Florida’s Freedom Bank Closure: Is the FDIC Up to the Job?

Published November 4, 2008

While U.S. banks have not yet reached a full-blown panic mode, there is plenty to be worried about with respect to the FDIC.

Florida is not alone with its concern about the stability of its banks: Banks are failing at a rate unheard of in recent decades. Freedom Bank is the 17th bank to be seized by the FDIC since the beginning of 2008. Is the FDIC really up for the job, and isn’t it at least partially responsibility for the failures?

Feds Close Freedom Bank in Bradenton

Florida’s Freedom Bank Is 17th in U.S. to Be Closed This Year

As of June 2008, the FDIC’s Deposit Insurance Fund (DIF) held roughly $45 billion in reserve and covered roughly $4.5 trillion in deposits, for a reserve ratio of around 1 percent. Using the highest possible requirements imposed on member banks and DIF reserves, the high-end reserve ratio reaches only 11.19 percent of total deposits.

The reserve ratios are likely far lower today, given the temporary expansion of the insured level per depositor from $100,000 to $250,000. According to the American Bankers Association, the FDIC’s recapitalization plan predicts the reserve ratio could fall as low as 0.65-0.70 percent in 2009. This is disturbing, and the ability of the FDIC to cover a large-scale panic should be called into question, not ignored. http://www.aba.com/aba/documents/FDIC/FDIC_Restoration_and_Risk_Assessment_Proposals.pdf

If bank closures continue at recent rates or accelerate, the FDIC may not be able to fully cover the deposits of its members. Federal Reserve and Treasury intervention might be required to meet the FDIC guarantee to depositors, costing taxpayers billions or even trillions of dollars over the long term.

The FDIC requires member banks to hold at a minimum 10 percent of their total deposits in reserve, to ensure withdrawal demands can be covered. The FDIC does not hold itself to its own standard. Many economists have warned for years that the FDIC insurance system encourages banks to take risks that have put their depositors, investors, and the U.S. taxpayers at risk.

Reserve requirements should be raised to ensure taxpayers are not held responsible for paying claims in the event of a large-scale banking collapse. While the FDIC has recently taken steps in the right direction by raising the premium rates it charges its member banks, real changes are needed to hold banks accountable and protect taxpayers.

A Heartland Research & Commentary addressing this issue is available at http://www.heartland.org/policybot/results.html?articleid=23629. It examines the role of the FDIC and its effects on the actions of bankers and consumers, and it comments on possibilities for privatization and reform.