New rule protects the FDIC from liability for foreign deposits in the event of U.S. bank failure.
The Federal Deposit Insurance Corporation approved a final rule denying insurance to any deposit made in foreign branches of American banks. This bar includes foreign deposits that are subsequently payable within the United States. The new rule aims to protect the U.S. government from global exposure in the event of multinational bank collapse.
The new rule emphasizes that the U.S. government is ultimately at risk during a bank failure, since it provides “full faith and credit” backing to all FDIC insurance guarantees. Shortly after a U.S. bank becomes insoluble, the FDIC guarantees that insured depositors can have uninterrupted access to their funds by arranging a sale to a second bank, or by paying insured depositors directly.
This FDIC foreign deposit exemption was proposed partially in response to a recorded rise in foreign banking activities. Since 2001, foreign deposits have doubled in worth. The bulk of foreign branch deposits originate from large businesses and multinational corporations seeking the ability to transfer funds easily within multi-country branch networks. As such, there is no indication that demand for foreign deposits will drop.
Prior to this rule, the FDIC suggested that foreign branch deposits could be insured if they were made payable within the U.S. The FDIC emphatically pointed to a projected rise in “dually-payable” foreign deposits—in other words, deposits that can be paid both in the U.S. and the country where the foreign bank branch is located. In approving this rule, the FDIC expressed concern over its increased exposure as a result of both the actual rise in foreign deposits, and the projected rise of U.S.-payable foreign deposits.
The Financial Services Authority, a now-dissolved U.K. financial services regulator, issued a Consultation Paper in September 2012 that, if approved, would have significant consequences to U.S. bank operations in the U.K. The proposals would prohibit non-European banks from accepting deposits in the U.K. if they provide preference to non-U.K. depositors during a bank liquidation. American banks were widely predicted to respond to the Consultation Paper by making U.K. branch deposits payable within the U.S.—a practice that could have extended FDIC insurance to these foreign deposits. Dually payable bank deposits were estimated to cost the Federal Reserve and the FDIC between £550 and £1,120 million, annually.
The new FDIC rule would not prohibit foreign branches from making their deposits dually payable in order to preemptively comply with the proposed FSA regulation. Indeed, once the FDIC rule goes into effect, it will facilitate compliance with FSA. The FDIC rule explicitly places foreign branch deposits on equal footing with domestic uninsured deposits in the event of a liquidation, by formally classifying foreign deposits as “deposit liabilities.”
Under current U.S. law, if a bank collapses entirely, its assets are distributed along a sequence that prioritizes “deposits” over general creditors. Although the term “deposit” was not explicitly defined by the law, the FDIC argued, in an earlier advisory opinion, that the term was limited to deposits which are payable in U.S. territories. When foreign deposits are not payable in the U.S., they are actually classified as “unsecured creditor” claims. In other words, they are paid after all U.S. unsecured depositors are paid. In the event of a bank liquidation, this ridge between domestic and foreign deposits would ensure that U.K. depositors are paid only after U.S. depositors are compensated. The FSA repeatedly expressed concern over this fact, noting that it amounted to “discrimination” against U.K. deposit holders.
Presently, it’s not certain when banks will begin instituting dual payability measures in compliance with FSA requirements. The FSA intended to finalize its rules on depositor preference by January 2013. Bank compliance was expected by January 2015. In a recent policy development update, however, the Financial Conduct authority—a U.K. agency replacing the FSA—revealed it has not established a timeline for implementing the depositor preference proposal.
By contrast, the FDIC rule will go into effect on October 15, 2013.
The Bank of New York Mellon Corporation, the Northern Trust Corporation, and the State Street Corporation argued, in a joint comment to the FDIC, that dual payability would violate parts of the Federal Reserve Act which limit foreign depositors from withdrawing funds in U.S. territories once their own government suddenly passes capital controls limiting domestic withdraws. The Clearing House Association noted that the risk of foreign capital controls has recently increased.
In its response to public concerns over sovereign risk and dual payability, the FDIC noted the limited scope of the rule, by stating that it was not placing affirmative obligations on banks—it was merely clarifying the scope of insurance coverage.