Question

2.(a)Suppose you have $400,000 in a deposit account at a Canadian bank that has just been declared insolvent. Would you prefer that the Canadian Deposit Insurance Corporation (CDIC) resolve the solvency under the “winding up method” or the “purchase and assumption” method? Explain your choice. (b) Suppose instead you are a shareholder in the now insolvent bank. Answer the question from part (a) in this case

Answer 1

(a) Winding up is the method of ending, or dissolving, a business. The winding up activity includes selling all assets, paying off creditors, and distributing remaining assets to the partners or shareholders. Winding up can refer to dissolving either a corporation or a partnership.

A purchase and assumption is a transaction in which a healthy bank or thrift purchases assets and assumes liabilities from an unhealthy bank or thrift. Purchase and assumption (P&A) is the most common of three basic resolution methods used by the Federal Deposit Insurance Corporation (FDIC) to deal with failing banks. The other types of assistance given to failing banks are deposit payoffs and liquidation and open bank assistance transactions. There was also a Troubled Asset Relief Program (TARP) payment program launched in response to failing banks that were deemed "too big to fail" during the global financial crisis.

Since, under winding up method only $100,000 are paid off, the depositor will lose remaining money. Hence, we would choose purchase and assumption method.

(b) If, instead, we are now a shareholder in the insolvent bank, we would prefer winding up method as it is usually cheaper than purchase and assumption method.