A net-worth certificate is a type of financial instrument that is 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 the deposit rate restrictions that had existed prior to that time. The net-worth certificate was utilized by the Federal Deposit Insurance Corporation (FDIC) to help banks offset situations in which the amount of interest owed to depositors was not being offset by the earnings collected on the investments held by the bank. Doing so provided the banks time to realign investments in a manner that would generate the revenue needed to honor those covenants of delivering interest payments to customers.
The underlying concept of a net-worth certificate has to do with forbearance. Owing to the abandonment of certain banking restrictions that had applied up until the early 1980’s, many banks and other financial corporations found themselves in a much more competitive environment that required revisiting the way interest rates were extended to customers. Simply put, offering customers better interest rates on accounts were necessary in order to maintain older customers and also attract new customers. At the same time, many institutions were generating revenue based on investments secured when the older restrictions were in place, creating a gap between their earnings and what was being paid out to customers in the form of interest.
The net-worth certificate served to bridge that gap for a time, and allow the 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 utilize the net-worth certificate as a means of remaining solvent while the necessary adjustments to the new market conditions were made.
While the use of the net-worth certificate is less common today, the merits of the instrument have been discussed during various types of economic situations, such as the recession that began in 2007 and lasted for several years. The general idea is that the certificates could help banks and other types of lending institutions to get through the economic downturn without requiring a great deal of government support and involvement. Although the net-worth certificate appears to be more of a thing of the past, the provisions that made it possible for this type of instrument to be issued remain in place.
