David Ancona-Cole BMGT445 Chapter 19: Deposit Insurance Problems (Do web exercise 1, in addition to questions 1, 2 and 3 below)

1. What are some of the essential features of the FDICIA of 1991 with regard to the resolution of failing Depository Institutions? One of the main features of the FDICA of 1991 changing the way the regulators were allowed to delay the closings of Depository Institutions. With this act, regulators would no longer be allowed to delay their closing unless there was a clear threat of systematic risk. The FDIC will not be providing subsidies like it did in the past, and instead will only provide this relief if the liquidated assets are not enough to cover insured deposits. There will also be oversight from the General Accounting Office to audit failure resolutions to make sure that they are actually using the least cost strategy that is now required. a. What is the least-cost resolution (LCR) strategy? It is a strategy that has been implemented by the FDICA to require each failure resolution alternative to be evaluated on a present value basis. b. When can the systemic risk exemption be used as an exception to the LCR policy of DI closure methods? It can only be allowed if it can be proven that there will be a major threat to the entire financial system if a major Depository institution is shut down. c. What procedural steps must be taken to gain approval for using the systemic risk exemption? There must be two-thirds approval from the Federal Board Reserve Members and the FDIC board. In addition there also has to be a recommendation from the Secretary of the Treasury as well as the President of the United States. d. What are the implications to the other DIs (Depository Institutions) in the economy of the implementation of this exemption? To compensate for the bailout by the government, there will be additional deposit premiums charged to other depository institutions based on how big they are and their funds borrowed. 2. A bank with insured deposits of $60 million and uninsured deposits of $45 million has assets valued at only $75 million. What is the cost of failure resolution to insured depositors, uninsured depositors, equity holders and the FDIC if an insured depositor transfer method is used? In this scenario, the FDIC would receive (75*.60) = 45 in liquidation of assets but then would incur a loss of (60-45) = 15 million. Insured depositors receive no loss and are paid by the FDIC. Uninsured Depositors receive (75*.45)= 33.75, and receive a loss of 45 33.75 = 11.25 million. 3. What is moral hazard? How did the fixed-rate deposit insurance program of the FDIC contribute to the moral hazard problem of the savings association industry? What

other changes in the savings association environment during the 1980s encouraged the developing instability of the industry? Moral hazard is when financial institutions accept asset risks based on liability guarantees or deposit insurance that are greater than the risks that would have been accepted without these provisions. The fixed-rate deposit insurance program created moral hazard problems by not differentiating between financial institutions that were actually risky and those that were not. Adding to the problem, managers were struggling to find low interest rates and were using the risky ventures as a way to offset the losses on their other loans. Another problem during the 1980s was that regulators were not closing down banks and were leading a policy of forbearance that caused severe instability in the industry. Web Exercise 1 1. The failed institutions were 25 in 2008 and then increased significantly the next two years and are currently about the same as they were before at 22 in 2013. 2. Most Failures since 2008- 2010 with 157 Largest number of problem institutions- 2010 with 884