Thursday, March 29, 2012

Here Comes Another Monkey: The PDIC


So, I heard the latest casualty of paper money system. The Export Bank, the famous Teodoro Borlongan's Urban Bank. But I am not here to tackle Export Bank. I am here to try to mumble some words about PDIC or the Philippine Deposit Insurance Corp.

Talking about things that is good for the public and the seriousness by which Philippine Deposit Insurance Corporation (PDIC) takes its job, it may seem I 
am out of sane character to mock PDIC. My mental faculties must be out of sync. Call me anything. But what would you expect from a man who took a whole dose of red pill?  

What is PDIC


PDIC is a government agency that serves mainly as an insurer of all deposits in all banks nationwide. The current maximum cover for every deposit account is PhP500,000.00. PDIC is under the Department of Finance. 

By law, PDIC simply guarantees that all depositors can get their money back even if a bank gets bankrupt. A bank closes down when it can no longer service all its liabilities. A hint that a bank may soon close is the dreadful bank run. Bank run literally means when clients “run to the bank” to pull all their monies out before the bank goes under. But because there is PDIC, a bank run is less likely to happen. People are at ease they deposits are covered by PDIC.

So, having in mind that PDIC is for the public good and it fulfills the mandated job with no joke, what a shame someone like me would still insinuate things that are unworthy to the perceived good image of the PDIC?

Why Deposit Insurance Exists

Bank runs during the USA Great Depression in 1930s were so prevalent because there was no deposit insurer in place.  In 1993, the USA Federal Government established the Federal Deposit Insurance Corporation (FDIC) and Federal Savings and Loan Insurance Corporation (FSLIC). The former is for commercial banks and the latter is for thrift banks. FDIC still operates now but FSLIC was terminated in 1989.

In a superficial sense, deposit insurance exists to prevent bank runs. This is not the true case. FSLIC did not prevent the bank runs in 1980’s. And in fact bank runs even brought the FSLIC to its knees and in 1989 it was declared dead because of insolvency. And all of its functions were transferred to FDIC.

In more accurate sense, deposit insurance exists only to protect the depositors. It strengthens the banking system, not necessarily by making bank-run-proof banks (which is of course impossible), but by making depositors much less weary of bank runs.

Where Insurance Fund Come From

As insurer, it collects premium from member banks. PDIC puts the collected premiums into a pool of fund it calls Deposit Insurance Fund (DIF). This is the rescue fund.

By the way, the term “member banks” is actually a redundant, not honest and inappropriate term to use. There are no “non-member” banks since it is mandatory to be a PDIC member before any bank is granted to operate. Thus, there must be no need to mention "member banks" since all banks are already under the PDIC.

Going back to DIF, it is interesting to note that DIF in extreme cases may not be enough. In the case of US FSLIC, it got a series of public money bailouts when its own fund was exhausted. DIF was proven to be  not crash-proof. Resorting to bail-out is the last remedy. But even this can fail too. That is why FSLIC was still terminated after a series of taxpayer bailouts. 

Why Banks Collapse ……so easily



A bank stays alive as long as the confidence of clients remains intact. However, only  one potentially damaging news or gossip can bring a bank down. Which brings me to the question: Why "sound banking" is ironically sensitive to gossips? And what is in there that makes banks vulnerable to bank runs and collapse so easily? What is in there that no matter how extent the "sound banking" PR campaign is, once public confidence starts to fade, a bank cripples to doom? The culprit: fractional reserve banking.

All banks today use fractional reserve banking. This means they don’t keep 100% of their clients’ deposit in their vaults. Banks only keep a smaller fraction of it (thus called fractional) and can lend out the other bigger fraction of it. The current rate of reserve requirement is 18%, as recently approved by the BSP. This means if you deposited P1000.00, your bank keeps P180.00 in their vault. The P820.00 is offered for lending. Assuming you are the only client your bank has, and for any reason you decided to pull- all your money out, your bank will be unable to give you your full money back since the only amount contained in their vault is P180.00.

In a large number of clientele, and for any reason that a large portion of them or all of them close all their accounts and demand all of their money back, the bank would collapse. The bank’s available cash or liquidity is very limited and very much incapable to meet all withdrawals. The ones who got their money first were already worry-less. When deposit vaults run empty, banks drops-out of business. Those who got the news late will get nothing.

Fractional reserve banking is the main reason why at times of mass withdrawals, banks can't service 100% all of their liabilities to their clients. In this sense fractional reserve banking is an unsound banking


Conclusion

Deposit insurance is a cunning strategy to perpetuate the corrupt system of fiat money  and fractional reserve banking - the root cause of almost all economic mess. It is to cheat the people to make them believe society operates in sound monetary system which in reality only ran by printing presses/electronic balance sheets behinds the hideous walls of every bank, which of course headed by the BSP no less.

PDIC, which is just a copy-cat of the USA FDIC, is just another assful monkey creation to plug the hole which is already there from the beginning - the fractional reserve banking.