Remarks by
FDIC Chairman Sheila Bair
to the
Exchequer Club of Washington D.C.
June 18, 2008
Introduction
Good afternoon everyone. Thank you, Ron, for that very kind introduction. I am pleased
that you have invited me back again this year to speak to you. In fact, with your
indulgence, I'd like to pick up where I left off in my speech last year. As you may recall, I
talked about why the FDIC is spending time worrying about what then seemed such a
low probability event as the failure of a large bank. I ended my speech by noting that–
[S]ome have come to believe that the FDIC should not spend any time worrying about
or planning for a large bank failure because these banks have become so well
diversified and sophisticated in their risk management.
What a difference a year makes. Since then, the FSA has taken over Northern Rock
after announcing it would protect all depositors to prevent a bank run and the Fed has
intervened to prevent the bankruptcy of Bear Stearns. The failure of a large bank
remains highly unlikely–and I am certainly not predicting one–but for many it is no
longer unthinkable.
Update on FDIC Readiness Efforts
Last year I spoke about the FDIC's efforts to prepare for such an event. At the FDIC, we
must plan for the worst and work with the industry to try to get the best outcome. Today,
I'd like to give you a brief update on what we have been doing this past year before I
proceed to my main topic, which will be the implications of Bear Stearns for the way we
treat investment banks.
Yesterday, the FDIC's Board adopted a final rule to modernize the claims process. The
rule reflects the comments we've received on several proposed rulemakings on the
claims process issued over the past few years. It also reflects extensive talks we held
with industry representatives.
The rule requires that large banks have the ability, in the event of failure, to do several
things. They must be able to place holds on a fraction of large deposit accounts,
produce depositor data for the FDIC in a standard format, and automatically debit
uninsured deposit accounts so that they will share losses with the FDIC.
This approach should give most depositors uninterrupted access to virtually all their
funds, thus diminishing the likelihood that liquidity problems for individuals and
businesses will lead to disruption in the financial system. To complement the industry's
FDIC Chairman Sheila Bair
to the
Exchequer Club of Washington D.C.
June 18, 2008
Introduction
Good afternoon everyone. Thank you, Ron, for that very kind introduction. I am pleased
that you have invited me back again this year to speak to you. In fact, with your
indulgence, I'd like to pick up where I left off in my speech last year. As you may recall, I
talked about why the FDIC is spending time worrying about what then seemed such a
low probability event as the failure of a large bank. I ended my speech by noting that–
[S]ome have come to believe that the FDIC should not spend any time worrying about
or planning for a large bank failure because these banks have become so well
diversified and sophisticated in their risk management.
What a difference a year makes. Since then, the FSA has taken over Northern Rock
after announcing it would protect all depositors to prevent a bank run and the Fed has
intervened to prevent the bankruptcy of Bear Stearns. The failure of a large bank
remains highly unlikely–and I am certainly not predicting one–but for many it is no
longer unthinkable.
Update on FDIC Readiness Efforts
Last year I spoke about the FDIC's efforts to prepare for such an event. At the FDIC, we
must plan for the worst and work with the industry to try to get the best outcome. Today,
I'd like to give you a brief update on what we have been doing this past year before I
proceed to my main topic, which will be the implications of Bear Stearns for the way we
treat investment banks.
Yesterday, the FDIC's Board adopted a final rule to modernize the claims process. The
rule reflects the comments we've received on several proposed rulemakings on the
claims process issued over the past few years. It also reflects extensive talks we held
with industry representatives.
The rule requires that large banks have the ability, in the event of failure, to do several
things. They must be able to place holds on a fraction of large deposit accounts,
produce depositor data for the FDIC in a standard format, and automatically debit
uninsured deposit accounts so that they will share losses with the FDIC.
This approach should give most depositors uninterrupted access to virtually all their
funds, thus diminishing the likelihood that liquidity problems for individuals and
businesses will lead to disruption in the financial system. To complement the industry's
efforts, we have been extensively modernizing our computer systems and expanding
our ability to categorize large numbers of claims in a very short time–one to two days.
I also expect that the Board will soon consider an NPR on qualified financial contracts
(or QFCs), which include derivatives and some other financial contracts. When a bank
fails, the FDIC has only one business day to decide how to treat the bank's QFCs. In
addition, we must decide whether to accept or repudiate all positions held with an
individual counterparty. When a bank has a large volume of QFCs, this can be
challenging. Banks may not keep their QFC records in a way that provides the
information we need quickly. I anticipate that the NPR would specify the information that
troubled banks would have to maintain on QFCs and how it would be provided to the
FDIC. We will also seek comment on whether all banks should be held to some
minimum recordkeeping requirements on their derivatives portfolios.
Over the past year, we have conducted a series of tabletop exercises to test and
improve our ability to handle the failure of a large bank if it were ever to occur. These
exercises usually target a single, hypothetical bank, but sometimes target several
banks.
In each case, we work through the FDIC's preparedness plans and identify areas for
improvement. The most recent exercise was held earlier this year and posed the
hypothetical failure of a very large commercial bank. We plan to continue these
exercises and are hoping to bring other regulators in to participate.
The Evolution of Too Big To Fail
When I was here last year, I described the evolution of "too-big-to-fail" for commercial
banks and the two events that served as the book ends for how the U.S. has
approached the tradeoff between stability and moral hazard - the resolution of
Continental Illinois in 1984 and the passage of the FDIC Improvement Act of 1991,
known as FDICIA.
The resolution of Continental Illinois was a turning point for the FDIC, just as Northern
Rock and Bear Stearns appear to be for the FSA and the Fed. In Continental Illinois, the
FDIC provided open bank assistance and protected more than just insured deposits, but
there were some key differences.
At the time, the FDIC had the statutory authority to act as receiver for a failed bank, and
the deposit insurance fund-built by industry contributions-was available for open bank
assistance. However, the FDIC still maintained a credible threat of closing the bank.
Although shareholders had to approve the transaction, their interests were greatly
reduced and subject to potential elimination.
After Continental, in response to concerns about disparate treatment of large and small
banks, the FDIC used its discretion to resolve failures in ways that protected most, if not
all creditors.
our ability to categorize large numbers of claims in a very short time–one to two days.
I also expect that the Board will soon consider an NPR on qualified financial contracts
(or QFCs), which include derivatives and some other financial contracts. When a bank
fails, the FDIC has only one business day to decide how to treat the bank's QFCs. In
addition, we must decide whether to accept or repudiate all positions held with an
individual counterparty. When a bank has a large volume of QFCs, this can be
challenging. Banks may not keep their QFC records in a way that provides the
information we need quickly. I anticipate that the NPR would specify the information that
troubled banks would have to maintain on QFCs and how it would be provided to the
FDIC. We will also seek comment on whether all banks should be held to some
minimum recordkeeping requirements on their derivatives portfolios.
Over the past year, we have conducted a series of tabletop exercises to test and
improve our ability to handle the failure of a large bank if it were ever to occur. These
exercises usually target a single, hypothetical bank, but sometimes target several
banks.
In each case, we work through the FDIC's preparedness plans and identify areas for
improvement. The most recent exercise was held earlier this year and posed the
hypothetical failure of a very large commercial bank. We plan to continue these
exercises and are hoping to bring other regulators in to participate.
The Evolution of Too Big To Fail
When I was here last year, I described the evolution of "too-big-to-fail" for commercial
banks and the two events that served as the book ends for how the U.S. has
approached the tradeoff between stability and moral hazard - the resolution of
Continental Illinois in 1984 and the passage of the FDIC Improvement Act of 1991,
known as FDICIA.
The resolution of Continental Illinois was a turning point for the FDIC, just as Northern
Rock and Bear Stearns appear to be for the FSA and the Fed. In Continental Illinois, the
FDIC provided open bank assistance and protected more than just insured deposits, but
there were some key differences.
At the time, the FDIC had the statutory authority to act as receiver for a failed bank, and
the deposit insurance fund-built by industry contributions-was available for open bank
assistance. However, the FDIC still maintained a credible threat of closing the bank.
Although shareholders had to approve the transaction, their interests were greatly
reduced and subject to potential elimination.
After Continental, in response to concerns about disparate treatment of large and small
banks, the FDIC used its discretion to resolve failures in ways that protected most, if not
all creditors.