Depositor Preference Legislation and Failed Banks' Resolution Costs

Included in the Omnibus Budget Reconciliation Act of 1993 was a provision that improved the priority of depositors and thus of the FDIC in the event of a depository institution’s failure. While intended to reduce the FDIC’s cost of resolving commercial bank failures, this provision might have induced general creditors to react so as to offset the intended benefit. Depositor preference legislation (DPL) might also have affected the FDIC’s choice of resolution type. Here we examine the empirical impact of DPL on resolution type and on resolution costs for commercial banks. Given the short time period since the passage of national DPL in 1993, we focus on the impact of state DPL statutes, utilizing call-report data and FDIC data on resolution costs and resolution types for all operating FDIC-BIF insured commercial banks that were closed or required FDIC financial assistance from January 1986 through December 1992. We improve on previous studies by controlling for the endogeneity of book capital and by adjusting for the sample selection bias induced by regulatory closure rules. We find that DPL has 1) tended to increase, rather than reduce, FDIC resolution costs and 2) induced the FDIC to choose assisted mergers over liquidations. However, the source of the higher resolution costs is unclear and there is no evidence that general creditors reacted by increasing collateralization.