The chairman of the Federal Deposit Insurance Corp. said yesterday that his agency's ability to regulate banks is being hampered by the large number of insured deposits that are being placed in problem banks by money brokers.
William Isaac said in an interview that brokers are taking large sums from investors like credit unions and savings and loan associations, "breaking them down into $100,000 chunks," and putting them in troubled banks that, to attract desperately needed funds, are willing to pay higher rates than healthy banks.
Because FDIC insures all deposits up to $100,000, many investors do not care where their funds are placed. The deposits, normally in the form of certificates of deposit, usually are made for a fixed-term of one to six months.
Isaac said the agency, which also regulates federally insured state-chartered banks that are not members of the Federal Reserve System, "will be putting forth proposals soon" to halt the practice.
Money brokers have been matching up investors with banks in need of funds for years. But when Penn Square National Bank of Oklahoma City failed last year, many of these investors--often credit unions and savings and loan associations--became reluctant to deposit more than the $100,000 insurance limit in any one bank. A number of large Penn Square depositors--some from as far away as Washington and New York--could lose 35 cents out of every dollar in excess of $100,000 that they had in Penn Square accounts.
Sources said that even federal agencies are placing insured deposits in troubled banks to take advantage of higher rates. Trust funds run by the Bureau of Indian Affairs had large deposits in eight banks that have failed in the last year. Generally the entire deposit is insured because each beneficiary of the trust is accorded $100,000 worth of protection by law.
The bureau had a fully insured $4 million on deposit at the State Bank of Barnum in Minnesota, which failed last February. The bank's total deposits were $13.1 million.
Because the money brokers are placing large amounts of deposits in troubled banks, the banks often can escape the need to borrow from the Federal Reserve. When troubled banks do borrow from the central bank, the Fed often requires them to take steps to remedy their problems, Isaac said. The FDIC can take steps against the banks, but it often takes as long as 18 months for any FDIC action to take effect.
Some of the banks probably should be closed, Isaac said, but the steady stream of brokered deposits makes it difficult for the regulators to shut them down.
Regulators can legally close a bank only when the bank runs out of cash (liquidity failure) or if its bad loans or other investments exceed its capital (book insolvency). "If a bank has a small amount of capital it is not book insolvent. If it continues buying funds, there is no liquidity insolvency," Isaac said in an interview.
Isaac said the practice of placing large amounts of insured deposits at troubled institutions also increases the FDIC's liability in the event the bank does close. The FDIC is responsible for $100,000 of a $1 million deposit, but for $1 million if it is composed of 10 deposits of $100,000.
The FDIC chairman said that in some cases it seems that brokers are looking for troubled banks because those banks pay interest rates far higher than rates paid by healthy institutions, but the brokers' clients bear no risk because of federal insurance.
"Banks have become insurance salesmen in the last year," according to one money broker who asked not to be identified. But he said the problems the FDIC pinpoints were created by the regulators.
"It was the regulators who decided that deposits of $100,000 or more are not subject to interest rate ceilings," he said, and Congress than decided accounts would be insured to $100,000. He predicted the problem would grow Oct. 1 when interest ceilings come off all deposits of 32 days or more, regardless of size.