Economic Review 1996 Q3, Federal Reserve Bank of Cleveland

  • William P. Osterberg, Stanley D. Longhofer
  • Published 1996


Omnibus Budget Reconciliation Act. This legislation contained an amendment to section 11(d)(11) of the Federal Deposit Insurance Corporation Act that changed the priority of claims on failed depository institutions. It gave depositors , and by implication the FDIC, claims on a failed bank's assets that are superior to those of general creditors. The stated objective of this shift was to reduce the FDIC's expected losses from bank failures. Several states had previously passed similar legislation. There has been little empirical research concerning the impact of depositor preference legislation (DPL), despite repeated claims of its benefits. Arguments that this legislation could reduce the FDIC's exposure are based on the assumption that creditors will make no offsetting responses. The only relevant study, by Hirschhorn and Zervos (1990), found that following the passage of state-level DPL, general creditors of affected savings and loans increased collateralization, and interest rates on uninsured certificates of deposit fell. No analogous study has been conducted for commercial banks. In this article, I analyze the impact of DPL on commercial banks. I first present a partial equilibrium analysis of its effects on the value and rates of return of various types of bank liabilities when failed banks are assumed to be resolved through liquidation. Next, I discuss creditors' possible responses. (The appendix shows how the FDIC's position would be affected by increased collateralization from general creditors.) In the third section, I give some descriptive statistics from Call Report data on portfolio shares, distinguishing between banks that were subject to state DPL in existence prior to the 1993 legislation and those that were not. In the fourth section, I present a regression analysis of DPL's impact on the costs of resolving bank failures. The fifth section concludes. The finding presented here—that average resolution costs were lower under DPL—is consistent with the view that the legislation has increased the value of the FDIC's claims. However , there is some evidence that creditors' actions may have partially offset the benefit to the FDIC. This section uses the cash-flow capital-asset pricing model developed by Chen (1978) to examine the impact of DPL on the values and rates of return for uninsured depositors, general creditors, and the FDIC. 1 I assume that the value of the FDIC's position is always negative. If correct pricing is defined as that which maintains the value of the FDIC's position at zero, I assume underpriced deposit insurance. However …

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Cite this paper

@inproceedings{Osterberg1996EconomicR1, title={Economic Review 1996 Q3, Federal Reserve Bank of Cleveland}, author={William P. Osterberg and Stanley D. Longhofer}, year={1996} }