What Are Loss Share Agreements and How Do They Work?
A loss share agreement is a type of transaction that is commonly used in the banking industry. It is an agreement between two or more banks, where one bank agrees to share the losses of another bank that has experienced default.
The loss share agreement is designed to protect the acquiring bank from the risks associated with acquiring a failed bank. In most cases, the FDIC (Federal Deposit Insurance Corporation) is involved in the transaction, as it is responsible for overseeing the transfer of deposits and assets between banks.
How Does a Loss Share Agreement Work?
When a bank fails, the FDIC steps in and takes control of the bank`s assets. The FDIC then looks for a bank that is willing to acquire the failed bank`s assets and liabilities. This is where the loss share agreement comes into play.
The acquiring bank and the FDIC will negotiate an agreement that outlines the terms of the transaction. The agreement will typically require the acquiring bank to purchase a certain percentage of the failed bank`s assets and liabilities.
Under a loss share agreement, the acquiring bank agrees to share a percentage of any losses that occur on the purchased assets and liabilities. The percentage may vary, depending on the agreement between the acquiring bank and the FDIC.
For example, let`s say a failed bank has $100 million in assets and $50 million in liabilities. The acquiring bank agrees to purchase $80 million of the bank`s assets. The loss share agreement between the acquiring bank and the FDIC stipulates that the acquiring bank will share 50% of any losses that occur on the purchased assets.
If the acquiring bank experiences losses of $10 million on the purchased assets, it will be responsible for 50% of those losses, or $5 million. The FDIC will cover the other 50% of the losses.
Why Are Loss Share Agreements Used?
Loss share agreements are used to protect acquiring banks from the risks associated with acquiring a failed bank. By sharing the losses, the acquiring bank is able to mitigate its exposure to potential losses that could occur on the purchased assets and liabilities.
In addition, loss share agreements can help to facilitate the quick transfer of assets and liabilities from a failed bank to an acquiring bank. This is important because it helps to minimize the disruption to customers and the overall banking system.
Final Thoughts
As a professional, it`s important to understand the terminology used in various industries. Loss share agreements are an important concept to understand in the banking industry, as they are commonly used for acquisitions of failed banks. By sharing the losses, acquiring banks are able to mitigate their risk exposure and facilitate a smooth transfer of assets and liabilities.