What is 'Modified Payoff'

A modified payoff is a partial insurance reimbursement that is paid to depositors of failed banks. Customers who have lost money in excess of what is covered by FDIC insurance can expect to receive a modified payoff. The payoff is based on an FDIC estimate of what they could collect from liquidation.

BREAKING DOWN 'Modified Payoff'

The FDIC instituted the modified payoff in the early 1980s. It was offered in response to a rash of bank failures that led to substantial customer losses.

Under the proposed FDIC ''modified payout program,'' depositors in a failed bank received up to the first $100,000, but those with funds not covered by insurance and other creditors would get a cash advance based on an estimate of what will be recovered from the failed bank's assets. If assets proved to be more valuable than estimates, these creditors would receive an additional payment.

Because the risk is high that creditors and uninsured depositors would lose money if a bank failed, modified payoff policies would increase the incentive for depositors to choose a bank based on its strength, rather than solely an offered interest rate.

The FDIC was advised to move forward with modified payoff policy because market discipline was seen as an essential ingredient of deregulation. The thought was that such a policy would impose market discipline on banks by virtue of their depositors understanding that they could lose their money.

Some state governments supplemented FDIC modified payoffs with state funds to ensure that depositors come out whole, even where institutions were not covered.

Abandonment of Modified Payoff Policies

Modified payoff policies were abandoned following the case of the failure of the Continental Illinois bank. The Continental Illinois National Bank and Trust Company was at one time the seventh-largest commercial bank in the United States as measured by deposits, with approximately $40 billion in assets. In 1984, Continental Illinois became the largest ever bank failure in U.S. history, when a run on the bank led to its seizure by the Federal Deposit Insurance Corporation (FDIC). Continental Illinois was the largest bank failure in the United States until the fall of Washington Mutual in 2008, during the financial crisis of 2008. Washington Mutual was over seven times larger than the failure of Continental Illinois.

Rationale for abandoning modified payoffs dealt mostly with the policy's demonstrated propensity to protect the creditors of large institutions more than those of small institutions. This not only removed an important source of market discipline on the risk-taking propensities of management, but also instituted a system of differential guarantees, in which large institutions were favored over smaller institutions. It was reasoned that differential coverage conveyed a subsidy to larger institutions, since their costs were not increased to cover their increased coverage. These policies also raised a fairness issue, since large institutions were given a competitive advantage over small firms by virtue of their better guarantees.

  1. Payoff Statement

    A payoff statement is a statement prepared by a lender providing ...
  2. FDIC Problem Bank List

    To make the FDIC problem bank list, a U.S. bank must have financial, ...
  3. Assisted Merger

    Assisted merger is the bringing together of two or more financial ...
  4. Insured Financial Institution

    An insured financial institution is any bank or savings institution ...
  5. Assuming Institution

    Assuming institution is a healthy financial institution that ...
  6. Bank Insurance Fund (BIF)

    Bank Insurance Fund (BIF) is a unit of the FDIC that provides ...
Related Articles
  1. Small Business

    A New Plan To Prevent Future Bailouts

    This new and innovative plan by the FDIC could help the government avoid the next bailout.
  2. Personal Finance

    Are Your Bank Deposits Insured?

    Learn how the FDIC is helping to keep your money in your pockets.
  3. Investing

    FDIC Sues Bank of America Over Deposit Insurance

    In a lawsuit filed Monday, the FDIC says Bank of America owes at least $542 million for deposit insurance.
  4. Investing

    Certificates Of Deposit

    Safety is a hallmark of the traditional certificate of deposit (CD) sold by a bank or credit union.
  5. Investing

    5 places to keep your money when you don’t trust banks

    Here's a list of places people can safely keep their money when they don't trust the banks to manage it for them.
  6. Investing

    Introduction to the Chinese Banking System

    China's banking system continues to evolve as it steps into a greater role in the global economic system.
  7. Personal Finance

    10 Bank Promotions That Pay You to Open an Account

    Find out which banks are running cash promotions and will pay you just for opening a new account.
  8. Insights

    The Role of Commercial Banks in the Economy

    We interact with commercial banks daily to carry out simple financial tasks. That said, the function and creation of a commercial bank is anything but simple.
  9. Insurance

    Are You Protected If Your Insurance Company Goes Belly-Up?

    Consumer protection against insurance company failures actually falls into the hands of state governments. How much protection do you have?
  10. Personal Finance

    Banking 101

    Do you really need a bank account? A quick survey of banking and how a relationship with a bank can organize your financial life.
  1. Are 401ks FDIC insured?

    Learn what part of your 401(k) retirement plan is covered by FDIC insurance, and what part is not. Find out what happens ... Read Answer >>
  2. Why is my 401(k) not FDIC-insured?

    Learn about the Federal Deposit Insurance Corporation (FDIC) and whether its protection extends to 401(k) accounts or just ... Read Answer >>
Trading Center