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Financial
Industry Perspectives
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The purpose of the Federal Deposit Insurance Corporation Improvement Act of 1991 was to provide additional resources to the Bank Insurance Fund and reduce the cost and likelihood of future failures. While the Act does accomplish these objectives, the changes it makes to bank supervision have the potential to affect banking's traditional safety net. This article discusses three provisions contained in FDICIA that could affect financial stability: prompt corrective action, least cost resolution, and liquidity support for troubled banks. While these provisions attempt to reduce the risky activities of troubled banks and force banks to promptly deal with problems, changes of this magnitude will alter the way depositors, investors, and bank management operate. These changes can have a negative impact on financial stability, particularly during an economic downturn. This article suggests that the limits FDICIA places on a troubled bank's ability to access sources of liquidity, combined with increased depositor discipline, will make it more difficult for banks to weather periods of economic uncertainty. Back to top FIP home
FDICIA outlines a system of bank supervision based on capital. This paper examines two of the assumptions behind this supervisory system. These are that banks will engage in more risky behavior as capital declines, and that reported capital ratios are leading indicators that accurately reflect a bank's condition. Studies of bank failures during the 1980s have failed to clearly demonstrate that bank supervisors allowed troubled banks to engage in such risky activities as paying excessive dividends or excessive growth. In addition, historical studies show that capital tends to be a lagging--not a leading--indicator of bank problems, which is further complicated by the incentives troubled banks have to under-report loan losses. This paper concludes that capital-based supervision cannot be viewed as a substitute for traditional supervisory practices, and that improved methods of analyzing the accuracy of reserves will be important to enhancing the effectiveness of capital-based supervision. Back to top FIP home |