How the Federal Deposit Insurance Corporation Works

If you bank in the United States, you've probably seen a sticker posted on the door of your bank that says "FDIC." Maybe you've taken the time to expand the acronym: Federal Deposit Insurance Corporation. Maybe you've read the sticker's little assurance: "Each depositor insured to at least $250,000."

But what is the FDIC? Why was it created? What does FDIC insurance cover? To understand, it helps to understand the basic premises of insurance.

When you buy an insurance policy, whether it's auto, life or medical insurance, the insurance company assesses the risk of insuring you by asking questions like, what's the likelihood that a driver of a certain age and driving history is going to get into a fender bender? What's the likelihood that a woman of a certain age and medical history is going to accrue serious medical costs? What's the likelihood that employees working in a warehouse filled with dangerous machinery are going to get hurt?

Once the company assesses that risk, the buyer is assigned a certain premium to pay. That money goes to the insurance company's insurance fund, which it uses to pay an insured member when her car gets sideswiped or he hits his head on a forklift.

The FDIC's depositor insurance is, in principle, no different from any other insurance. Instead of insuring cars and workers, however, the FDIC insures people who hold deposit accounts with U.S. banking institutions. What's different is that bank account holders don't have to pay a penny for FDIC coverage or even fill out an application; it's free and automatic.

The FDIC is a corporation set up by the United States government to help regulate the U.S. banking system, and is not funded by federal income tax dollars. It is funded by insurance premiums of member banks and by its own investments [source: FDIC].

How long has the FDIC been around? And how did it come to exist in the first place?

What Is the FDIC?

When the Great Depression hit the United States in the late 1920s, banks collapsed like houses of cards. Between 1930 and 1933, some 9,000 U.S. banks failed and took $6.8 billion worth of consumer deposits with them [source: Wheelock]. Some of the banks eventually reopened and recovered their customers' deposits, but the public as a whole had lost faith in the banking system.

To shore up confidence in the banks, President Franklin D. Roosevelt signed the Banking Act of 1933, which, among other things, created the Federal Deposit Insurance Corporation. The primary purpose of the FDIC was to ensure that consumers who banked with an insured bank didn't lose their money if the bank curled up and died. The original coverage limit for each depositor was $2,500, which increased to $5,000 in 1934 [source: FDIC].

Other major events in the FDIC's history include:

The Federal Deposit Insurance Act of 1950 boosted insurance coverage to $10,000 per depositor. This law also authorized the FDIC to invest money in (or "bail out") a failing U.S. bank, if the bank's failure would cause serious economic turmoil in the community it served. The FDIC usually uses the term "too big to fail" to describe such financial institutions [source: FDIC].
The Depository Institutions Deregulation and Monetary Control Act of 1980 increased the FDIC's insurance coverage to $100,000 per depositor [source: FDIC].
The Federal Deposit Insurance Corporation Improvement Act of 1991 changed the flat-rate premium paid by insured banks to a risk-based premium, as with health insurance and auto policies. In the 1980s, years of recession saw massive bank failures in the U.S., especially among savings and loan institutions. The FDIC spent billions of dollars to bail out banks it deemed "too big to fail," but some of these banks ended up failing anyway. To prevent the FDIC from wasting money on unwise bailouts, this Act requires presidential approval of any bailout [source: FDIC].
The Emergency Economic Stabilization Act of 2008 was signed by President George W. Bush during the Great Recession to temporarily raise FDIC insurance coverage from $100,000 to $250,000 per depositor. The increase was supposed to last only through 2009, but was extended several times before President Barack Obama made the coverage hike permanent in 2010 when he signed the Dodd-Frank Wall Street Reform and Consumer Protection Act [source: FDIC].

FDIC Structure and Practices

Today, the FDIC is overseen by a five-member board of directors. The Chairman is appointed by the President of the United States and is subject to approval by the U.S. Senate. The other board members are a vice chairman, a director, a comptroller of the currency, and a director of the Consumer Finance Protection Bureau (CFPB) [source: FDIC]. The CFPB was created by the Dodd-Frank Act of 2010 [source: CFPB].

The FDIC consists of seven divisions: the Division of Finance, the Division of Information Technology and the Division of Administration provide logistical and administrative support for the corporation [source: FDIC]. The other four divisions handle the FDIC's major responsibilities:

Division of Depositor and Consumer Protection: These are the FDIC's police officers, so to speak. This division examines the business practices and investment strategies of insured banks and determines whether they are sound or have potential for failure. The division's compliance examiners conduct studies to make certain banks are following federal banking regulations. Employees of this division visit individual banks to make their assessments [source: FDIC]. In response to the 2010 Dodd-Frank Act, the FDIC created an Office of Complex Financial Institutions (CFI) to police banks and other large financial institutions with assets greater than $100 billion [source: FDIC].
Division of Resolutions and Receiverships: When an insured bank fails, these guys swoop in to save the account holders. If there is a bank willing to take the accounts under its wing, the FDIC draws on its insurance fund to essentially re-create the depositors' accounts (up to the insured amount) in the volunteering bank. If no bank will take the accounts, the FDIC directly pays the depositors up to the insured amount of $250,000. For example, if Sarah had $3,345 in her checking account when the bank failed, the FDIC pays Sarah $3,345 within a matter of days. To replenish the FDIC's insurance fund, the DRR sells the failed bank's loans and assets. Assets might include bank offices, office supplies and even office chairs, desks, and computers [source: FDIC].
Legal Division: In addition to handling the corporation's litigation, this division enforces federal banking regulations in banks declared in violation by the Division of Depositor and Consumer Protection.
Division of Insurance and Research: This division employs statisticians and economists to assess the nation's economic health. These analysts examine business activity, markets, regulatory policy and real estate trends to look for warning signs of bank failure.

The FDIC does not insure every kind of bank account. Find out on the next page what types of accounts the FDIC does and does not insure.

What the FDIC Does and Does Not Insure

The FDIC insures many of the accounts involved in everyday banking -- but it doesn't insure everything. Here's a look at what is and isn't covered [source: FDIC].

The FDIC insures:

Checking accounts
Savings accounts
Revocable and irrevocable trust accounts
Money market deposit accounts
Cashier's checks and money orders
Certificates of Deposit (CDs)
Negotiable Order of Withdrawal accounts (NOWs), a type of bank account that earns interest. The account holder can write checks from a NOW account.

The FDIC separates insured accounts into different ownership categories: single accounts, joint accounts, qualifying retirement accounts, revocable and irrevocable trusts and government accounts. To learn more, visit the FDIC Web page that describes ownership categories.

What do these categories mean to you? The FDIC insures up to $250,000 per owner per account category. If you have money in both a checking account and a retirement account at the same bank, the FDIC will insure both accounts up to $250,000 each, because they are two different categories. Likewise, if you and your spouse have $500,000 in a joint CD account, you are both insured up to $250,000 each, so that $500,000 is fully covered by FDIC deposit insurance.

Note that single and joint accounts are two different categories. It's possible for John Smith to have up to $250,000 in a single checking account and another $500,000 in a joint checking account he shares with his wife. Both accounts are fully covered by the FDIC. The trouble comes when two or more accounts fall into the same category, like a single checking account worth $200,000, a single CD worth $50,000 and a single savings account worth $100,000. Since all three accounts are single deposit accounts — and not retirement accounts or trusts — the owner is $100,000 over the $250,000 FDIC coverage limit.

To determine your exact FDIC coverage at an FDIC-insured bank, use this FDIC calculator.

The FDIC does NOT insure:

Stocks
Bonds
Mutual funds
Municipal securities
Annuities
Life insurance policies
Contents of safety deposit boxes

Even if you buy stocks, bonds or other securities through your bank, the FDIC does not cover them. Why not? First of all, they are not deposit accounts. Second, it would be impractical. Except for life insurance policies, these accounts' respective values are subject to fluctuations in economic, social and political circumstances, making them bad gambles for the FDIC. These types of accounts generally involve much larger amounts of money than the FDIC would be able to reliably and consistently cover. You might compare insuring such an account to insuring a Ferrari in a war zone.

The FDIC has undergone many changes over the years, but it has never failed to fulfill that mission. Since 1933, every depositor at every failed FDIC-insured bank has been reimbursed every last penny.

If you'd like to learn more about the Federal Deposit Insurance Corporation, you can follow the links on the next page.

Lots More Information

Author's Note: How the Federal Deposit Insurance Corporation Works

The FDIC is a wonderful example of effective government regulation. The FDIC was created to address a massive failure in the banking system and the loss of public trust in their financial institutions. It doesn't cost a dime of taxpayer money to operate and it has successfully insured every U.S. bank account holder since 1933. The regulatory powers of the FDIC were extended in the wake of the global financial crisis and Great Recession of 2007 through 2009. It remains to be seen whether new agencies like the Consumer Finance Protection Board and the Office of Complex Financial Institutions will be able to rein in the country's largest banks and safeguard the ordinary bank customer and homeowner against the volatility of the financial markets. Unless someone buys me a winning Powerball lottery ticket for Christmas, I am never going to have more than $250,000 in a single bank account. But it's comforting to know that my cash savings — as meager as they are — are at least fully insured.

Sources:

Consumer Finance Protection Board. "About Us" (July 2, 2013) http://www.consumerfinance.gov/the-bureau/
Encyclopedia Britannica. "Federal Deposit Insurance Corporation (FDIC)" (April 3, 2008) http://www.britannica.com/eb/article-9033896/Federal-Deposit-Insurance-Corporation
FDIC. "The 1930s." May 2, 2006 (April 3, 2008) http://www.fdic.gov/about/learn/learning/when/1930s.html FDIC. "The 1940s." May 2, 2006 (April 3, 2008) http://www.fdic.gov/about/learn/learning/when/1940s.html
FDIC. "The 1950s." May 2, 2006 (April 3, 2008) http://www.fdic.gov/about/learn/learning/when/1950s.html
FDIC. "The 1960s." May 2, 2006 (April 3, 2008)
FDIC. "The 1970s." May 2, 2006 (April 3, 2008) http://www.fdic.gov/about/learn/learning/when/1970s.html
FDIC. "The 1980s." May 2, 2006 (April 3, 2008) http://www.fdic.gov/about/learn/learning/when/1980s.html
FDIC. "The 1990s." May 2, 2006 (April 3, 2008) http://www.fdic.gov/about/learn/learning/when/1990s.html (April 3, 2008)
FDIC. "Basic FDIC Insurance Coverage Permanently Increased to $250,000 Per Depositor." July 21, 2010 (July 1, 2013) http://www.fdic.gov/news/news/press/2010/pr10161.html
FDIC. "FDIC Announces Organizational Changes to Help Implement Recently Enacted Regulatory Reform by Congress." August 10, 2010 (July 2, 2013) http://www.fdic.gov/news/news/press/2010/pr10184.html
FDIC. "FDIC Divisions." March 17, 2006 (April 3, 2008) http://www.fdic.gov/about/learn/learning/who/division.html
FDIC. "History of the FDIC." December 12, 2006 (April 3, 2008) http://www.fdic.gov/about/history/index.html
FDIC. "Insurance Coverage Basics." (July 2, 2013) http://www.fdic.gov/deposit/deposits/insured/basics.html
FDIC. "Insuring Your Deposits." May 25, 2007 (April 3, 2008) http://www.fdic.gov/deposit/deposits/insuringdeposits/
FDIC. "Who is the FDIC?" (July 1, 2013) http://www.fdic.gov/about/learn/symbol/
FDIC. "Who Runs the FDIC?" May 25, 2007 (April 3, 2008) http://www.fdic.gov/about/learn/learning/who/runs.html
FDIC. "Who Works for the FDIC?" March 17, 2006 (April 3, 2008) http://www.fdic.gov/about/learn/learning/who/index.html FDIC. "Why Was the FDIC Created?" (April 20, 2008) http://www.fdic.gov/about/learn/learning/why/index.html