Net worth certificates were developed in the 1980s to support banks affected by deregulation of deposit rate restrictions. They allowed banks to restructure investment portfolios and remain solvent during economic downturns. Although less common today, the provisions that made them possible still exist.
A net worth certificate is a type of financial instrument used to provide capital to banks and similar financial institutions based on the net worth of the institution’s assets. This type of instrument was first developed in the early 1980s in the United States, as a means to support banks that were dealing with the effects of the sudden deregulation of deposit rate restrictions that existed before the that moment. The certificate of net worth was used by the Federal Deposit Insurance Corporation (FDIC) to help banks compensate for situations in which the amount of interest owed to depositors was not offset by earnings collected on investments held by the bank. In doing so, the banks had time to realign investments in a way that would generate the income needed to meet agreements to deliver interest payments to customers.
The underlying concept of a net worth certificate has to do with forbearance. Due to the abandonment of certain banking restrictions that had been in place until the early 1980s, many banks and other financial corporations found themselves in a much more competitive environment that required reviewing the way interest rates were extended to customers. Simply put, it was necessary to offer customers better interest rates on accounts to keep older customers and also attract new customers. At the same time, many institutions were generating income based on insured investments when the older restrictions applied, creating a gap between their earnings and what was paid out to clients in the form of interest.
The net worth certificate served to close that gap for a time and allow affected financial institutions to restructure investment portfolios. Since the certificates were based on the net worth of the institutions, it was possible to provide temporary financial support as those changes were made. In the best of circumstances, banks were able to use the certificate of net worth as a means to remain solvent while making necessary adjustments to new market conditions.
While the use of the net worth certificate is less common today, the instrument’s merits have been discussed during various types of economic situations, such as the recession that began in 2007 and lasted several years. The general idea is that certificates could help banks and other types of lending institutions weather the economic downturn without requiring a large amount of government support and involvement. Although the certificate of net worth seems to be a thing of the past, the provisions that made it possible to issue this type of instrument are still in force.
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