A Matter of Trust: How the FDIC Works

You have heard it many times in those rapid-fire announcements on bank advertisements: “FDIC insured.” Before the recent high-profile bank failures, that was likely all most depositors knew about the FDIC, that it was insurance on their money. But current events have brought FDIC into the headlines over actions to protect depositors after the collapse of Silicon Valley Bank on March 10, 2023, the second-largest bank failure in U.S. history.

So, it seems like a good time to take a closer look at the Federal Deposit Insurance Corporation (FDIC), and how it operates.

Confidence Booster

The FDIC is an independent agency of the federal government, headquartered in Washington, D.C., and managed by a board that includes members from the Office of the Comptroller of the Currency and the Consumer Financial Protection Bureau. Congress created the FDIC, but it doesn’t get its money from congressional appropriations. Instead, banks and savings associations pay the FDIC insurance premiums to cover their customer’ deposits.

The FDIC was created in 1933, during the Great Depression, to help foster more trust between consumers and financial institutions. In the aftermath of the stock market crash of 1929, thousands of banks failed. Fueled by fear of losing their money, bank customers rushed to withdraw their funds. This led President Franklin D. Roosevelt to declare a four-day bank holiday in March 1933. In June of that year, Roosevelt signed into law the Banking Act of 1933, which created the FDIC.

Designed to instill confidence in the American banking system, the FDIC protects depositors of insured banks located in the United States against the loss of their deposits if an insured bank fails. This ensures that the U.S. banking system continues to perform its vital roles of protecting deposits and providing access to credit to households and businesses in a manner that promotes strong and sustainable economic growth.

Any person or entity can have FDIC insurance coverage in an insured bank. A person does not have to be a U.S. citizen or resident to have his or her deposits insured by the FDIC. FDIC insurance is backed by the full faith and credit of the United States government.

In addition to providing deposit insurance, the FDIC supervises and examines banks and savings associations across the country to make sure they are operating soundly. The FDIC serves as the primary federal regulatory agency for banks that are chartered by states but are not part of the Federal Reserve System.

It’s also the FDIC’s responsibility to make sure banks comply with consumer-protection laws, including the Fair Credit Billing Act, the Truth in Lending Act, and the Fair Debt Collection Practices Act.

The FDIC proudly proclaims on its website that no depositor “has ever lost a penny of insured deposits since the FDIC was created in 1933.”

The FDIC does not protect deposits held at credit unions. Instead, credit unions are generally insured by the National Credit Union Administration (NCUA), a fund created by Congress in 1970 to insure deposits in member credit unions.

What Happens When a Bank Fails?

A bank failure is the closing of a bank by a federal or state banking regulatory agency. Generally, a failure occurs when a bank becomes insolvent, meaning it lacks the funds to cover its customers’ deposits and the money it owes to others, according to the FDIC.

Bank failures are somewhat common, with a few typically happening every year. It’s rare for there to be periods when no banks closed. But because we’ve had a few times when no failures occurred, such as in 2005-06, 2018, and 2021-22 (the second-longest period without a bank failure since 1933), the recent events have been newsworthy.

The Great Recession of 2008 led to many bank failures in the United States. The FDIC closed 465 banks from 2008 to 2012. In contrast, in the five years prior to 2008, only 10 banks had failed. The receivership of Washington Mutual Bank (WaMu) by federal regulators on September 26, 2008, was the largest bank failure in U.S. history. Regulators simultaneously brokered the sale of most of WaMu’s assets to JPMorgan Chase.

The difference between 2008-12 and the current situation is that the banks are now able to figure out what their losses are with some degree of confidence, whereas during the Great Recession it was more difficult because many of the losses were from mortgage-related financial assets. At the time, the market value of a home, the underlying asset, was harder to value on a day-to-day basis.

Before March 10, 2023, only three banks had failed since the coronavirus pandemic began in 2020, and all three in 2020 (First State Bank in West Virginia, First City Bank of Florida, and Almena State Bank in Kansas) had experienced previous financial problems, according to the FDIC.

When a bank’s capital levels are too low or it cannot meet obligations, the FDIC is named as receiver for a bank’s assets. After the bank’s assets are placed into receivership, the FDIC acts in two capacities—first, the agency pays insurance to the depositors (up to the deposit insurance limit of $250,000 per account) for assets not sold to another bank. Second, as the receiver of the failed bank, the FDIC assumes the task of selling and collecting the assets of the failed bank and settling its debts, including claims for deposits more than the insured limit.

For Silicon Valley Bank (SVB), the FDIC transferred all deposits—both insured and uninsured—and substantially all assets of the bank to a newly created, full-service FDIC-operated “bridge bank.”

A bridge bank is chartered and operates under a board appointed by the FDIC. It assumes the deposits and certain other liabilities and purchases certain assets of a failed bank. The bridge bank structure is designed to span the gap between the failure of a bank and the time when the FDIC can stabilize the institution and implement an orderly resolution.

In addition, the Federal Reserve announced that was establishing a new Bank Term Funding Program, which will offer loans of up to one year in length to eligible depository institutions and U.S. branches or agencies of foreign banks that pledge qualifying assets as collateral. This lending program is meant to provide short-term to medium-term liquidity to institutions that hold assets with long maturities, to mitigate the need to sell such assets at a loss in times of stress. There are no minimum or maximum borrowing amounts.

Shareholders and certain unsecured debtholders of SVB and another failed institution, Signature Bank of New York (SBNY), will not be protected. The banks’ senior management has also been removed. Any losses to the FDIC’s Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.

Depositors do not need to file insurance claims to recoup their deposits. Nor do they need to apply for deposit insurance when they open a bank account at an FDIC-insured institution.

It can take a few years to recover deposits that exceed the insurance limit. As the FDIC sells off a failed bank’s assets, it issues periodic payments to depositors. Funds that exceed insurance limits are repaid on a cents-on-the-dollar basis.

What’s Covered

The standard FDIC insurance limit is $250,000 per depositor, per account ownership type, or per financial institution. Funds deposited in separate branches of the same insured bank are not separately insured. FDIC insurance covers all types of deposits received at an insured bank but does not cover investments, even if they were purchased at an insured bank.

Consumers don’t have to do anything to take advantage of this coverage. If you have deposits at an FDIC member bank, you’re automatically covered. Banks and financial institutions pay a premium to the FDIC for this coverage, but consumers pay nothing.

The meanings of “per depositor” and “per financial institution” are straightforward. The “account ownership type” categories include:

•  Single accounts (owned by one person)
•  Joint accounts (owned by two or more people)
•  Certain retirement accounts including IRAs.
•  Revocable and irrevocable trusts
•  Employee benefit plans held at an insured institution.

The $250,000 coverage maximum can apply in different ways. For example, if you have a checking account, a savings account, and multiple CDs at one bank, all of which are owned by you as an individual, then they are insured for a combined total of up to $250,000 because they all fall within one ownership category as single accounts.

However, if you also have a joint account with your spouse at the same bank, you’d receive another $250,000 coverage limit for half of the funds in that account.

Another way to receive more than $250,000 in coverage is to have deposit accounts with multiple FDIC-insured banks. Your accounts would each be covered up to the insurance limit per depositor for each ownership category at each bank.

The FDIC does not insure investments. Even if you buy stocks, bonds, mutual funds, annuities or life insurance policies through a bank, your money is not protected. The FDIC also doesn’t cover the contents of your safe-deposit box.

Conclusion: Have Confidence

Deposit insurance is one of the significant benefits of having an account at an FDIC-insured bank. It’s how the FDIC protects your money in the unlikely event of a bank failure. As noted, bank failures are rare.

At its meeting on March 22, 2023, Fed chair Jerome Powell announced a rate hike of 25 basis points. He expressed confidence in banking systems’ soundness and resiliency.

The U.S. banking sector as a whole and particularly the large, systemically important institutions have been through significant stress testing and are forced to carry exceedingly high levels of capital and liquidity while also being very closely monitored by regulators. Banking regulators have expressed confidence that the recent failures are isolated events and will not spread broadly through the country’s financial sector.

We will continue to monitor and analyze for other associated risks to client portfolios and take action to mitigate those risks as appropriate.

If you have more questions, check out the government’s FDIC website: https://www.fdic.gov/

If you like reading our “Bowen Reports Blogs”, Bowen Asset does have a Facebook page: https://www.facebook.com/BowenAsset Please check it out as we frequently make comments on the page about not just finance and economic events that happen in between our blogs.