Outgoing Federal Deposit Insurance Corp. Chairman William M. Isaac yesterday proposed that the Federal Reserve begin making unsecured loans to troubled financial institutions.
Such a policy shift by the central bank, which now loans money only with collateral, would have a reassuring effect on creditors as well as make the bank's limited collateral available to other lenders, he said.
Isaac also told the Senate Banking Committee that the number of bank failures is expected to exceed 100 this year and next. One-third of the 1,000 banks now on the troubled list are small and are engaged in agricultural lending.
Isaac, who long has been an advocate of deregulation, declared, "It is essential to recognize that deregulation . . . requires that we strengthen our supervision of banks and that we reform our system of deposit insurance. To fail to do either is a prescription for disaster." He said the FDIC's trouble-spotting ability has improved to the point where all of the 79 banks that failed last year had received an unsatisfactory rating from the agency, and 95 percent of them had been spotted on the previous examination.
Isaac contended that labeling the Fed's discount window as a "lender of last resort" is a misnomer because the Fed does not place any funds at risk. "All such loans to banks or thrifts are more than adequately secured," he said. "Increasingly over the years, the FDIC has become the banking industry's lender of last resort in the sense that it is the only agency at risk." He suggested that Congress might authorize or direct the Fed to make unsecured loans to solvent institutions.
Using the example of Continental Illinois National Bank, Isaac noted that the Fed provided close to $10 billion in loans to bail it out, but demanded collateral equal to about $20 billion.
He added that other lenders will run away because the Fed has taken all the good assets. A Federal Reserve spokesman had no comment yesterday on the proposal, but said Chairman Paul Volcker may address it when he testifies in September.
Isaac declared that deposit-insurance reform should take precedence over all other banking legislation such as granting banks new powers, geographic restraints and nonbank banks. Of the reforms he suggested, an increase in capital requirements is the most important, Isaac said.
Isaac also urged a merger of the weak Federal Savings and Loan Insurance Corp. with the stronger FDIC. Continuing to raise FSLIC premiums merely would encourage the strongest FSLIC-insured thrifts to desert FSLIC and become FDIC-covered banks, he said.