Would the FDIC flunk the SEC disclosure standards?

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  • Well, it is true than most deposits are covered by the Federal Deposit Insurance Corporation, but definitely not all of them.

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  • The FDIC usually protects all the deposits of a failed bank by merging it into another bank-but not always.

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  • How would the SEC demand that this very real risk be disclosed to potential depositors?

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Bank deposits are financial assets offered for sale to the public. Should they have risk disclosure standards of poorer quality than the SEC would require for other financial assets purveyed to the public?

Think about the remarkable difference between the information in a prospectus for an SEC-registered bond offering, which must include, for example, an explicit list of risks of the potential investment, with what typical depositors are told about the bank in which they are investing (very little, if anything).

But, you object, the depositors are guaranteed by the government-that's all they need to know. Well, it is true than most deposits are covered by the Federal Deposit Insurance Corporation, but definitely not all of them. Any amounts over the deposit insurance limits are not covered. The FDIC usually protects all the deposits of a failed bank by merging it into another bank — but not always. Large depositors can and have taken losses on their deposits.

How would the SEC demand that this very real risk be disclosed to potential depositors?

Moreover, what would the SEC demand be explained to potential investors in deposits about the nature and risks of the FDIC itself? Everybody knows that a bank can go broke and be unable to pay its depositors at par. Do they know that a government deposit insurance fund can become insolvent, as many such funds have, including the Federal Savings and Loan Insurance Corporation in the 1980s? Would the SEC demand that this be disclosed to depositors? But, you object again, deposit insurance is backed not merely by the FDIC fund, but also by the U.S. Treasury.

Indeed, in every banking office in the country you will find this notice: "insured deposits are backed by the full faith and credit of the United States Government." (This does not apply to other deposits.) But perhaps the SEC would be interested in the legal status of this statement.

It turns out that, beginning in 1989 for savings banks and in 2005 for commercial banks, U.S. law has required all banks "to display a sign" with this notice. But although requiring this reassuring sign, Congress has never enacted a provision simply stating that insured deposits are guaranteed by the full faith and credit of the government. Would the SEC think that depositors need to be aware of this fact?

It seems very likely that the FDIC sticker displayed in every bank would not pass muster with the SEC as an adequate risk disclosure. First, it does not say anything about the risk of uninsured deposits. Second, it does not disclose the risks of the banking business, which are manifold. Third, it does not disclose the exact legal status of the government backing in the event the FDIC should become insolvent, as the Federal Savings and Loan Insurance Corporation did.

Therefore, the SEC would probably require, and if you believe in real financial disclosure to protect investors, you would agree, that the FDIC sticker needs to be rewritten along the following lines:

"Banking is a business subject to substantial credit, interest rate and liquidity risks. Banking is typically run at much higher leverage and with smaller capital ratios than most other businesses. By making deposits, you are lending money to this bank. Deposits in amounts over the deposit insurance limits are not insured and are not backed by the FDIC or by the government. Such deposits my lose value and may suffer losses of both principal and interest. The FDIC deposit insurance fund takes substantial risks and may become insolvent in a financial crisis. U.S. law requires that a notice be posted in each bank that deposits insured by the FDIC are backed by the full faith and credit of the United States Government; however, Congress has never enacted a provision that these deposits are guaranteed by the United States Government."

Something like this might be an adequate risk disclosure which could satisfy the SEC. Since the SEC has no jurisdiction here, the Consumer Financial Protection Bureau, which is represented on the FDIC board, needs to get on this.

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About the Author

 

Alex J.
Pollock
  • Alex J. Pollock is a resident fellow at the American Enterprise Institute (AEI), where he studies and writes about housing finance; government-sponsored enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks; retirement finance; and banking and central banks. He also works on corporate governance and accounting standards issues.


    Pollock has had a 35-year career in banking and was president and CEO of the Federal Home Loan Bank of Chicago for more than 12 years immediately before joining AEI. A prolific writer, he has written numerous articles on financial systems and is the author of the book “Boom and Bust: Financial Cycles and Human Prosperity” (AEI Press, 2011). He has also created a one-page mortgage form to help borrowers understand their mortgage obligations.


    The lead director of CME Group, Pollock is also a director of the Great Lakes Higher Education Corporation and the chairman of the board of the Great Books Foundation. He is a past president of the International Union for Housing Finance.


    He has an M.P.A. in international relations from Princeton University, an M.A. in philosophy from the University of Chicago, and a B.A. from Williams College.


  • Phone: 202.862.7190
    Email: apollock@aei.org
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    Name: Emily Rapp
    Phone: (202) 419-5212
    Email: emily.rapp@aei.org

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