The Federal Deposit Insurance Corporation should be commended for the sentiment behind its decision on Tuesday to clarify that deposit insurance does not cover deposits held in foreign branches of U.S. banks even if those deposits are payable in the United States. The FDIC's decision, however, demonstrates the difficult international comity issues associated with deposit insurance.
The FDIC's clarifying rule came in response to plans by the United Kingdom's financial regulator to require that depositors in U.K. branches of U.S. banks have the same access to the assets of failed banks as American depositors. The British regulator explained that "[i]t is not acceptable that UK branch depositors are more exposed to potential losses than home country depositors if a firm fails especially when both classes of depositors have placed their deposits with the same firm." The U.K. regulator underscored the depth of its concern with the ominous statement that "When host country depositors are treated less favourably, co-operation between host and home country authorities in a resolution could be more challenging." The U.K. has the bulk of U.S. foreign branch deposits, but other countries share the same concerns.
The U.K. suggested several ways for U.S. banks to comply, one of which would be to make U.K. branch deposits dually payable (payable in the U.S. as well as at the U.K. branch). This would mark a change from the standard practice of U.S. banks operating overseas branches. Banks argue that this is an unnecessarily costly, complex, and legally perilous approach to addressing the U.K.'s concerns. They advocated instead that the FDIC define "deposit liability" to include foreign branch deposits. Doing so would not extend deposit insurance to foreign branch depositors, but would guarantee them the same high-priority status as U.S. depositors when it comes to dividing up the assets in a bank liquidation. The FDIC, concluding somewhat weakly that it lacks the statutory authority to make this change, instead adopted a rule intended to clear the way for banks to afford foreign branch deposits dually payable status.
The FDIC did so in a way that it believes will prevent the FDIC's deposit insurance fund--"and by implication the U.S. government"--from taking on new risk. As the FDIC explained, "[t]here is no indication that Congress ever intended the [deposit insurance fund] to have global liability." The current deposit insurance cap of $250,000 is high enough that it would be a magnet for foreign branch deposits if they were covered. Foreign branch depositors tend to be large businesses--exactly the kind of depositors who will keep an eye on the banks holding their deposits if they are not insured.
While the FDIC is right to put limits on the geographical reach of deposit insurance, any approach that would satisfy foreign regulators would still place some burden on the deposit insurance fund, and by extension U.S. taxpayers. Giving foreign branch depositors equal priority with American depositors reduces the ability of the deposit insurance fund to get repaid for outlays it has made. When a bank fails, the deposit insurance fund pays depositors up to the $250,000 limit. The FDIC then takes over the insured depositors' claims against the bank's assets. It stands in the shoes of the depositors it has compensated and, in so doing, enjoys the same priority over general unsecured creditors as other depositors. Any action that expands the pool of depositors that have priority over general creditors will weaken the FDIC's ability to recoup the amounts it has paid out to insured depositors. As a consequence, the FDIC's commendable efforts to defend the deposit insurance fund will be difficult to sustain as it also tries to manage its relationships with foreign regulators.