Since the European financial crisis of 2011, new legislation has been written that could affect something as simple as your deposits at a bank. The traditional understanding is that, as a depositor, one has up to $250,000 of FDIC coverage per account. However, that may now change during the next financial crisis. In the simplest terms, too-big-to-fail banks (technically called "SIFIs"), such as JP Morgan Chase (NYSE:JPM), Citigroup (NYSE:C), Bank of America Merrill Lynch (NYSE:BAC) and Morgan Stanley (NYSE:MS), would be transitioned from being FDIC-covered into FDIC "Orderly Liquidation Authority" (OLA) receivership status under new Dodd-Frank legislation in the event of a systemic risk.
The new OLA status permits the FDIC to repay the banks' obligations to its depositors with stock instead of cash in the event of systemic distress. Much of this is known within the financial community as part of a broader package of bank reforms. However, a critical component of the reform regarding the most basic assumption we make when we walk into a bank and make a deposit may be being overlooked.
Many depositors are unaware of how banks account for their deposits. When any one of us enters a bank, and makes a deposit, it is immediately recorded as a liability on the bank's balance sheet. Therefore, you, the depositor, are actually a "creditor" to the bank. The new OLA receivership rules state that the Federal Reserve and FDIC now have the authority, under financial distress, to convert your cash deposits, savings, and CD's at the bank into equity shares of the bank itself in order to make the bank whole. This is often called a "bail-in."
What one financial advisor based in Los Angeles, California discovered is that the basic FDIC coverage of $250,000 per account is not a certainty any longer under the new rules. She and her father-in-law, a former attorney, wrote an email to the FDIC to get clarification on the issue of deposit coverage under OLA status, and this is what they wrote.
From: FDIC STARSMail <StarsMail@FDIC.gov>
Sent: Thu, Jul 10, 2014 2:03 pm
Subject: FDIC Reply
July 10, 2014
Ref. No: SCC2014N-00XXXX-X
Dear Mr. XXX:
Thank you for contacting the Federal Deposit Insurance Corporation (FDIC). In your e-mail you specifically asked the following:
"Re: FDIC Insurance
Does the Dodd Frank Act place bank depositors at risk of losing their FDIC insurance?
Presently the standard FDIC insurance amount is $250,000 per depositor, per insured bank, for each ownership category. This includes principal and accrued interest and applies to all depositors of an insured bank.
The Dodd Frank Act has a provision giving the FDIC "Orderly Liquidation Authority" (OLA), for a "Globally Active Systemically Important Financial Institution" (GSIFI).
OLA permits the FDIC to repay the banks obligations to its depositors with stock instead of cash. OLA permits conversion of the banks obligations to its depositors, ie savings accounts, checking accounts, CD's, to stock.
If I am a depositor of a bank that is a GSIFI,which "fails", and becomes subject to the OLA, will I be covered under FDIC Insurance for $250,000 (cash to be returned to me)or will I be converted to a stockholder and receive stock in lieu of cash? Is this mandatory or discretionary with the FDIC?
Does this change the present standard FDIC insurance for bank depositors?
Does the OLA only affect deposits in excess of 250,000? What are the new rules? Pleaase explain. Does the OLA create a gap in FDIC protection for bank depositors where depositors will get stock instead of cash? Under what circumstances?
The FDIC's response, after an initial, "We'll get back to you," was this….
Your inquiry has been forwarded to the FDIC's Legal Division for review and response. You will receive a response directly from the FDIC Legal Division.
If you have additional questions while the Legal Division reviews your inquiry, feel free to write us back or contact our office directly at (877) 275-3342.
Federal Deposit Insurance Corporation
Division of Depositor and Consumer Protection
550 17th Street, N.W.
Washington, DC 20429
"I was shocked by the ambiguity of the FDIC's response. I would have expected to have a pretty swift and simple answer on these direct questions. The fact that the legal team of the FDIC needs to contact me is worrisome," says this financial advisor. "It goes completely against what we have come to expect in our generation of what happens to our cash at a bank under times of duress."
She is still waiting for a response from the FDIC. Perhaps it's time we ask more questions of the new laws and their broader implications. It seems that the Federal Reserve and FDIC should at least be able to be more forthcoming about what their new legislation exactly means for regular Americans.