Remarks of
Martin J. Gruenberg, Vice Chairman,
Federal Deposit Insurance Corporation (FDIC)
on
The International Role of Deposit Insurance
The Exchequer Club,
Washington, D.C.
November 14, 2007
Good afternoon and thank you for inviting me to speak today. It is a great privilege to be
here.
Many of you, I know, have been involved in financial services issues for a long time. I
think we would all agree that the recent developments in the credit markets are rather
extraordinary. Any one of a number of developments could be the topic of a speech –
the collapse of underwriting standards in the subprime mortgage market, the
transmission of that credit risk to investors around the world through the rapid growth of
securitization, the role of the credit rating agencies in the assessment of the risk of
securities backed by those mortgages, the exposure of some of our largest financial
institutions to those securities, the liquidity issues created for financial institutions
dependent on mortgage-backed securities for their funding, and the challenge of
avoiding foreclosure for the hundreds of thousands of homeowners with subprime
mortgages they cannot afford to pay. These are all critically important issues.
As the Vice Chairman of the FDIC, there has been a particular development in this still
evolving credit market experience that has caught my attention and that I wanted to
discuss with you today. The development is the heightened appreciation of the role of
deposit insurance in maintaining financial stability during times of economic stress. The
UK experience with Northern Rock, Britain's fifth largest mortgage lender that was the
object of a bank run, illustrates, I think, the need for effective systems of deposit
insurance to maintain public confidence in financial institutions, especially during times
of economic uncertainty. It also illustrates the growing important international dimension
of deposit insurance systems.
I would like to take this opportunity today to speak to you about the role of deposit
insurance in maintaining financial stability, the expansion of explicit systems of deposit
insurance to countries around the world, and the FDIC's efforts to bring about greater
cooperation among those systems and to enhance their effectiveness.
The U.S. Deposit Insurance System
The first national deposit insurance system in the world was the FDIC. It was created in
1933 during the Great Depression to restore public confidence in the U.S. financial
system and to protect small depositors. At the time of its creation, the U.S. was in the
midst of the largest financial crisis in its history. During the first few months of 1933,
Martin J. Gruenberg, Vice Chairman,
Federal Deposit Insurance Corporation (FDIC)
on
The International Role of Deposit Insurance
The Exchequer Club,
Washington, D.C.
November 14, 2007
Good afternoon and thank you for inviting me to speak today. It is a great privilege to be
here.
Many of you, I know, have been involved in financial services issues for a long time. I
think we would all agree that the recent developments in the credit markets are rather
extraordinary. Any one of a number of developments could be the topic of a speech –
the collapse of underwriting standards in the subprime mortgage market, the
transmission of that credit risk to investors around the world through the rapid growth of
securitization, the role of the credit rating agencies in the assessment of the risk of
securities backed by those mortgages, the exposure of some of our largest financial
institutions to those securities, the liquidity issues created for financial institutions
dependent on mortgage-backed securities for their funding, and the challenge of
avoiding foreclosure for the hundreds of thousands of homeowners with subprime
mortgages they cannot afford to pay. These are all critically important issues.
As the Vice Chairman of the FDIC, there has been a particular development in this still
evolving credit market experience that has caught my attention and that I wanted to
discuss with you today. The development is the heightened appreciation of the role of
deposit insurance in maintaining financial stability during times of economic stress. The
UK experience with Northern Rock, Britain's fifth largest mortgage lender that was the
object of a bank run, illustrates, I think, the need for effective systems of deposit
insurance to maintain public confidence in financial institutions, especially during times
of economic uncertainty. It also illustrates the growing important international dimension
of deposit insurance systems.
I would like to take this opportunity today to speak to you about the role of deposit
insurance in maintaining financial stability, the expansion of explicit systems of deposit
insurance to countries around the world, and the FDIC's efforts to bring about greater
cooperation among those systems and to enhance their effectiveness.
The U.S. Deposit Insurance System
The first national deposit insurance system in the world was the FDIC. It was created in
1933 during the Great Depression to restore public confidence in the U.S. financial
system and to protect small depositors. At the time of its creation, the U.S. was in the
midst of the largest financial crisis in its history. During the first few months of 1933,
4,000 U.S. banks suspended operations. Bank runs had become commonplace and
President Roosevelt was forced to impose a national banking holiday. The issue of the
moment was how to restore confidence in the banking system.
When the FDIC was created, there was no national system of deposit insurance in the
world. President Roosevelt actually opposed its creation, even threatened to veto the
legislation that was to create the FDIC. He was concerned about the moral hazard that
can occur when protection extended to depositors makes them less diligent in the
selection and monitoring of their banks, and makes banks less careful in their lending
practices. Banking industry groups also opposed the FDIC's creation because they were
concerned about the premiums their members might have to pay.
But the American public demanded a system of deposit insurance that would provide a
safe place for people to put their money. The public had experienced widespread bank
runs and did not want to have that experience again. Broad public support overcame
the obstacles to the creation of the FDIC.
Without a doubt, the FDIC helped restore public confidence in the U.S. financial system.
In 1934, the year after the FDIC was created, only nine banks failed compared to 4,000
bank closures during the nine months prior to its creation. Deposit insurance effectively
ended bank runs in the U.S. The FDIC is widely viewed as one of the most successful
legacies of that era, and remains highly relevant to the challenges facing the U.S.
financial system today.
The International Expansion of Deposit Insurance
I would now like to discuss briefly the expansion of deposit insurance systems to other
countries around the world since the creation of the FDIC.
At the start I should point out that I am talking about the expansion of explicit systems of
deposit insurance. Experience indicates that all countries have some form of deposit
insurance, explicit or implicit. When a financial crisis develops and bank depositors
begin to withdraw their funds, governments typically take steps to protect depositors to
stop banks runs and restore public confidence. The issue is whether the country has a
defined, explicit system or not.
By definition, implicit deposit insurance systems create uncertainty about how
depositors and other interested parties will be treated in the event of a bank failure. This
uncertainty can undermine financial stability during times of stress. It can result in the
government having to resort to blanket deposit insurance coverage, which tends to
generate the most costly funding issues and the most severe form of moral hazard.
A well-designed, explicit deposit insurance system that is understood by the public is
likely to be the most effective in helping to prevent bank runs, limiting the severity of
financial crises and the resolution costs of bank failures, and contributing to overall
financial stability.
President Roosevelt was forced to impose a national banking holiday. The issue of the
moment was how to restore confidence in the banking system.
When the FDIC was created, there was no national system of deposit insurance in the
world. President Roosevelt actually opposed its creation, even threatened to veto the
legislation that was to create the FDIC. He was concerned about the moral hazard that
can occur when protection extended to depositors makes them less diligent in the
selection and monitoring of their banks, and makes banks less careful in their lending
practices. Banking industry groups also opposed the FDIC's creation because they were
concerned about the premiums their members might have to pay.
But the American public demanded a system of deposit insurance that would provide a
safe place for people to put their money. The public had experienced widespread bank
runs and did not want to have that experience again. Broad public support overcame
the obstacles to the creation of the FDIC.
Without a doubt, the FDIC helped restore public confidence in the U.S. financial system.
In 1934, the year after the FDIC was created, only nine banks failed compared to 4,000
bank closures during the nine months prior to its creation. Deposit insurance effectively
ended bank runs in the U.S. The FDIC is widely viewed as one of the most successful
legacies of that era, and remains highly relevant to the challenges facing the U.S.
financial system today.
The International Expansion of Deposit Insurance
I would now like to discuss briefly the expansion of deposit insurance systems to other
countries around the world since the creation of the FDIC.
At the start I should point out that I am talking about the expansion of explicit systems of
deposit insurance. Experience indicates that all countries have some form of deposit
insurance, explicit or implicit. When a financial crisis develops and bank depositors
begin to withdraw their funds, governments typically take steps to protect depositors to
stop banks runs and restore public confidence. The issue is whether the country has a
defined, explicit system or not.
By definition, implicit deposit insurance systems create uncertainty about how
depositors and other interested parties will be treated in the event of a bank failure. This
uncertainty can undermine financial stability during times of stress. It can result in the
government having to resort to blanket deposit insurance coverage, which tends to
generate the most costly funding issues and the most severe form of moral hazard.
A well-designed, explicit deposit insurance system that is understood by the public is
likely to be the most effective in helping to prevent bank runs, limiting the severity of
financial crises and the resolution costs of bank failures, and contributing to overall
financial stability.