Funding deposit insurance

Hedge funds are going to help out with deposit insurance. In fact, the Federal Deposit Insurance Corporation's role in the Treasury's legacy loan programme means all manner of private investors, including insurance companies, pension funds and even private equity, could help repair the US depository safety net. Those investors might even be foreign under the programme's rules.

The FDIC has always been funded through premiums on the banking industry. But it is moving to broaden its funding base. The deposit insurance fund, at just 0.4 per cent of insured deposits, is depleted – and top-up premiums are unwise when banks are under stress. So, the FDIC last week announced surcharges on institutions using its debt guarantee programme. The latest move goes further. A portion of the fees for guaranteeing private investors' debt funding to buy banks' loans will go to the DIF. Unclear is how much, and to what extent guarantee fees will be risk-adjusted.

Using the FDIC's line of credit to the Treasury, if necessary, would be simpler – which legislators are discussing more than trebling. The FDIC is, after all, a government agency. But the creative thinking is appealing. Investors buying pools of US bank loans stand to make sizeable returns. The global character of the crisis means the FDIC would probably back foreign deposits of US banks in extremis. So using fees to support the DIF makes sense, after setting aside reserves for losses on loans to investors themselves.

Selling loans into the programme is likely to result in banks taking losses. Regulators, then, may need to nudge banks to sell while using fees from the buyers to boost systemic deposit protection. This neat trick, however, relies on the FDIC charging enough for the risk it is taking on. Should loan losses mount, it will be back to the usual suspects to help out: the banking industry and the taxpayer.

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