Federal Deposit Insurance Corporation
Group of Thirty
International Insolvency in the Financial Sector
May 14, 1997
When I glimpsed the Bank of England on the way here this morning, I was reminded just
how great a contribution that institution has made by inventing many of the practices in finance
that are now used around the world. The Bank of England was founded in 1694, almost a
century before the United States became a nation, when a group of merchants agreed to lend 1.2
million pounds sterling to King William III at eight percent, in return for a monopoly on bank
notes and the right to receive deposits. Over time, the Bank of England would also invent the
role of a central bank.
By contrast, we in the United States did not establish an enduring connection between our
banking system and our federal government until 1864 -- 170 years after the Bank of England
was created. We did not create our own central bank until 1913.
With the Federal Deposit Insurance Corporation (FDIC), however, the United States
created the oldest system of national deposit insurance in the world. Because I believe strong
national systems for resolving failed financial institutions can make international coordination
more effective, today I will talk about the FDICs experiences in resolving two banking crises in
the United States as a case study of the issues associated with the failures of financial
institutions. I will also contrast that case study with another case study: the considerably less
successful effort at dealing with savings and loan insolvencies in the United States in the 1980s
and early 1990s.
The FDIC was created in 1933 to halt a banking crisis. Nine thousand banks -- a third of
the industry in the United States -- failed in the four years before the FDIC was established. The
failure of one bank would set off a chain reaction, bringing about other failures. Sound banks
frequently failed when large numbers of depositors panicked and demanded to withdraw their
deposits -- leading to a run on a bank. As depositors began withdrawing their cash in amounts
larger than the bank could sustain, banks suspended operations and states across the country
declared moratoria on bank transactions. The banking system of the United States was on the
verge of collapse.
The behavior of depositors was not irrational. They had learned from hard experience
that if they kept their money in a bank, it might not be available when they needed it, and they
might lose a large portion of it as well. As a general practice, between 1865 and 1933 before the
creation of the FDIC, depositors of national and state banks were treated in the same way as
other creditors -- they received funds from the liquidation of the banks assets after those assets
were liquidated. The time taken at the federal level to liquidate a failed banks assets, pay the
depositors, and close the books averaged about six years -- although in at least one case, it took
21 years. From 1921 through 1930, more than 1,200 banks failed and were liquidated. From
those liquidations, depositors at banks chartered by the states received, on average, 62 percent of
their deposits back. Depositors at banks chartered by the federal government received an average
of 58 percent of their deposits back.
Given the long delays in receiving any money and significant reductions in deposits when
banks failed, it was understandable why anxious depositors would withdraw their savings at any
hint of problems. With the wave of banking failures that began in 1929, it became widely
recognized that the lack of liquidity that resulted from the process for resolving bank failures
contributed significantly to the economic depression in the United States.
To deal with the crisis, the government of the United States focused on returning the
financial system to stability by restoring and maintaining the confidence of depositors in the
banking system. When it created the FDIC, the United States Congress addressed that problem
in three ways: it created an agency to insure deposits, it gave that agency bank supervision
responsibilities, and it gave that agency special powers to resolve failed banks. I will briefly
discuss each of these three in turn.
First, the FDIC was established to insure bank deposits, initially up to $2,500. If a bank
failed, its depositors were guaranteed to receive that much of their money from the government,
in many instances within days.
In 1934, coverage was raised to $5,000. With that increase, 45 percent of the deposits in
the banking system were covered by insurance. By providing the public with an assured source
of liquidity, federal deposit insurance restored confidence in the banking system, insulated banks
from runs and panics, and stabilized the financial system. The year after the FDIC was created,
nine insured banks failed -- and total deposits in the banking system increased by 22 percent.
Today, we insure deposits of up to $100,000 at just under 11,500 institutions. With $27
billion in reserves, our Bank Insurance Fund (BIF) insures about two-thirds of the deposits at its
member institutions. With just under $9 billion in reserves, our Savings Association Insurance
Fund (SAIF) insures about 95 percent of the deposits of the thrift institutions that belong to it.
Our insured institutions pay premiums to the funds based on the total amount of their insured
deposits and the level of risk they present to the insurance fund. This risk is measured by their
capital levels and the supervisory ratings they receive from bank examinations.
Second, the FDIC supervises state-chartered banks that are not members of the Federal
Reserve System -- today this is just over 6,300 banks. Without a strong supervisory system,
which in the United States includes three federal regulators, granting insurance on deposits
would be an even riskier business for the guarantor of a deposit insurance system, which in our
case is the U.S. government.
Third, the FDIC acts as the receiver responsible for resolving any potential failure
involving one of the 11,500 insured institutions. Its extraordinary powers as receiver enable it to
act quickly when a bank fails. These powers were enhanced in 1989 during the midst of our
recent banking crisis.
We do not have to return to the 1930s for evidence that the FDICs ability to act quickly
stabilizes the banking system of the United States during times of crisis. In 1991-- just six years
ago -- the New York Times described events when a large regional bank called the Bank of New
England was failing: Frantic depositors pulled nearly $1 billion out of the bank in two days;
small savers trooped through the lobbies with their money in wallets, bulging envelopes and
briefcases, and money managers yanked out multimillion-dollar deposits by remote control with
computer and telex orders. Yet as soon as Washington stepped in, with the Federal Deposit
Insurance Corporation taking over the bank on Sunday, the panic subsided, the Times
concluded. The Bank of New England case underscores how rapidly public confidence in a
financial institution can evaporate. It also underscores the importance of having a bank
regulatory authority who can move quickly to address a bank failure. Bank of New England
customers had doubts about their bank -- but the doubts were not contagious. A run on the Bank
of New England did not spread into a general banking panic, with depositors at other banks also
demanding their funds, despite the fact that nearly 1,200 banks had already failed in the United
States in the 10 years leading up to the Bank of New Englands failure.
Against that background, it is useful to look more closely at the nature of the FDICs role
as receiver, how that role is important in promoting liquidity after bank failures, some of the
lessons we learned from our recent crisis, and why a special approach to resolving bank failures
is better than handling them through bankruptcy proceedings.
Turning to the FDICs role as receiver, we generally use one of three techniques in
resolving a bank that fails. The first technique permits the FDIC to pay depositors their insured
deposits using money from insurance reserves. The FDIC then liquidates the failed institutions
assets and replenishes the insurance funds with the proceeds. Typically, when using this
technique, the FDIC issues checks to depositors for the amounts of their insured deposits within
three days of a banks failure -- note I said in days, not weeks or years. The roles of
insurer and receiver are two roles we play in one process: as insurer, the FDIC pays depositors of
failed institutions from its insurance funds, which also provides the working capital for the
resolution of failed bank assets. Then, as receiver, the FDIC liquidates the assets of the failed
institution to replenish the insurance funds.
The second technique allows the FDIC to sell an institution that has failed, or parts of the
institution, to a purchasing institution, which would assume the liability for the deposits of the
failed institution. Generally, such a sale is carried out by the FDIC during a weekend, so
depositors and customers have no interruption of banking service -- once again we are talking
Using the third technique, the FDIC can provide financial assistance to keep an
institution open and serving its community. That is what the FDIC did when Continental Illinois
National Bank -- then the seventh largest bank in the United States -- failed in 1984.
From 1980 through 1994, during our banking crisis, the FDIC used the first technique --
paying depositors from our insurance funds and then liquidating assets to replenish the funds --
in 297 bank failures. We sold 1,184 failing banks to other institutions, sometimes with loss
sharing arrangements. We also provided financial assistance to keep 136 failing banks open. We
have not used this latter technique for several years, however, and are much less likely to use it in
the future because of a change in the law in 1991 requiring the FDIC to use the least costly
method for resolving a bank failure. This requirement is intended to introduce greater incentives
for shareholders and large creditors of insured banks to impose more discipline on the
management of insured banks to operate safely and soundly.
When appointed receiver, the FDIC assumes an obligation to all creditors of the
receivership with the responsibility to recover for them the maximum amount possible on their
credits as quickly as it can. When the FDIC pays off insured deposits, it becomes a creditor of
the receivership for the amount of advances made to insured depositors. As assets of the
receivership are liquidated, proceeds are periodically distributed as dividends to creditors,
including the FDIC, on a pro rata basis. To promote the rapid return to liquidity of creditors,
including depositors, the FDIC is able to declare advance or accelerated dividends based on
an estimate of recoveries using its substantial insurance reserves.
Thus the FDIC seeks to assure stability in the financial system by guaranteeing the
liquidity of insured deposits and the consequent liquidity of the banking system in times of
The FDIC also returns assets of failed banks as quickly as possible to the private sector,
which encourages greater market discipline in the economy and more rapid economic recovery.
The 1,617 banks that failed or received financial assistance from the FDIC between 1980 and
1994 held nearly $320 billion in assets. That level of exposure for the financial system to
insolvencies did not result in catastrophe in part because the FDIC was able immediately to
return approximately $240 billion of those bank assets -- or about 75 percent -- to the private
sector. Over time, the FDIC sold the bulk of the remaining assets, with only $4.3 billion in
assets of failed banks to liquidate as of year-end 1996. Because the FDIC as receiver was able to
resolve bank failures quickly, providing liquidity to local and regional economies, and promoting
their recovery from recessions, it helped the U.S. economy return to its current robust health.
A good example of where the FDIC acting as receiver assured liquidity in the context of
multiple bank failures arose in Texas, one of our major banking markets. In just three years --
1987 to 1990 -- 473 banks in Texas failed or received FDIC financial assistance to stay open.
They held nearly 26 percent of total bank assets in the state. Of these 473 banks, only 15
involved direct payouts to depositors for insured deposits. In the other 458 failures and
assistance transactions, 384 banks were sold to acquirors and 74 were kept open with FDIC
assistance to continue serving their communities.
Another example was our state of New Hampshire, which suffered from both a collapse
of the local real estate market and the economic recession of the early 1990s. On October 10,
1991, seven of the banks in New Hampshire were closed, including six of the states ten largest
banks. The seven failed banks held 28 percent of banking assets in the state. More than three
quarters of those assets were sold by the FDIC to local acquirers immediately upon closure.
The FDICs rapid response to bank failures allowed the economies of these states to
recover more quickly than would otherwise have been possible. In contrast, the United States
also has experience with what happens when the widespread failures of financial institutions are
not handled quickly or effectively -- which occurred during the collapse of our savings and loan
industry in the 1980s.
The problem of the savings and loan associations began with rising interest rates. Until
the 1980s, those institutions were by law generally limited to the business of accepting short-
term deposits from the public and lending the funds for long-term home mortgages, with the
maximum interest rates for deposits also limited by law. When interest rates began to climb in
the late 1970s and early 1980s, the ceilings on the interest rates for deposits were phased out, and
savings and loan institutions found themselves earning low interest rates on their loans long after
they had to start paying high interest rates for their deposits. Over time, many institutions
became insolvent -- far more than the old savings and loan insurance fund -- a fund not managed
by the FDIC -- had the resources to liquidate. By one estimate, it would have cost that fund
approximately $25 billion to close financial institutions that were insolvent in early 1983 -- four
times the reserves that it actually held at that time. The problem was exacerbated by the fact that
savings and loan associations in the United States were regulated unevenly and ineffectively by
an agency that has subsequently been replaced.
In 1986, the reserves for the old savings and loan insurance fund were estimated to be
negative $6.3 billion. By 1989, there were 517 insolvent savings and loan associations being
kept open because no insurance reserves were available to resolve the failures. To clean up the
problem, Congress ultimately had little choice but to establish a special government corporation
to resolve the insolvent thrift institutions. Over all, Congress voted more than $132 billion to
pay the direct costs of resolving savings and loan failures in the 1980s and early 1990s. The
FDIC was also given the responsibility for managing a new Savings Association Insurance Fund,
which the Congress passed legislation last year to capitalize fully using assessments on the thrift
From the savings and loan crisis, the regulators in the United States learned that strong
and effective supervision of depository institutions is essential to a sound system of government-
sponsored deposit insurance and the rest of the safety net. Without such supervision, the insurer
is faced with writing a blank check for losses. Without strong supervision, deposit insurance and
the broader safety net simply become a public resource that risk takers can exploit. We also
learned the importance of closing or transferring the obligations of insolvent, insured financial
institutions promptly to keep the losses in the banking system to a minimum. Finally, we learned
that a strongly capitalized deposit insurance fund is essential (1) to effective bank supervision so
that problems in institutions can be addressed quickly, (2) to assuring liquidity in times of
financial stress, and (3) to facilitating economic recovery by returning the assets of failed
financial institutions to the private sector as soon as possible.
For more than two years, economists and other analysts at the FDIC have been
systematically analyzing the bank and savings and loan association failures that occurred in the
United States from 1980 through 1994 to draw specific lessons from the experience. Part One of
our study -- focusing on lessons for future supervision of financial institutions -- was discussed
with outside experts at a symposium earlier this year and will be published in a few months. Part
Two of our study -- on how our role as receiver evolved during the banking crisis and what we
have learned for the future -- will be the subject of a symposium later this year, with analyses and
conclusions to be published in 1998.
It is our hope that all of us can learn from these historical studies.
Despite the FDICs success during the banking crisis, a small number of observers have
recently proposed eliminating the FDIC as receiver and shifting that function to the bankruptcy
system. Could the bankruptcy system have acted as quickly as the FDIC did in our recent
banking crisis? The answer is clearly no, an answer substantiated by U.S. bankruptcy statistics.
From 1982 through 1995, only 491 companies in the United States successfully emerged
from bankruptcy proceedings under Chapter 11, which gives companies protection from creditors
while they reorganize. The average length of time for a company to emerge from this process
was 17.2 months -- although it took one company more than 82 months, or almost seven years.
Moreover, for Chapter 7 proceedings -- which applies to liquidation of companies -- the
process ranged from two to four years. Given a wave of regional bank failures or one large
institution failure, such a delay in providing liquidity could have devastating effects on
individual communities, regions, or even the financial system of an entire country. In addition,
the delay in returning failed bank assets to the private sector could have a significant impact on
the speed at which the economy recovers from a recession and returns to economic growth.
Governments have long recognized that they have a responsibility to maintain stability
and liquidity in the financial markets. It is instructive to note that the Bank of England -- at only
26 years of age -- played an essential rescue role by buying 4.2 million pounds sterling of the
stock of the collapsed South Sea Company when speculative mania in that government-
sponsored enterprise collapsed in 1720. The Bank of England, one of our hosts today, has
repeatedly been a key factor in stabilizing the financial markets in the United Kingdom since that
time, and in working with U.S. and other bank regulators to assure international stability.
In conclusion, as we consider how to plan for the insolvency of an international financial
institution, our experiences in the United States have taught us that we will be more effective at
assuring stability and liquidity in the banking system if we have a structure in place for dealing
with financial crises.
While it is true that addressing an insolvency that in significant ways crosses national
boundaries, as well as different legal regimes, means a formal structure cannot soon be put in
place, such a conclusion should not deter us from formalizing the kinds of international
cooperation that is necessary to act together quickly and effectively. Moreover, having clear
mechanisms in place for resolving domestic financial institution insolvencies will, I believe,
enhance our ability to set up a more effective, albeit informal, international structure. Finally, we
need to study domestic systems, like ours in the United States, and develop international
standards for addressing insolvency issues.
As Cervantes Don Quixote told Sancho Panza: Forewarned, forearmed -- to be prepared
is half the battle. The answer then to the question: Will we be ready the next time? is yes --
if we learn from our individual past experiences and if we engage in a coordinated effort to build
on those experiences by implementing international standards and mechanisms for addressing
financial institution insolvencies.