit union to stockholder form and by the intensity of proactive monitoring of troubled credit unions by sister institutions and other private coinsurers. We conjecture that expanded use of coinsurance and private monitoring could reduce taxpayer loss exposure elsewhere in government deposit insurance systems.

Reinventing a Government Corporation: Professional Priorities and a Clear Bottom Line

Economic theories of organizational behavior assume that private organizations are driven by efficiency concerns. If the organization is not reaching its goals in an efficient manner, profits drop, dividends are withheld, and competitors are encouraged to challenge the organization's place in the market. A bottom-line profit allows these organizations to measure successes and failures, and motivates the search for less costly ways of delivering goods and services. The public administration literature has long advocated that public executives adopt business-like techniques to make their operations similarly efficient (Wilson, 1887; Gulick and Urwick, 1937; Fayol, 1949), and today's public management literature is no exception. Executives are encouraged to create bottom lines, or measures of performance toward which employees can work, and by which they can measure their progress (Behn, 1992; Osborne and Gaebler, 1992). In this case study, I examine management changes in the Federal Deposit Insurance Corporation (FDIC) at the height of the recent banking crisis and argue that the agency's clear bottom line, the Bank Insurance Fund (BIF), played a crucial role in motivating and facilitating important shifts in organizational resources, authority, and structure. More than an indicator of performance, a well-managed and solvent BIF provides the agency with income and is essential to the agency's political autonomy. Further, professionals in the FDIC place a high value upon protecting the BIF because it is also key to their own professional autonomy. Management changes aimed at facilitating the BIF's viability have consequently been embraced by agency personnel as necessary adjustments. The FDIC was created in 1934 to manage the federally guaranteed insurance fund for bank depositors and to be the primary supervisor for several thousand state-chartered banks. For more than half a century, the deposit insurance fund was solvent. Premiums paid by banks for insurance coverage and the interest earned on insurance funds through the investment in government bonds provided sufficient income to protect depositors in failed institutions, and to cover the FDIC's operating expenses. Beginning in 1983, however, the FDIC's expenses began to exceed the amount it received in bank premiums. Most critical, the number of bank failures that year escalated from 5 (on average) to 48, and reached a decade total 1,086 in 1989 (FDIC Annual Report, 1991, p. 132).(1) The FDIC's own operating expenses also placed a strain on the fund. There were more troubled banks to supervise, more failed banks to resolve, and a greater number of failed-bank assets to liquidate; as a result, the FDIC had to hire and train more personnel (FDIC Annual Report, 1991; 31-32). The operating stress was heightened in 1989 when Congress gave the agency oversight responsibility for resolving the savings and loan crisis, and management responsibility for the new Savings Association Insurance Fund (to replace the insolvent Federal Savings and Loan Deposit Insurance Fund); the same legislation renamed the Deposit Insurance Fund, the Bank Insurance Fund.(2) By 1991, the FDIC projected a first-time deficit of $7 billion (Konstas, 1992; 15). In one decade, the FDIC's workload, and the conditions under which it operated changed dramatically. What was once a relatively obscure sleepy existence was crashed by fiscal stress and intense political scrutiny. Obvious parallels were made to the savings and loan crisis, and the potential for a $100 billion taxpayer bailout of the banking industry brought the Congress, the administration, and the national media into the FDIC's daily operations. The FDIC responded with key management changes in order to guide the corporation from projected deficits to long-term solvency, and, hence, to reestablish some autonomy in managing its responsibilities. Management of bank resolutions and the FDIC's litigation activities (both directly related to liabilities placed on the BIF) were centralized, and the FDIC committed to conducting both activities in-house rather than rely upon private sector contractors. …

The consequences of a policy of necessity: Bank regulatory forbearance, 1986–1989

While it is widely recognized that bank regulators choose the policy of forbearance because of an undercapitalized bank insurance fund, a key policy question centers on what were the effects of forbearance. This study uses a survival model to track capital deficient banks from December 1986 to December 1989, a period in which regulators explicitly used forbearance in managing troubled banks. Despite the contention that forbearance returns banks to safe-and-sound practices, this study concludes that forbearance did not enable troubled banks to return to viability. Furthermore, the evidence from the survival analysis provides negligible support, if any, for the interrelationship between forbearance and too-big-to-fail doctrine.

Federal Reserve Lending to Banks That Failed: Implications for the Bank Insurance Fund

During the 1980s, many banks failed, imposing large losses on the Bank Insurance Fund (BIF). The Federal Reserve loaned to many of the banks that ultimately failed, an association that convinced many that Federal Reserve lending practices had increased BIF losses.

Taxpayer Loss Exposure in the Bank Insurance Fund

Taxpayer Loss Exposure in the Bank Insurance Fund

Implications of Annual Examinations for the Bank Insurance Fund

The Federal Deposit Insurance Corporation Improvement Act of 1991 requires federal supervisors to examine insured depository institutions annually. This article investigates whether mandatory annual examinations will make supervisors more effective in limiting losses to the Bank Insurance Fund (BIF) that result from bank failure.

The Effects of Legislating Prompt Corrective Action on the Bank Insurance Fund

The Effects of Legislating Prompt Corrective Action on the Bank Insurance Fund