Money, Banking, and International Financecertificates of deposits, the FDIC would insure a total of $250,000. If your bank fails, you are
guaranteed that you will get at least $250,000 from FDIC, potentially losing $50,000. In some
cases, the FDIC insured all deposits that exceeded $250,000 per person, while it did not for
other bank failures. It depends how FDIC handles the bank failure.
FDIC receives its funding from insurance premiums. Every commercial bank that is a
member of FDIC must pay approximately $100,000 per year. The FDIC became very successful
because bank failures averaged 10 per year between 1934 and 1981. On the other hand, bank
failures averaged 2,000 per year during the Great Depression before the U.S. government
created the FDIC.
The FDIC uses two methods to deal with bank failures. First, the FDIC closes the bank and
seizes the bank’s assets. Then the FDIC sells the bank’s assets and returns the money to the
depositors. If FDIC does not receive enough money to pay all depositors from selling the bank’s
asset, subsequently, the FDIC pays the difference from its own funds. Thus, the FDIC rarely
uses the first method because the FDIC could pay out millions or billions in claims. Second, the
FDIC purchases and assumes control of the failed bank. Next, the FDIC keeps the bank open
and searches for another bank that will buy the failed bank. If the FDIC cannot find a buyer,
then FDIC can grant extra incentives, such as low-interest rate loans from the FDIC, or the
FDIC buys the problem loans from the failed bank’s portfolio. The FDIC also allows a bank to
cross a state line to buy a failed bank. Although federal law prohibited banks from crossing state
lines and opening banks in another state, the federal government did not hesitate to violate its
own rules when it needed to.
The U.S. government established the FDIC to reduce the bank failure rate by preventing
bank runs. A bank run is depositors discover their bank has financial trouble, so everyone runs
to the bank to withdraw their deposits. Unfortunately, a bank holds only a fraction of the total
deposits because a bank grants loans. Thus, a bank will close its doors after the bank has drained
all the cash from the vault. Furthermore, if the bank granted many illiquid loans, then the bank
must sell these loans at a discount in order to raise more reserves. Selling the illiquid loans at a
discount can cause the bank to become insolvent. Insolvent occurs as a bank's total liabilities
exceed its total assets. Consequently, any bank on the verge of failing cannot return money to its
depositors. Even a financially healthy bank could fail if people spread rumors the bank has
financial troubles. Then the rumor triggers a bank run.
Bank runs can lead to contagion. Contagion is a bank run on one bank leads to bank runs
on other banks. For example, depositors line up at one bank to withdraw their accounts;
subsequently, many depositors do not get their money back. Then the depositors tell friends and
family, and they begin questioning the health of their banks. Many people cannot gauge the
financial health of banks. Friends and family run to their banks to withdraw funds from their
accounts, triggering more bank runs. As the contagion spreads, it causes a wave of severe bank
runs called financial panics. Financial panics can push the economy into a serious recession.
The FDIC charges insurance premiums based on the total amount of deposits at the bank
and the risk level the depository institutions pose to the FDIC. Many banks are experiencing
financial difficulties that resulted from the 2008 Financial Crisis because the banks approved
anyone for a mortgage. As the U.S. entered a recession in 2007, some homeowners started