Wednesday, April 14, 2010

FDIC Says TAG Will Reduce the Cost of Bank Failures

FDIC argues that extending the Transaction Account Guarantee (TAG) program would lower the cost of bank failures.

FDIC wrote that if the TAG program had been allowed to expire on June 30, 2010, in this current economic environment, a number of community banks could experience deposit withdrawals from large transaction account depositors. This would expose the community bank needlessly to liquidity risk and could lower the franchise value of the bank.

This deposit migration of longstanding large depositor relationships would adversely impact “the franchise value to an acquirer in the event of a failure, thus increasing FDIC’s resolution cost.” The loss of franchise value would make it more difficult for FDIC to satisfy the least cost test for any bank resolution.

FDIC writes that liquidity failures tend to be more costly for FDIC, as it must market the institution on an accelerated time line.

“In most cases, liquidity failures are more costly for the FDIC to resolve as there is little time to market the institution. This leads to fewer and less informed bidders who will reduce the value of their proposals to compensate for the uncertainty in the transaction. Bidders are more reluctant to enter into transactions that transfer high-risk assets without having the time to conduct due diligence; this will result in more assets being retained by the FDIC.”

Finally, the erosion in the franchise value could lead to more deposit payouts, which are expensive and consume large amounts of FDIC resources, instead of purchase and assumption transaction.

So, extending the TAG allows the FDIC to be a good steward of the DIF.


Anonymous said...

James, Am I your only post-er? The TAG is optional isn't it? Is there any sense of how many banks will decide not to stay in the program?
Thanks GT

James Chessen, ABA Chief Economist said...

The Transaction Account Guarantee Program is an optional program.

Banks that wish to opt out must do so by April 30 and notify customers of that decision by May 20. No additional opt-out would be offered later even if the program is extended an additional year. Thus, this would obligate banks to stay in the program even if it’s extended for another year. Many larger banks opted out of the current extension. Since the pricing is not expected to be changed, I don’t expect a large exodus from the program.

The FDIC publishes a list of banks that have opted out of the program at the link below:

Anonymous said...

The pricing hasn't changed however, they lowered the interest rates banks can pay on eligible NOW accounts from .50% to .25%.

If a bank thinks interest rates might change in the next 18 months they might think twice about opting in.

If rates go up, banks might have some tricky conversations with their customers. "Mr. customer, I know rates have gone up, but if we pay you more on your NOW account you lose the unlimited FDIC insurance."

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