Wednesday, March 13, 2013

What is FDIC insurance?

FDIC or the Federal Deposit Insurance Corporation is created by the US Congress to insure the safety of deposits in participating members’ banks up to $250,000 per depositor per bank. Also, accounts in different ownerships (such as beneficial ownership, trusts, and joint accounts) are considered separately for the $250,000 insurance limit. Under the Federal Deposit Insurance Reform Act of 2005, Individual Retirement Accounts are insured to $250,000.

The FDIC was started after the Great Depression as several thousand banks failed after major runs on the banks. Many depositors lost large chunks on their principal. In order to prevent people from withdrawing their savings from banks which are deemed unstable by the general public, the FDIC started guarantying the principal which the depositor has at each individual bank up to a certain limit. The FDIC limits have been raised from the $10,000 in 1933 to $250,000 in 2008.

To receive this benefit, member banks must follow certain liquidity and reserve requirements. Banks are classified in five groups according to their risk-based capital ratio:

Well capitalized: 10% or higher
Adequately capitalized: 8% or higher
Undercapitalized: less than 8%
Significantly undercapitalized: less than 6%
Critically undercapitalized: less than 2%

When a bank becomes undercapitalized the FDIC issues a warning to the bank. When the number drops below 6% the FDIC can change management and force the bank to take other corrective action. When the bank becomes critically undercapitalized the FDIC declares the bank insolvent and can take over management of the bank. The FDIC insurance only covers deposits in US banks only. If you hold dollars in a foreign bank, your deposit is subject to the laws and regulations of the country. You need to do a very thorough forex analysis of the country's currency, before you move your money there, in order to prevent the risk of it being translated in the local currency, should the country face an economic emergency. This happened in Mexico in the 1980's, when dollar deposits were converted to peso's at the official market rate. At the same time however, the "black market" or actual rate was much higher, leading to steep losses for savers.

The Federal Deposit Insurance Corporation (FDIC) ensures that depositors recover 100% of their principal plus any interest rate accumulated in arrears before the collapse of the bank. This guarantee makes the banking system more stable and less prone on runs on the banks spurred by rumors.

The products covered by the FDIC limits of $250,000 include savings accounts, checking accounts, certificates of deposits, Outstanding Cashier's Checks, Interest Checks, and other negotiable instruments.

Time for the Carnivals:

Carnival of Wealth, Sequestration Edition

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