Depositor Preference Legislation and Failed Banks' Resolution Costs

Depositor preference legislation was enacted as part of the Omnibus Budget Reconciliation Act of 1993. The purpose of this legislation was to reduce FDIC failed-bank resolution costs by subordinating the claims of other creditors to depositors and the FDIC. However, an unintended consequence of depositor preference might be increased resolution costs through an offsetting reaction by general creditors. In addition, by changing the priority of off-balance sheet liabilities depositor preference may affect the FDIC's choice of resolution type. We empirically examine the possible impact of national depositor preference on failed-bank resolution costs by looking at state depositor preference laws in effect prior to 1992. In doing so we extend the previous studies of closed-bank resolution costs by controlling for the endogeneity of book measures of bank capital, correcting for sample selection bias introduced by regulatory closure rules, and taking account of depositor preference's possible impact on the FDIC's choice of resolution type. Overall, we find that depositor preference has tended to increase resolution costs and it induced the FDIC to choose assisted mergers over liquidations