Loss Sharing Agreement FDIC: What You Need to Know
The Federal Deposit Insurance Corporation (FDIC) is a government agency responsible for insuring banks and savings institutions in the United States. In the event of a bank failure, the FDIC ensures that depositors are protected up to a certain amount. But what happens to the bank itself?
This is where the Loss Sharing Agreement (LSA) comes into play. An LSA is a contract between the FDIC and an acquiring institution that stipulates how losses will be shared in the event that the acquired bank experiences further losses after the acquisition.
What is an LSA?
When a bank fails, the FDIC steps in and takes over the bank`s assets and liabilities. The FDIC then sells the failed bank to an acquiring institution, which takes over the bank`s operations and assumes its deposits and liabilities.
An LSA is a contract between the FDIC and the acquiring institution that stipulates how losses will be shared if the acquired bank experiences further losses after the acquisition. The acquiring institution agrees to share a percentage of the losses with the FDIC up to a certain amount.
For example, let`s say the FDIC sells a failed bank to an acquiring institution for $100 million. The LSA may stipulate that the acquiring institution covers the first 20% of any losses up to $10 million, with the FDIC covering the remaining 80%. This means that if the acquired bank experiences $5 million in losses, the acquiring institution would cover the first $1 million, and the FDIC would cover the remaining $4 million.
Why are LSAs necessary?
LSAs are designed to provide stability to the banking system and protect taxpayers from bearing the full cost of a bank failure. Without LSAs, acquiring institutions may be hesitant to purchase failed banks, which could lead to further bank failures and an even greater burden on the FDIC.
LSAs also provide an incentive for acquiring institutions to manage the acquired bank prudently and minimize losses. If an acquiring institution can successfully manage the acquired bank and avoid further losses, it can retain a greater share of the profits from the acquired bank`s operations.
Conclusion
In summary, an LSA is a contract between the FDIC and an acquiring institution that stipulates how losses will be shared if the acquired bank experiences further losses after the acquisition. LSAs are necessary to provide stability to the banking system and protect taxpayers from bearing the full cost of a bank failure. Acquiring institutions that manage the acquired bank prudently and avoid further losses can retain a greater share of the profits from the acquired bank`s operations.