A White House economic policy group is considering the first proposed revision of the deposit insurance system in 51 years, a proposal that includes several ideas that have been under discussion for more than a year at different regulatory agencies.
The proposal calls for institutional insurance premiums to be based on relative risk. It also calls for higher capital requirements for banks and thrift institutions and for making the requirements similar for both types of institutions, common accounting standards and more public disclosure of financial condition by the institutions. It would not change the $100,000 coverage for depositors.
The study was conducted by a working group of the Cabinet Council on Economic Affairs studying financial institutions. The group is headed by Assistant Treasury Secretary for Domestic Policy Thomas J. Healey. The Cabinet officers are expected to vote on it next week.
The half-century-old system, based on a flat rate for healthy and weak institutions alike, has been shaken in recent years by costly bank failures and the gradual erosion of banks' equity resulting from the recession, high interest rates, deregulation and tough competition that induces institutions to take greater lending risks. There is a wider gap between strong and weak banks today than at any time in the past 15 years. One third of all savings and loans are still losing money, and their actual net worth or reserves is less than 1 percent.
The proposed revisions in deposit insurance aim to protect depositors and the banking system through more flexible supervision and market-oriented measures to minimize taxpayer subsidy. The five recommendations contain broad policy outlines but not specific mechanisms.
Risk-related premiums would be based on "objective" measurements of factors such as credit risk, interest rate risk, liquidity, leverage, and amount of purchased funds or uninsured deposits. The Federal Deposit Insurance Corp. and the Federal Savings and Loan Insurance Corp. would each publish an appropriate premium formula rather than make subjective judgments of risk.
No formal ratings would be accorded banks and thrifts. However, the information would be available to the public, according to a Treasury spokesman, so that people could calculate the relative soundness of each institution.
Ratios of capital to assets would be increased gradually. The FDIC has proposed a 9 percent level for banks. Savings and loans, which currently have smaller capital requirements than banks, would eventually have to maintain the same levels. Thin capital requirements have led to excessive growth and greater risk taking. About 300 S&Ls, representing 40 percent of the industry's assets, have doubled in asset size during the past two years without adequately increasing their capital cushion, making them more susceptible to failure.
One third of total capital requirements could be met by subordinated debt, rather than equity. The idea is to let the market rather than the regulators monitor capital accumulation. Because institutions that seek to raise capital by floating bonds regularly require a fitness rating, weak ones would have more difficulty raising money than if they issued stock.
Accounting methods would gradually be harmonized and, in the interim, existing differences made public so investors would be alerted to weak institutions. Currently, banks use generally accepted accounting principles (GAAP), but savings and loans use regulatory accounting principles. The latter allow savings and loans to include such intangible items as goodwill and appraised equity and loss deferrals as net worth. That boosts their net worth to about 4 percent; computed according to GAAP, it is almost zero.
Before they reach accounting parity, S&Ls would have to post a sign saying they do not comply with GAAP as a warning. Non-stock S&Ls that are not regulated by the Securities and Exchange Commission would also have to disclose material events to their own regulators.
The group was unable to reach any conclusion on whether the FDIC and FSLIC trust funds that insure deposits are sufficiently large, so a further study was offered. FSLIC's fund has now reached a historic low of 92 cents to cover every $100 of insured deposits.