FDIC – Government insurance program covering bank accounts originally put in place in 1934Current Maximum Coverage -- $250,000FDIC – Government insurance program covering bank accounts originally put in place in 1934Current Maximum Coverage -- $250,000Effectively stopped bank runs and stabilized the financial industry Two methods that FDIC has for dealing witha failed institution1. Payoff method2. Purchase and assumptionProblem of “Too Big To Fail”Existence of FDIC creates adverse selection and moral hazard problems in the banking industry. Regulations to reduce these problems.1. Restrictions on asset holdingsreduces the moral hazard problem2. Capital requirementsreduces the moral hazard problemall banks must maintain the leverage ratiobanks involved in risky off-balance sheet activities must hold additional capital based on the amount of riskprompt corrective action if a bank does not have sufficient capital3. Charteringreduces the adverse selection problemnational banks – Office of the Comptroller of the Currencystate banks – state banking authority4. ExaminingReduces the moral hazard problemAll banks examined at least once a year and given a CAMELS ratingAll banks file periodic reports5. Disclosure requirementsMore public information reduces excessive risk taking6. Consumer protectionProvide informationReduce discriminationRestrictions on competition that helped shape the financial industry.- McFadden Act of 1927Prohibited bank branching- Glass Steagall 1933Separated commercial banking from investment bankingMicroprudential supervision -- focuses on the safety and soundness of individual financial institutions.Macroprudential supervision -- focuses on the safety and soundness of the financial system.Why a Banking Crisis in the 1980s?Early Stages- Financial innovation decreased the profitability of traditional banks- Deregulation increased opportunities for risk-taking- FDIC limits increased from 40,000 to 100,000Problems- S&L managers lacked expertise to manage risk in new avenues open to them- Rapid growth in lending- Required expansion of regulatory resources to monitor appropriatelyLater Stages- Regulatory forbearance – refrained from exercising the right to close insolvent institutionsWhy?1. Insufficient funds2. Regulators too close to people they were regulating3. Hoped problems would go away- Insolvent S&Ls had nothing to lose and took on even more risk- “Zombie” S&Ls hurt healthy S&LsCorrectionsFDIC takes over FSLICProvided funds to close failed institutionsReimposed restrictions on S&L activitiesPrompt corrective actionIncreased examinations, capital requirements, and reporting requirementsDodd-Frank Legislation- Consumer Protection- Resolution Authority- Systemic Risk Regulation- Volcker Rule-
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