FDIC offers solutions for strengthening deposit insurance
A Public Policy Question
The FDIC looked at the deposit insurance system and found three fundamental problems that needed correcting:
Deposit insurance was crudely priced.
We were charging for deposit insurance at the wrong point in the business cycle.
And the value of insurance coverage was shrinking over time.
One need only look at the Bank Insurance Fund itself to see how these problems affect you. Despite the economic boom we’ve all enjoyed, the BIF reserve ratio has been treading water since 1997. And our preliminary data show it at 1.35 percent of insured deposits at the end of the year 2000 – 10 basis points above the legal requirement.
That sounds like a big cushion but it can disappear. The recent slowdown in the economy casts doubt on banks’ ability to sustain recent growth rates in the face of softening loan demand. The distant cloud is a reminder that good times don’t last forever. When bad times return, more banks will naturally fail. If banks fail in greater numbers, the insurance fund will decline.
What could these dark clouds do to the insurance fund? Even in these good times, the BIF reserve ratio has been basically unchanged since 1997. Therefore, in bad times, the BIF has no where to go but down.
Looking out over the horizon, a second concern we have is the effects of the inflow of new deposits covered by the insurance program, without any corresponding payment for that coverage – the so-called “free-rider” problem. This inflow is not new. It has been occurring over the past five years. It was more pronounced than ever last year – deposits grew at 6 percent, compared to historical growth of 3 percent annually in recent years. And the inflow of deposits may continue in various ways, as new products come on line.
While this deposit growth is a successful and legitimate activity, there is no denying that, over time, it could contribute to a large enough dilution of reserves to trigger premium payments by all banks.
Let me be clear: Under the current law, when the BIF falls below 1.25 percent, if it is not replenished within a year, the entire industry will be facing steep 23 basis point premiums.
The possibility of upticks in bank failures from a cooling economy and the growth of deposits makes the need for deposit insurance reform ever more pressing. If we find ourselves in a confluence of events – a slowing economy, expensive bank failures and significant deposit growth the cushion in the BIF can disappear. And, if 23 basis point premiums kick in, the surviving institutions will end up paying for the high fliers.
Here are our recommendations:
First: Merge the BIF and the Savings Association Insurance Fund. We cannot rationalize the deposit insurance system without eliminating the incongruous requirement to maintain two separate funds.
Second: Eliminate the “hard target” reserve ratio of 1.25 percent. Instead, we could maintain the reserve ratio within a more flexible target range.
Third: Price insurance to be steadier – less volatile – over the business cycle.
Fourth: Price insurance more closely to the risk an institution presents, rewarding the safest institutions over time.
Fifth: Establish an adjustment or rebate to work in conjunction with this more flexible reserve ratio. Adjustment rules could provide for a gradual return to the midpoint of a range and some flexibility to adjust to changing conditions.
Sixth: Index deposit insurance coverage levels to an appropriate base year of the Consumer Price Index.
In short, our recommendations will make the deposit insurance system stronger. They will make the system fairer. And they will allow banks more flexibility to serve the credit needs of communities throughout the business cycle. In doing so, they will ensure the system that has served the American public well in the past will continue to serve the American public well in the future. -:
This column by the FDIC Chairman is an abbreviated version of the speech she delivered March 7 at the annual convention of the
Independent Community Bankers of America.
Copyright NFR Communications Inc Apr 1, 2001
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