The U.S. Government Accountability Office (GAO) has issued a report recommending that Congress amend the Federal Deposit Insurance Act (FDI Act) to achieve greater transparency and accountability when the FDIC takes emergency actions under the systemic risk exception. The GAO report delivered to Congress on April 15 also recommends that regulatory reform legislation should ensure greater regulatory oversight of systemically important institutions to mitigate the effects of weakened market discipline from use of the systemic risk exception. According to the report, the FDIC, Treasury and the Federal Reserve collaborated before announcing five potential emergency actions under the systemic risk exception. In each case, the FDIC and the Federal Reserve recommended the emergency actions to Treasury, but Treasury made a determination that allowed the FDIC to proceed with emergency assistance in only three of the five cases. The GAO found that these actions could have affected markets by increasing confidence in financial institutions with an expectation of imminent government assistance, while similarly generating negative effects such as moral hazard.

Nutter Notes: Under the FDI Act’s systemic risk exception, the FDIC can provide certain types of emergency assistance to depository institutions at risk of failure if the Secretary of the Treasury, in consultation with the President and with the written recommendation of the Federal Reserve, determines that compliance with the least-cost resolution requirements of the FDI Act would result in serious adverse effects on economic conditions or financial stability and that emergency assistance could mitigate those systemic effects. Treasury’s determination exempts the FDIC from the least-cost resolution rule, which otherwise requires the FDIC to use the least costly method when assisting an insured institution and prohibits FDIC from increasing losses to the Deposit Insurance Fund by protecting creditors and uninsured depositors of an insured institution. The GAO report points out that the recent applications of the systemic risk exception raise questions about whether the exception may be invoked based only on the problems of a particular institution or on problems of the banking industry as a whole, and whether and under what circumstances assistance can be provided to healthy institutions. The report expressed concern that the agencies’ use of the systemic risk exception may weaken market participants’ incentives to properly manage risk if they come to expect similar emergency actions in the future. The GAO recommended that Congress amend the FDI Act to clarify the statutory requirements and forms of assistance authorized under the systemic risk exception.