FDIC Plan Would Shore Up Fund
Wednesday, October 8, 2008
The Federal Deposit Insurance Corp. yesterday proposed to recoup the cost of recent bank failures and prepare for additional failures by more than doubling the insurance premiums that banks must pay.
The plan would raise about $10 billion a year in additional revenue for the FDIC, which has spent $11 billion this year to clean up the largest crop of bank failures since the early 1990s. Banks would pay the higher rates beginning next year, pending final approval of the plan after a comment period.
For the first time, the agency also plans to use its fee structure as a policy tool, prodding banks to adopt less risky business practices by offering large discounts on premiums.
The change is partially an effort to limit the premium increase for low-risk institutions, by imposing higher fees on banks that are more likely to fail. But the changes also underscore the administration's efforts to reign in the banking industry, sometimes by pulling on previously untouched ropes.
The FDIC guarantees that depositors will be repaid in the event of a bank failure. Last week, Congress temporarily raised to $250,000 the amount insured by the FDIC in each bank account. All told, the agency insures more than $5 trillion in deposits at several thousand institutions.
The FDIC is funded entirely by assessments on banks, and the agency is required to maintain its insurance pool at a fixed percentage of the total deposits that it insures. The failure of IndyMac Bancorp in July cost the FDIC an estimated $9 billion, and about a dozen smaller bank failures have cost the agency more than $1 billion, reducing the balance in the insurance fund below the minimum required by law.
The changes will take effect in two phases. The FDIC needs to begin raising money now, but it needs time to fine-tune the new system of discounts and penalties, according to an FDIC spokesman.
For the first quarter of next year, the average premium would rise to 13.5 cents on every $100 in deposits, from 6.3 cents now. The FDIC will reward banks that rely mostly on deposits gathered from their community and banks that raise funding without pledging assets as collateral. Conversely, banks will pay higher insurance premiums if they gather deposits through third-party brokers or if they raise money by pledging loans as collateral.
FDIC officials say those practices makes a bank more likely to fail. But setting policy on bank practices is generally the job of the federal regulatory agencies -- including the FDIC for the institutions it oversees -- raising the possibility that banks will get divergent signals from the FDIC and from their primary regulator, either the Office of the Comptroller of the Currency, the Office of Thrift Supervision or the Federal Reserve.
John L. Douglas, a former FDIC general counsel, said the new approach was an extension of the FDIC's long-standing practice of setting rates based on the risk that a bank will fail.
Brokered deposits have played a role in several recent bank failures. They are gathered by offering high interest rates to attract deposits that flow through third-party brokers. But they are an unstable funding source because the depositors leave if the interest rate falls -- or someone else offers a higher rate. As a result, banks that rely on brokered deposits are more vulnerable to a sudden loss of critical funds.
"This is like the insurance company saying if you drink and drive you're going to pay more premiums," said Douglas, now a banking lawyer with the law firm Paul Hastings.
But some of the other regulatory agencies have already expressed concern about the size of the penalties, particularly for using secured funding. Secured funding generally carries lower interest rates. The major source of such loans are the federal home loan banks, which allow mortgage loans to be pledged as collateral.
Research shows that such loans may correlate slightly with a higher risk of bank failure. Primarily, however, secured loans make bank failures more expensive because secured creditors are paid on a priority basis. That means the FDIC's concerns may be driven by the cost rather than the risk.
Bert Ely, a banking consultant who runs his own firm, said the size of the penalty is "grossly excessive." He said his own research showed the added risk associated with a reliance on secured debt was very small.