Federal Reserve Lending to Banks that Failed: Implications for the Bank Insurance Fund

Abstract

Debate that led to passage of the Federal Deposit Insurance Corporation Improvement Act (FDICIA) in 1991 focused on changes in public policy to reduce losses of the deposit insurance funds. One aspect of public policy subject to such scrutiny was lending by the Federal Reserve to troubled banks. Analysis prepared by Congressional staff indicated that over 300 of the banks that failed in 1985–91 were borrowing from the Fed when they failed, and that 90 percent of the banks that borrowed for extended periods of time eventually failed.¹ Other evidence caused the authors of that Congressional staff study to conclude that Fed credit extended the life of borrowers that ultimately failed. Critics of Fed lending practices concluded on the basis of this evidence that lending to troubled banks increased losses to the Bank Insurance Fund (BIF).² This concern led to constraints on Federal Reserve lending to troubled banks in FDICIA (see the next section below).