One Year Later

Return to Article

FDIC Shores Up Bank Liquidity

Philip van Doorn

This morning the Federal Deposit Insurance Corp. unveiled details of a plan that aims to free up lending between banks and greatly reduce the risk of runs on deposits.

The temporary liquidity guarantee program guarantees new senior unsecured debt issued by financial institutions and provides unlimited deposit insurance coverage on all non-interest bearing transaction deposit accounts, even those exceeding the FDIC's $250,000 individual insurance limits.

The moves are part of a sweeping plan to shore up confidence in the banking system, which has dried up lending and sent equities into a tailspin. Federal officials Tuesday morning said they would use $250 billion of the $700 billion bailout package recently approved by Congress to buy preferred stock in a number of banks. Treasury Secretary Henry Paulson said nine financial institutions have agreed to the plan and published reports have identified Goldman Sachs (GS), Morgan Stanley (MS), JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), Wells Fargo (WFC) and other large bank holding companies as among the participants.

Inter-bank Credits

Banks, thrifts or holding companies can participate in the federal program to guarantee new senior unsecured debt issued through June 2009. Debt will be guaranteed for a maximum of three years.

The program limits the guaranteed debt to 125% of debt outstanding as of Sept. 30, that was scheduled to mature by June 30, 2009.

There will be no fees for the coverage for debt issued over the first 30 days. After that, the fee will be an annualized 75 basis points on the amount of the insured debt.

This should lead to a massive churning of bank debt over the next 30 days, as institutions scramble to refinance at lower rates, while avoiding a significant fee.

Business Transaction Accounts

Under the new program, the FDIC will provide participating institutions with unlimited deposit insurance coverage on all non-interest bearing transaction deposit accounts, even those with balances exceeding the FDIC's temporary individual account insurance limit of $250,000.

Banks and thrifts that choose to participate in this program will have a 10-basis point surcharge added to their current FDIC deposit insurance assessment.

All banks and thrifts will have their non-interest bearing deposit transaction account balances covered by unlimited FDIC insurance for the next 30 days. After that, unless they opt out of the program, the institutions will be assessed the 10-basis point surcharge and the coverage will continue until the end of 2009.

This prevents the type of loss faced by businesses when a bank or thrift fails. Businesses and other entities can easily have very large amounts of somebody else's money flowing through a transaction account at any time, facing major risks when an institution fails, as we discussed last year when NetBank was closed down.

This should reduce the likelihood of the type of rapid deposit flight that brought down Washington Mutual (whose branches and deposits were then taken over by JPMorgan Chase (JPM)) and almost brought down Wachovia (WB), set to be acquired by Wells Fargo (WFC).

Depositors Still Face Risks

They sure do, since the new coverage only extends to non-interest bearing transaction accounts. That leaves a whole range of deposit accounts under the FDIC's temporary $250,000 limit for deposit insurance on individual accounts. Insurance coverage gets more complicated for multiple joint accounts and accounts held in the names of trusts and other entities. Please see the FDIC's guide to Insuring Your Deposits for more details.

Bank Ratings

TheStreet.com Ratings issues financial strength ratings on each of the nation's 8,600 banks and savings and loans which are available at no charge on the Banks & Thrifts Screener. In addition, the Financial Strength Ratings for 4,000 life, health, annuity, and property/casualty insurers are available on the Insurers & HMOs Screener.