[House Hearing, 107 Congress]
[From the U.S. Government Printing Office]

                      ON DEPOSIT INSURANCE REFORM



                               BEFORE THE

                            SUBCOMMITTEE ON

                                 OF THE


                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION


                             JULY 26, 2001


       Printed for the use of the Committee on Financial Services

                           Serial No. 107-39

74-493                     WASHINGTON : 2001

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                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         

             Terry Haines, Chief Counsel and Staff Director
       Subcommittee on Financial Institutions and Consumer Credit

                   SPENCER BACHUS, Alabama, Chairman

DAVE WELDON, Florida, Vice Chairman  MAXINE WATERS, California
MARGE ROUKEMA, New Jersey            CAROLYN B. MALONEY, New York
DOUG BEREUTER, Nebraska              MELVIN L. WATT, North Carolina
RICHARD H. BAKER, Louisiana          GARY L. ACKERMAN, New York
MICHAEL N. CASTLE, Delaware          KEN BENTSEN, Texas
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             MAX SANDLIN, Texas
BOB BARR, Georgia                    GREGORY W. MEEKS, New York
SUE W. KELLY, New York               LUIS V. GUTIERREZ, Illinois
PAUL E. GILLMOR, Ohio                FRANK MASCARA, Pennsylvania
JIM RYUN, Kansas                     DENNIS MOORE, Kansas
BOB RILEY, Alabama                   CHARLES A. GONZALEZ, Texas
STEVEN C. LaTOURETTE, Ohio           PAUL E. KANJORSKI, Pennsylvania
DONALD A. MANZULLO, Illinois         JAMES H. MALONEY, Connecticut
WALTER B. JONES, North Carolina      DARLENE HOOLEY, Oregon
JUDY BIGGERT, Illinois               JULIA CARSON, Indiana
PATRICK J. TOOMEY, Pennsylvania      BARBARA LEE, California
ERIC CANTOR, Virginia                HAROLD E. FORD, Jr., Tennessee
FELIX J. GRUCCI, Jr, New York        RUBEN HINOJOSA, Texas
MELISSA A. HART, Pennsylvania        KEN LUCAS, Kentucky
MIKE FERGUSON, New Jersey            JOSEPH CROWLEY, New York

                            C O N T E N T S

Hearing held on:
    July 26, 2001................................................     1
    July 26, 2001................................................    31

                        Thursday, July 26, 2001

Bair, Hon. Sheila C., Assistant Secretary for Financial 
  Institutions, U.S. Department of the Treasury..................     5
Hawke, Hon. John D., Jr., Comptroller, Office of the Comptroller 
  of the Currency................................................     7
Meyer, Hon. Laurence H., Member, Board of Governors, Federal 
  Reserve System.................................................     3
Seidman, Hon. Ellen, Director, Office of Thrift Supervision......     9


Prepared statements:
    Bachus, Hon. Spencer.........................................    32
    Oxley, Hon. Michael G........................................    34
    Bair, Hon. Sheila C..........................................    50
    Hawke, Hon. John D., Jr. (with attachment)...................    59
    Meyer, Hon. Laurence H.......................................    35
    Seidman, Hon. Ellen..........................................    86

              Additional Material Submitted for the Record

Bair, Hon. Sheila C.:
    Written response to a question by Hon. Spencer Bachus........    56
    Written response to a question by Hon. Frank Mascara.........    58
Hawke, Hon. John D., Jr.:
    Written response to a question by Hon. Frank Mascara.........    84
Meyer, Hon. Laurence H.:
    Written response to a question by Hon. Frank Mascara.........    48
Seidman, Hon. Ellen:
    Written response to a question by Hon. Frank Mascara.........    98



                        THURSDAY, JULY 26, 2001,

             U.S. House of Representatives,
            Subcommittee on Financial Institutions 
                               and Consumer Credit,
                           Committee on Financial Services,
                                                    Washington, DC.
    The subcommittee met, pursuant to call, at 10:05 a.m., in 
room 2128, Rayburn House Office Building, Hon. Spencer Bachus, 
[chairman of the subcommittee], presiding.
    Present: Chairman Bachus; Representatives Bereuter, Barr, 
Biggert, Grucci, Hart, Capito, Tiberi, Waters, C. Maloney of 
New York, Watt, Sherman, Meeks, Mascara, Moore, Gonzalez, 
Kanjorski, Hooley, Hinojosa and Lucas.
    Chairman Bachus. The Subcommittee on Financial Institutions 
and Consumer Credit will come to order. Without objection, all 
Members' opening statements will be made a part of the record.
    The subcommittee meets today for a second hearing in this 
Congress on reforming the Federal deposit insurance system. At 
our first hearing on this subject in mid-May, Donna Tanoue, the 
outgoing Chairman of the Federal Deposit Insurance Corporation, 
(FDIC), presented the agency's recommendations for reform. 
Today, we will hear the perspectives of the other Federal bank 
regulators as well as the Treasury Department.
    Since the subcommittee last met to consider these issues, 
there have been significant developments. First, President Bush 
chose to replace Ms. Tanoue at the FDIC. His choice was Don 
Powell, who has been confirmed by the Senate and is expected to 
assume his responsibilities shortly. My hope is that Chairman 
Powell will appear before the subcommittee in September to 
share his views on deposit insurance reform.
    Second, the FDIC released data last month reflecting that 
in the first quarter of this year, the ratio of reserves to 
insured deposits in the Bank Insurance Fund, (BIF), dropped 
from 1.35 percent to 1.32 percent. That ratio now stands at its 
lowest point since 1996. As most of the people in this room are 
well aware, once the number falls below the current ``hard 
target'' of 1.25 percent, every bank in America faces a 23-
basis-point premium assessment. It is estimated that such an 
assessment would require banks to pay billions of dollars in 
premiums, a rude awakening after an extended period in which 
over 90 percent of banks paid no premiums at all. Such a 
massive outflow of funds from the banking system would curtail 
lending to consumers and small businesses with potentially 
devastating consequences for our economy and for communities 
and families throughout America.
    By contrast, the FDIC reports that the designated reserve 
ratio in the Savings Account Insurance Fund, (SAIF), which 
covers thrifts, held steady in the first quarter at 1.43 
percent, unchanged from the last report at the end of 2000. 
Assuming that current trend continues, the possibility exists 
that banks will face sizable premium assessments at a time when 
most of their thrift counterparts are paying no premium.
    The significant growth in insured deposits that has 
triggered the decline in this reserve ratio in the first 
quarter is, in some respects, a ``good news/bad news'' story. 
The bad news is obvious for banks. They could find themselves 
on the receiving end of a multi-billion-dollar premium payout 
if current patterns persist and the current law remains in 
    The ``good news'' is an apparent reversal of the trend of 
core deposits leaving the banking system in recent years, in 
search of higher returns elsewhere. As we all know, those 
higher returns did not always materialize.
    The outflow of deposits made it difficult for some banks to 
meet loan demand in their local communities. The $84 billion 
jump in insured deposits in the first quarter reported by 
FDIC--coming on the heels of a substantial increase in deposits 
in the fourth quarter of last year--is a welcome development 
for those concerned about the future of small community banks 
in America. Whether this flow of funds back into the banking 
system will be sustained or prove to be temporary, driven by 
investors seeking safe haven from more speculative investments, 
remains to be seen.
    Another contributor to the declining BIF ratio has been the 
subject of heated debate: large infusions of money by large 
brokerage firms from uninsured cash management accounts to 
insured accounts at banks owned by those same brokerage firms.
    Former Chairman Tanoue addressed the so-called ``free 
rider'' issue and made it a centerpiece in her reform proposal. 
I, for one Member, welcome that. We will learn at today's 
hearing whether the other banking regulators share her concerns 
in this regard.
    Let me now recognize the Ranking Minority Member, Ms. 
Waters, for her opening statement.
    [The prepared statement of Hon. Spencer Bachus can be found 
on page 32 in the appendix.]
    Ms. Waters. Good morning. I'd like to thank Chairman Bachus 
for calling this hearing, the second in a series on Federal 
deposit insurance reform. Deposit insurance has served America 
well for over 65 years. It has maintained public confidence in 
our banking system throughout times of prosperity and times 
that weren't so good.
    It is important that we examine these issues closely in 
order to maintain and strengthen today's system for tomorrow's 
consumers. I look forward to hearing the testimony of the 
witnesses so that we can ensure that we have a deposit 
insurance system that will serve us well throughout the new 
millennium. I will yield back the balance of my time.
    Chairman Bachus. I want to welcome our panel today. The 
first panelist, going from my left, is Governor Laurence Meyer, 
Governor of the Board of Governors of the Federal Reserve, who 
has testified before our subcommittee on several occasions, and 
we welcome you back and look forward to your testimony. It's 
always insightful. We appreciate that.
    We have a new Madam Assistant Secretary for Financial 
Institutions, Ms. Bair. We want to welcome you to the 
subcommittee and look forward to a long and cooperative 
relationship with you.
    Ms. Bair. Thank you.
    Chairman Bachus. I talked to her earlier and she brought 
her daughter to the Senate confirmation hearings, and I was, 
for one, looking forward to meeting her, but I think it's 
probably better that she's in a more comfortable environment 
than here.
    Ms. Bair. There will be future opportunities, I'm sure.
    Chairman Bachus. Thank you. I want to welcome back an old 
friend of this subcommittee, the Honorable John D. Hawke, the 
Comptroller of the Currency. And then the Honorable Ellen 
Seidman, who is the Director of the Office of Thrift 
Supervision, (OTS). And Ms. Seidman, I appreciate the service 
that you have given to the OTS.
    At this time we will welcome opening statements from the 
witnesses. You do not have to limit yourselves to 5 minutes, if 
you want to go over that. We would rather hear from you rather 
than enforce some arbitrary limit, and we have time.


    Mr. Meyer. Thank you. Mr. Chairman, Congresswoman Waters, 
Members of the subcommittee, it's a pleasure to appear before 
you to present the views of the Board of Governors of the 
Federal Reserve System on deposit insurance reform as proposed 
by the FDIC this past spring.
    Deposit insurance has played a key role, sometimes a 
critical one, in stabilizing banking and financial markets. In 
addition, deposit insurance has provided a safe and secure 
place for those households and small businesses with relatively 
modest amounts of financial assets to hold their transactions 
and other balances.
    But these benefits have not come without cost. The very 
same process that has ended deposit runs has made insured 
depositors largely indifferent to the risks taken by their 
banks. It has thus increased the ability of insured depository 
institutions to take risks while reducing market monitoring of 
that risk, necessitating greater governmental supervision. The 
crafting of reforms of the deposit insurance system must 
therefore struggle to balance the tradeoffs between these 
benefits and costs. The FDIC has made five broad 
    The Board strongly supports the FDIC's proposal to merge 
the BIF and SAIF funds. Because the charters and operations of 
banks and thrifts have become similar, it makes no sense to 
continue the separate funds.
    The Board also strongly endorses the FDIC recommendations 
that would require a premium be imposed on every insured 
depository institution and eliminate the statutory restrictions 
on risk-based pricing. The current rule requires the Government 
to give away its valuable guarantee to well-capitalized and 
well-rated banks when the fund reserves meet some ceiling 
level. At the end of last year, 92 percent of banks and thrifts 
were paying no premium. Included in this group are new banks 
that have never paid any premium for their, in some cases 
substantial, coverage, and fast-growing entities whose past 
premiums were extraordinarily small relative to their current 
    Although the establishment of a robust risk-based premium 
system would be technically difficult to design, a closer link 
between insurance premiums and individual bank and thrift risk 
would reduce banks' incentive to take risk. We note, however, 
that for risk-based premiums to do their job of inducing 
behavioral change, a substantial range of premiums is required. 
Thus, if a cap is required, as the FDIC recommends, it should 
be set quite high so that risk-based premiums can be as 
effective as possible in deterring excessive risk-taking.
    The current rules can result in sharp changes in premium 
when the reserves of the fund rise above or fall below 1.25 
percent of insured deposits. These rules are clearly 
procyclical, lowering or eliminating fees in good times and 
abruptly increasing fees sharply in times of weakness. We 
strongly support the FDIC's proposal for increased flexibility 
and smoothing of premiums by the establishment of a targeted 
fund reserve range. However, we recommend that the FDIC's 
suggested target reserve range should be widened in order to 
further reduce the need to change premiums sharply.
    The FDIC proposals would be coupled with rebates for 
stronger entities when the fund approaches the upper end of the 
target range, and surcharges when the fund trends below the 
lower end of the range. The FDIC also recommends that the 
rebates vary with the size and duration of past premiums and 
the scale of the current FDIC exposure to the entity. These 
proposals make considerable sense, and the Board endorses them.
    The FDIC recommends that the current $100,000 ceiling on 
insured deposits be indexed. The Board does not support this 
recommendation and believes that, at this time, the current 
ceiling should be maintained. In the Board's judgment, it is 
unlikely that increased coverage today, even by indexing, would 
add measurably to the stability of the banking system. Thus, 
the problem that increased coverage is designed to solve must 
be either with the individual depositor, the party originally 
intended to be protected by deposit insurance, or the 
individual bank or thrift, clearly, both of which would prefer 
higher coverage if there were no costs. But Congress needs to 
be clear about the problem for which increased coverage would 
be the solution.
    Our surveys of consumer finances suggest that depositors 
are adept at achieving the level of deposit insurance coverage 
they desire by opening multiple accounts. Such spreading of 
asset holdings is perfectly consistent with the counsel always 
given to investors to diversify their assets across different 
    Does the problem to be solved by increased deposit 
insurance coverage concern the individual depository 
institutions? If so, the problem necessarily would be 
concentrated at smaller banks that generally do not have access 
to the money market or to foreign branch networks for 
supplementary funds. Since the mid-1990s, and adjusted for the 
effect of mergers, the smaller banks, those below the largest 
1,000, have actually grown almost twice as rapidly as all 
banks. Most important, the uninsured deposits at the smaller 
banks have grown nearly twice as rapidly, over a 20 percent 
annual rate, compared to the larger banks. Clearly, small banks 
have a demonstrated skill and ability to compete for uninsured 
    With no obvious problem to be solved, the Board, as I 
noted, has concluded that there is not a case for increasing 
the current $100,000 level for insured deposits, even by 
indexing. There may come a time when the Board finds that 
households and businesses with modest resources are finding 
difficulty in placing their funds in safe vehicles, and/or that 
there is a reason to be concerned that the level of deposit 
coverage could endanger financial stability. Should either of 
those events occur, the Board would call our concerns to the 
attention of Congress and support adjustments to the ceiling by 
indexing or other methods.
    Thank you.
    [The prepared statement of Hon. Laurence H. Meyer can be 
found on page 35 in the appendix.]
    Chairman Bachus. Madam Assistant Secretary Bair.


    Ms. Bair. Thank you, Mr. Chairman, Congresswoman Waters, 
and Members of the subcommittee, I appreciate the opportunity 
to comment on the Federal Deposit Insurance Corporation's 
recent paper recommending reform of the deposit insurance 
    The Treasury Department has a substantial interest in this 
issue, as we have a critical role to play in deposit insurance. 
The deposit insurance funds have authority to borrow up to $30 
billion from the U.S. Treasury. In addition, Congress has 
assigned to the Secretary of the Treasury the final 
responsibility for determining whether the resolution of a 
failing bank poses a systemic risk to the financial system.
    My comments this morning will be general in nature, 
focusing on the key policy issues raised in the FDIC paper, and 
I would add that even though we are not in complete agreement 
with those recommendations, we think it's an excellent piece of 
work. The FDIC staff should be commended. It certainly provides 
an excellent starting point, a framework for considering this 
important issue.
    We are in general agreement with the FDIC report on three 
points. First, the potential procyclical effects of deposit 
insurance pricing and reserving should be reduced. Reserves 
should be allowed to grow when conditions are good in order to 
better absorb losses under adverse conditions without sharp 
increases in premiums. Allowing growth above a designated 
reserve ratio in good times or growth within a wide range would 
afford greater room for the insurance fund to handle bank 
failures without exhausting its resources. It also would allow 
for more stable premiums that would smooth over time the costs 
borne by the industry.
    Second, all insured depository institutions should pay 
premiums on current deposits, with potential rebates taking 
into account each institution's recent history of premium 
payments. Banks and thrifts benefit every day from deposit 
insurance, and they should compensate the FDIC for that 
benefit, preferably through relatively small, steady premiums. 
Most banks and thrifts now pay no premiums for deposit 
insurance, which creates incentives to increase deposits and 
thus raises the FDIC's uncompensated risk exposure.
    Third, the bank and thrift insurance funds should be 
merged. A larger combined insurance fund would have a greater 
ability to diversify its risks than either fund separately. A 
merger would underscore the fact that BIF and SAIF are already 
hybrid funds. Each one insures the deposits of commercial 
banks, savings banks, and savings associations.
    We have different views from the FDIC report in two areas. 
First, while we agree with the FDIC report on the conceptual 
appeal of risk-based premiums, at this stage we would give 
priority to reforms that would charge every institution a 
premium on current deposits that is relatively stable over 
time. We would defer development of a new risk-based premium 
structure, a process that promises to be complex and time 
consuming, for a later time.
    Second, and most importantly, we have a different view with 
respect to insurance coverage. We believe that the deposit 
insurance coverage level should remain unchanged. We see no 
clear evidence that the current limit on deposit insurance 
coverage is burdensome to consumers, nor do we see clear 
evidence that increasing coverage across the board would 
enhance competition for the banking industry. Moreover, an 
increase in the coverage level would increase risks to the FDIC 
and ultimately taxpayers. In other words, there would be little 
if any tangible benefit and definite risk and excess costs to 
the fund and ultimately taxpayers.
    Finally, two issues not addressed in the FDIC report should 
be considered. While we recommend that all institutions pay 
premiums assessed on current deposits, we also feel that it 
would be a missed opportunity not to consider what should 
constitute the assessment base. In particular, reform efforts 
should consider whether the existing assessment base should be 
modified to account for the effect of liability structure on 
FDIC's expected losses.
    Also, we support Comptroller Hawke's and Director Seidman's 
call for addressing the uneven distribution of supervision 
costs between national and State-chartered banks. We believe 
that the Office of the Comptroller of the Currency's proposal 
is an interesting approach that deserves further consideration, 
and there may be other approaches and considerations that 
should also be explored.
    We look forward to working with the incoming FDIC Chairman 
Powell and the FDIC Board to devise a solution to this problem.
    Thank you, Mr. Chairman, again for the opportunity to 
appear before you today, and I look forward to working with you 
in my new capacity.
    [The prepared statement of Hon. Sheila C. Bair can be found 
on page 50 in the appendix.]
    Chairman Bachus. We appreciate your testimony.
    Comptroller John Hawke.


    Mr. Hawke. Thank you, Chairman Bachus, Congresswoman Waters 
and Members of the subcommittee, I appreciate this opportunity 
to discuss reform of our Federal deposit insurance system. Too 
often, reform occurs against the backdrop of a crisis. 
Fortunately, we are not in that position today. The deposit 
insurance funds and the banking industry are strong. 
Nevertheless, the flaws in the current deposit insurance system 
pose an unnecessary risk to the stability of the banking system 
and so merit a careful and timely review by the Congress.
    Let me summarize our positions on the major issues that 
have been raised in connection with reform proposals. We think 
the Bank Insurance Fund and the Savings Association Insurance 
Fund should be merged. A merged fund would enable the FDIC to 
operate more efficiently and to realize the benefits of 
    Deposit insurance premiums should be more sensitive to 
    Chairman Bachus. Comptroller, several on the panel are 
having problems hearing you. I don't know whether that mike is 
on. If you'll just pull it closer. I think there's something 
wrong with the mike.
    Ms. Bair. Do you want to use mine?
    Chairman Bachus. If you can just substitute.
    Mr. Hawke. Thank you.
    Chairman Bachus. Oh, that's much better.
    Mr. Hawke. Saved by the Treasury Department once again.
    Mr. Hawke. Deposit insurance premiums should be more 
sensitive to risk. Today, 92 percent of all insured 
institutions pay no premiums, yet common experience, as well as 
the markets, tell us that these institutions have widely 
varying risk characteristics.
    The requirement that the premium for banks in the lowest 
risk category be set at zero whenever the insurance fund 
reserve ratio equals or exceeds 1.25 percent of insured 
deposits should, in our view, be eliminated. Furthermore, we 
believe that to compensate the Government for the benefits 
conferred by deposit insurance on all banks, even the least 
risky banks should pay some reasonable minimum insurance 
    We strongly support eliminating the current designated 
reserve ratio (DRR) of 1.25 percent of insured deposits. 
Instead, we favor empowering the FDIC to establish a range for 
the fund based on the FDIC's periodic evaluation of the risks 
borne by the fund and its assessment of potential losses. The 
FDIC should have the authority to pay rebates when the upper 
end of the range is exceeded and to impose surcharges when the 
ratio falls below the lower end of the range.
    We see no compelling case for an increase in deposit 
insurance coverage. There is no evidence that depositors are 
demanding increased coverage, nor is there a reliable basis for 
projecting whether an increase would bring new deposits into 
the system or simply result in a disruptive reshuffling of 
deposits among banks.
    There is one further set of issues that should be 
considered in the context of deposit insurance reform, in our 
view: the way the insurance fund is used, and should be used, 
to support the cost of bank supervision and the inequitable 
treatment of national banks in the way the BIF is currently 
used to pay the costs of supervision of State banks. These same 
issues apply to the way the SAIF fund is used with respect to 
thrift institutions.
    Under the current system, the FDIC draws on the insurance 
funds for about $600 million a year to fund the cost of its 
supervision of State non-member banks, that is, its costs of 
performing for State banks exactly those functions that the OCC 
performs for national banks. None of these costs are passed on 
to State banks in the form of direct assessments. By contrast, 
the OCC must charge national banks directly for the full cost 
of their supervision.
    This disparity is compounded by the fact that more than 
half of the funds spent by the FDIC for Federal supervision of 
State non-member banks are attributable directly to the 
accumulated contributions of national banks to the insurance 
fund. Thus, the earnings of a fund that has been built up by 
all banks finance the supervisory costs of only a portion of 
the banking industry. In other words, for every dollar that the 
FDIC spends on the supervision of State banks, national banks, 
by our estimates, effectively contribute about 55 cents. And, 
that is in addition to paying the full cost of their own 
supervision to the OCC.
    Fee disparity presents a constant incentive for national 
banks to convert to the heavily-subsidized State charter. And, 
that incentive can be strongest when the banking system is 
under stress and the OCC faces the need to expand its 
supervisory resources--and thus its assessments--to deal with 
an increased level of problem banks.
    A key principle at the heart of deposit insurance reform is 
that the premiums paid by individual institutions should be 
closely related to the expected costs they impose on the funds. 
The objective is to identify and eliminate subsidies in the 
current system that, among other things, result in healthy, 
well-managed banks bearing the costs and risks presented by 
less well-managed. riskier banks. Similarly, bank supervision 
should not be based on a system of subsidies--such as those 
embedded in the current deposit insurance system--that result 
in national banks paying a substantial portion of the FDIC's 
cost of supervising State banks, because one of the main 
purposes of bank supervision is to protect the insurance fund. 
Ensuring that supervision is funded in a fair and equitable 
manner is inextricably related to the subject of deposit 
insurance reform.
    Attached to my written testimony is a paper that discusses 
the disparity in funding supervision in greater detail and 
proposes a remedy. We believe it would make sense to extend the 
existing arrangement to cover the costs of both State and 
national bank supervision from the FDIC fund, just as the fund 
today is used to cover the FDIC's costs of supervision. In 
other words, instead of funding supervision through direct 
assessments on banks, we propose that it be funded by payments 
to supervisors from the insurance fund, to which all banks 
contribute. This would ensure that all supervisors have access 
to the resources needed to deal with stresses in the system and 
could eliminate the perverse situation we have today in which 
our resources can be significantly depleted at the very time 
when the heaviest supervisory demands may be placed on us.
    Thank you, Mr. Chairman.
    [The prepared statement of Hon. John D. Hawke Jr. can be 
found on page 59 in the appendix.]
    Chairman Bachus. Thank you.
    Director Ellen Seidman.


    Ms. Seidman. Thank you. Good morning, Chairman Bachus, 
Ranking Member Waters, and Members of the subcommittee. Thank 
you for the opportunity to testify about Federal deposit 
insurance reform.
    Over the past several years, those of us who have worked 
closely with the deposit insurance system have come to realize 
that while it is very important to serve the American people 
well, it is not optimal. Several areas are in need of reform if 
the system is to continue to serve the American people.
    The current economic period, with few failures and adequate 
reserves, provides a perfect opportunity to improve the system. 
The FDIC has done a fine job of both laying out the areas in 
which the system needs improvement and suggesting possible 
solutions. Nevertheless, I believe there are some refinements 
in thinking about risk parameters that might usefully be added 
to the discussion. And there is one additional issue--how 
supervisory costs are paid for--that needs to be part of the 
discussion of deposit insurance reform.
    The FDIC has identified four areas of weakness in the 
Federal deposit insurance system: Maintenance of two separate 
funds that provide identical insurance; inadequate pricing of 
insurance risks, which distorts incentives and increases moral 
hazard; excessive premium volatility and a tendency for 
premiums to increase in economic downturns; and coverage levels 
that do not adjust on a regular basis.
    On the first point, the FDIC recommends merging the funds. 
We agree. There are still very real differences between the 
operations of banks and thrifts, who remain overwhelmingly 
residential mortgage lenders. Nevertheless, experience since 
the BIF and SAIF were established in 1989 argues strongly in 
favor of fund merger. Because, while the differences between 
banks and thrifts remain, those between the BIF and the SAIF 
have become increasingly artificial and tenuous.
    The two funds no longer insure distinct types of 
institutions, with many banks and thrifts holding deposits 
insured by both funds. The funds provide identical products. 
Yet keeping them separate raises the possibility of premium 
differentials that could handicap institutions that happen to 
be insured by the fund that charges the higher premiums.
    Industry consolidation has also increased the funds' 
exposure to their largest institutions. Merging the funds will 
alleviate these problems and strengthen the entire system by 
diversifying risks and eliminating the possibility of fund 
premium differentials.
    To address the inadequate pricing of insurance risks, the 
FDIC recommends implementing a system of risk-based premiums 
under which all institutions would be required to pay annually 
for the cost of insurance. I believe this is an extremely 
important part of comprehensive reform. Deposit insurance is a 
valuable good to institutions as well as to depositors. And 
like all casualty insurance, it should be paid for even if the 
eventuality insured against does not arise.
    The most glaring problem in our current system is that it 
provides free deposit insurance coverage to the vast majority 
of institutions. Risk-based premiums would provide risk 
management incentives to institutions and allocate insurance 
costs based on the individual institution's risk profile. The 
system that prices appropriately would reward those who 
minimize fund exposure, but not impose too great a cost on 
those with a more aggressive, but still not unreasonable risk 
    Implementing an effective risk-based system will entail 
enhancing the current risk groupings for insured institutions. 
The FDIC's proposed scorecard is an attractive approach for 
refining existing risk groupings. The approach permits the 
incorporation of information beyond the prompt-corrective 
action (PCA) category and safety and soundness ratings into the 
risk classifications. This is increasingly important as non-
traditional activities and funding, including asset 
securitization and collateralized funding sources, play a 
greater role in defining the relationship between deposits and 
the risk of loss to the fund.
    While the FDIC's approach is a good start, my experience 
over the past several years leads me to be interested in an 
enhancement that would focus on whether an institution, 
particularly a larger institution, presents a heightened risk 
of sudden failure. Sudden failure presents a problem that often 
frustrates the use of supervisory tools. A sudden failure can 
put maximum pressure not only on the deposit insurance fund, 
but also on the financial system as a whole.
    One way to address this issue would be to identify indicia 
of high risk for sudden failure and charge higher premiums for 
those who present such risks. This could help discourage such 
risks as well as shift the costs of sudden failure risks to 
those who take them.
    The current pricing structure, which restricts how the FDIC 
sets fund targets and insurance premiums, also tends to promote 
premium volatility and make the system procyclical. In good 
times, the FDIC levies no premiums on most institutions. When 
the system is under stress projected to last more than a year, 
the FDIC is required to charge high premiums, which can 
exacerbate problems at weak institutions and reduce lending at 
sound ones.
    Increasing the FDIC's flexibility to set fund targets and 
premiums would reduce premium volatility and institutions' 
exposure to overall economic conditions and to sectoral 
industry problems. Authorizing the FDIC to rebate excess funds 
is also an important element of an effective risk-based pricing 
system, as it allows the FDIC to charge premiums to all 
institutions at all times, but also avoids the possibility of 
the fund building to an excessive level.
    I believe the most important point in addressing the issue 
of raising or indexing deposit insurance coverage levels is not 
whether it should be done, but how and when. Improved risk-
based pricing and other reforms should be regarded as 
preconditions to even considering any action to raise or index 
the deposit insurance ceiling. Optimally, any action to 
increase deposit insurance coverage levels would be considered 
only as a part of the comprehensive deposit insurance reform 
    The final point I want to address is the importance of 
allocating costs within the insurance system based on a 
structure that preserves the integrity of the system's pricing 
mechanism. Currently more than 40 percent of the FDIC's 
operating budget, which comes from the insurance funds, is used 
to pay for the supervisory costs relating solely to the FDIC's 
role as primary Federal regulator of State non-member banks. 
This is particularly ironic as premiums paid by OTS and OCC-
supervised institutions and the earnings on those premiums 
account for the bulk of the current balance of the insurance 
    Whether the costs of day-to-day bank supervision should be 
paid from the insurance funds can certainly be debated. 
However, I think there are really only two logical conclusions. 
Either all bank supervision is an insurance function for all 
charters, in which case all supervisory costs, Federal and 
State, should be paid from the insurance funds, or it is not. 
And if it is not, the only costs of supervision that should be 
paid from the insurance funds are the often considerable costs 
that arise when there is a higher risk of failure. And in such 
cases, again, all supervisory costs, not just those of the 
FDIC, should be paid from the insurance fund.
    Since the issue affects the proper pricing of insurance, it 
is an integral element in getting deposit insurance reform 
    I thank you for this opportunity to testify on the subject 
of Federal deposit insurance reform. As you know, this may be 
my last opportunity to testify before this subcommittee. I want 
to thank each and every one of you for the opportunity to work 
with you over the past 3\1/2\ years. I've enjoyed my time as 
OTS Director, and I appreciate having had the opportunity to 
meet individually with many of you to discuss some of the 
issues facing the thrift industry, OTS, and the financial 
system as a whole. Thank you very much.
    [The prepared statement of Hon. Ellen Seidman can be found 
on page 86 in the appendix.]
    Chairman Bachus. Thank you.
    We certainly appreciate the testimony of all our witnesses. 
Let me read back over just a portion of Governor Meyer's 
testimony. And I'd like maybe a comment on this issue. You 
said: ``At the end of last year, 92 percent of banks and 
thrifts were paying no premium. Included in this group were 
banks that have never paid any premium for their, in some cases 
substantial, coverage and fast-growing entities whose past 
premiums were extraordinarily small relative to their current 
coverage. We believe that these anomalies were never intended 
by the framers of the Deposit Insurance Fund Act of 1996 and 
should be addressed by the Congress.''
    What are your suggestions for Congress addressing this 
    Mr. Meyer. I think that, first of all, all banks should 
have to pay a premium, as opposed to now, where we have 92 
percent of banks paying zero premium. And the way this is 
accomplished in the FDIC proposal is to have a range, rather 
than a point. And as long as the fund was within that range, 
the premiums are stable and all the banks are paying.
    If the reserves would go above the upper end, then there 
would be a flexible approach to gradually returning the funds 
to within that range by rebates. But those rebates would be 
small enough so that the banks would generally still be paying 
some premium, and we would be having both risk-based premiums 
and never having a zero cost for the Federal guarantee.
    Chairman Bachus. Thank you.
    OK, Assistant Secretary.
    Ms. Bair. We would certainly agree that the current 
statutory restriction on the FDIC's inability to charge 
premiums to well-capitalized banks that have a high CAMEL 
rating be eliminated. All banks pose some risk to the fund. All 
banks derive a benefit from deposit insurance, and all banks 
should pay a premium.
    Chairman Bachus. Comptroller Hawke.
    Mr. Hawke. I would just note, Mr. Chairman, that the so-
called ``free rider'' problem that you're alluding to of banks 
getting the benefit of deposit insurance despite never having 
paid into the fund is kind of a slippery issue to deal with. 
Banks that have paid into the fund over the years have had the 
benefit of deposit insurance in return. It is a little bit like 
a term life insurance policy, though, where once the policy 
comes to an end, you generally have to pay more premium. So, 
any bank that has increased its deposits at a time when it 
isn't paying any premiums is, in a sense, getting a free ride.
    I think the real problem here is not the free ride. It's 
the fact that we have a hard-wired designated reserve ratio of 
1.25 percent that really aggravates the problem. Banks that 
have paid in over the years see the potential for dilution of 
the fund down below that reserve ratio, with the consequent 
imposition of costs on them, and they understandably are 
concerned about that. We would prefer to see the 1.25 ratio 
eliminated and instead have the FDIC set a range for the fund, 
which I think would mitigate to a great extent the concerns 
about free riders. Of course, that should be combined with a 
new approach to premium setting and a basic minimum premium for 
the benefit of deposit insurance.
    Chairman Bachus. Director Seidman.
    Ms. Seidman. I think substantively, everything has been 
said. I would like to say that this is a very good example of 
how everything is interconnected. For example, simply removing 
the restriction that the 1996 Act put on the FDIC's ability to 
charge premiums when the fund is at 1.25 percent will generate 
new problems, and in particular, could generate very fast fund 
    So I think that it really is a good example of the 
interconnectedness of the whole system.
    Chairman Bachus. The subcommittee assembled at least one 
estimate of the cost of the premiums. I almost hesitate to use 
this figure, but I'm going to throw it out--$65 billion of 
premiums. When I first saw that, I questioned it. I sent it 
back and said, this can't be right. But apparently, that would 
be the cost of tripping that 1.25. But, do you have a comment? 
Have the agencies looked at the actual cost?
    Ms. Seidman. Let me just say that I was surprised when I 
saw that number also and traced it back to what, I think, was 
to some extent a piece of rhetoric in the FDIC's original 
options paper. It is a calculation that starts with the fund 
ratio not only falling down below 1.25, but falling low enough 
for long enough that the trigger that says you have to do 23 
basis points would come into play. As you know, if, for 
example, the fund goes down to 1.22, that trigger will probably 
not come into play. You'll be able to have a much smaller 
premium amount that will bring it back to 1.25 within a year.
    So first it assumes that it falls low enough for long 
enough so that the projection is you can't bring it back within 
a year at anything less than 23 basis points. The 23 basis 
points generates about $7 billion in premiums. And the theory 
is that that full $7 billion would then, with a multiplier 
effect, result in $65 billion less lending.
    Well, the problem is that the full multiplier effect is 
also subject to a lot of questions. First of all, it is quite 
clear that any number of banks would react to having to pay 
greater premiums the way they react to any increase in cost--
they reduce other costs, they reduce dividends, they do 
something other than reduce lending. Second, the multiplier is 
largely an effect of the capital of the bank. In the current 
situation, many banks are heavily overcapitalized, and it is 
therefore unclear that the full multiplier would apply in any 
event. And third, banks might take the premium increase out of 
some other part of their operations, not lending.
    So, I think it is a number that got thrown out there. It's 
a very big number. It's a very scary number. I think it's one 
of these numbers where a whole chain of very bad things all 
have to occur for it to really be true. But I do think, again, 
it is a reason for us to think about the kind of structure 
we've created and to recognize that while $65 billion may not 
be the number, it is likely that some decline in lending would 
indeed, occur.
    Chairman Bachus. I appreciate that. Let me compliment you 
on that answer. Does any other panelist wish to comment?
    Ms. Bair. I would just say whatever the right number is, we 
need to get rid of the 23 basis point cliff. I think that's the 
important thing, especially for small banks. You'd be taking 
tremendous amounts of capital out to rebuild the fund, probably 
in an economic downturn, which is the worst possible time to be 
taking the money out. So I think, again, I would agree with 
Ellen, whatever the right number is, we need to get rid of that 
    Chairman Bachus. All right. Because I think we know that 
these deposits are fleeing the stock market on a downturn and 
they're going back to deposits. So it would occur in all 
likelihood during a downdraft in the economy.
    Governor Meyer.
    Mr. Meyer. I certainly agree that we should get rid of the 
cliff. We don't want to extend that argument and say, 
therefore, banks shouldn't have to pay for deposit insurance.
    Chairman Bachus. Thank you.
    The Ranking Member is recognized.
    Ms. Waters. Thank you very much. I too, would like to thank 
our panelists today for sharing with us the information they 
have shared relative to reform of Federal deposit insurance.
    I'd like to know what risk factors do you believe should be 
used in determining risk-based premiums. I'd like you to be as 
specific as you can be. I'd like to know what factors should be 
accorded the most weight in determining deposit insurance 
rates. And would you consider certain activities to be part of 
that risk calculation? What behaviors would you seek to 
discourage by classifying them as risks? And if you don't mind, 
I'd like you to discuss this in relationship to the expanded 
activities of financial institutions, such as proposed real 
estate brokerage and management. I'll start with the Honorable 
John Hawke.
    Mr. Hawke. Thank you, Congresswoman Waters. I think your 
question shows how complex the issue of setting truly risk-
related deposit insurance premiums is. A risk-related premium 
system that is really prospective would have to get into 
enormous detail, looking at the quality and risk presented by 
different kinds of assets. That is one of the reasons we think 
that what's really needed here is a better tuning of the 
existing system, which is essentially based on a matrix that 
takes into account the CAMEL rating of the institution and the 
capital adequacy level of the institution. It is risk-related, 
but it's not prospective in nature the way I think you were 
suggesting it might be done.
    The real problem with the risk relationship in the present 
system is that the matrix is too coarse. It treats 92 percent 
of the banks as presenting an equivalent risk to the fund when 
we know, and the market tells us, that there are very 
significant variations in the risks presented by those banks.
    So we are not proposing that the FDIC attempt to create a 
very finely tuned, forward-looking mechanism for determining 
risk, for example, along the lines of what the Basel Committee 
is presently considering, which is enormously complicated, and 
looks at the prospective risks, the expected loss and 
unexpected loss that attach to different types of assets.
    Ms. Waters. I'd like to hear from Assistant Secretary Bair 
on that question.
    Ms. Bair. Thank you, Congresswoman. The Treasury Department 
has a slightly different view on the necessity for extending 
risk-based premiums at this time.
    We believe that that process, though in an ideal world, 
would have premiums that accurately reflect the risk that the 
institution posed to the fund. In practice, developing complex 
risk-based premium matrices is quite difficult and we think 
promises to be quite time consuming.
    We believe it's more important to, again, as I said, get 
rid of the cliff for those 92 percent of the banks that 
currently are paying no premiums. They should start to pay some 
premium, a small premium that would remain constant over time 
to gradually build up the fund to some range that needs to be 
determined in lieu of the 1.25 DRR, but save for a later day, 
really extending dramatically the risk-based structure that we 
currently have. Because we just think, though again it sounds 
like a nice idea, in practice it could be quite complicated and 
bog down the urgency of other reforms.
    Ms. Waters. How would you calculate any premiums? How would 
you do that? How would you determine the premium for any given 
    Ms. Bair. I think that's a difficult job. The FDIC sets out 
some criteria. It leaves several issues open. If you read 
Director Seidman's testimony, if you read Governor Meyer's 
testimony, they have a little different approach on some of 
these issues.
    Another problem, I think, is to come up with a matrix that 
would accurately assess risk for each institution, the spread 
among premiums that would accurately reflect risk may be so 
wide as to be politically impractical, and that is acknowledged 
in the FDIC study, that for some reason the premiums would be 
so high that they would cap it. The Fed may have a different 
view. That's just one of many issues, I think, which would need 
to be worked out if we're going to extend risk-based premiums, 
which is why we're saying hold that for a later time.
    Ms. Waters. Mr. Meyer.
    Mr. Meyer. Thank you. We do support a risk-based pricing 
structure, and we recognize that it would be a challenging 
task, but we believe that the FDIC is pointed in a reasonable 
direction. They've identified three kinds of information that 
could be used to differentiate the risk across banks. One they 
call objective factors, the second, supervisory information, 
and the third, market signals.
    In objective factors, we could use such information as the 
amount of capital that the bank has relative to their assets, 
their net income relative to assets, because earnings are the 
first cushion if there are problems in the loan portfolio, the 
amount of non-performing loans relative to assets that indicate 
the risk exposure in the current portfolio, the amount of 
liquid assets relative to assets, because liquidity is also a 
very important factor in problems, and the degree of asset 
growth, because there is a correlation between very rapidly 
growing banking organizations and risks.
    And then, in terms of market information, when available--
and for the larger banks, this information is available--we 
have information coming from subordinated debt spreads and 
information that can be gleaned from equity prices about the 
probability of default for the bank.
    Now, this information can be used to separate the banks 
into risk class. Once you identify the different risk classes, 
you would use information the FDIC suggested on the historical 
pattern of losses within each group to identify the premiums 
that would just, on average, pay for those losses over, they 
suggested, a 5-year period.
    So I think this is a very reasonable methodology. I think 
it's a challenging one. I think it can be refined over time. 
But I think we have a good direction to move in here.
    Ms. Waters. Thank you very much.
    I would also like to hear from Director Seidman on this 
question. But I'd also like to ask you to add a little 
something and discuss it in relationship to small banks. And if 
you use the general kind of criteria that was just described, 
would this not disadvantage small banks, small financial 
    Ms. Seidman. Could I add something about large banks first?
    Ms. Waters. Yes, of course.
    Ms. Seidman. Let me just say that we not only have the 
example in the FDIC options paper, our neighbors to the North 
have done a rather good job of this. This does not have to be 
as enormously complicated, as Comptroller Hawke has said, as 
the Basel proposal.
    I would suggest that the concentration of activities is an 
area the Canadians take into account that is not mentioned in 
the FDIC matrix, and it's one that I would think would be quite 
    Now, with respect to small versus large institutions, I'm 
not sure how it cuts precisely. I realize that there are 
certain issues like the extent to which small institutions, 
particularly small institutions down the midsection of the 
country, are fully lent up, that would make them come out worse 
on the FDIC's matrix. On the other hand, other small 
institutions, particularly on the coasts, have a tendency, in 
fact, to have very high amounts of deposits and less reliance 
on non-deposit funds and fewer problem assets, and things like 
that, than large institutions. So I'm not sure it's purely a 
small versus large issue. I think it's worth running the 
numbers and seeing how they come out and seeing whether when 
you do get the answer it looks right. That's always an 
important thing to do when you're doing detailed mathematical 
    But the lending up problem, I think, is the one that 
everyone is focused on. It is a serious issue in the midsection 
of the country for small institutions, and I think it's worth 
taking a look at.
    Ms. Waters. Mr. Chairman, if I may just get another minute 
here. The S&L scandals have led us to understand what happens 
when institutions get away from the concentration of 
activities, kind of the terminology you used, their basic core 
activities. We're looking now at institutions that may be 
delving into all kinds of commercial activity. Doesn't this 
make it extremely difficult to do the kind of assessments to 
determine the risk that we would like to know about in order to 
develop pricing for the premiums?
    Ms. Seidman. Because you mentioned the S&L situation, I 
guess I have to take the first answer here, but then I'm going 
to leave it to my colleagues to finish up. I think we're 
talking about concentration in two somewhat different ways. 
There's no doubt but that a significant portion of what 
happened at the beginning of the 1980s with respect to the S&Ls 
was that they went beyond what they had traditionally done.
    On the other hand, they went beyond what they had 
traditionally done in an era of a good deal less supervision, 
when they were trying to fight a very bad interest rate risk 
problem that was causing them to want to bet the farm in ways 
that they should never have been allowed to do. The ones that 
stuck to their knitting, that stuck to the residential mortgage 
lending that they had always done, in general, came through it. 
At least where they didn't have a massive real estate bubble to 
deal with, they came through it OK.
    However, some diversification of activities is definitely a 
good idea. A diversified portfolio, as Governor Meyer pointed 
out, is the traditional recommendation about how you reduce 
risk. It is important, however, to diversify into activities 
that you know how to do, and to do them well, and to monitor 
them thoroughly, and to make sure you have the systems that 
support them.
    Chairman Bachus. Thank you.
    Mr. Bereuter.
    Mr. Bereuter. Thank you, Mr. Chairman. I'd like to, of 
course, add my welcome to the panel today. I think I must share 
some of the concerns the gentlelady from California has from 
her comments about small banks. It seems you agree that you 
don't like the statutory restrictions on premiums imposed in 
1996. You're not interested in increasing the deposit coverage, 
and you want to merge the BIF and the SAIF. But I think, if I 
may say so, you're not very explicit about giving us a good 
rationale for doing those things.
    I also had the view that ``free rider'' is an interesting, 
and sort of negative, term to use, which might not be 
altogether appropriate.
    Governor Meyer, may I start with you and talk about your 
opposition to the 1996 statutory restrictions on premiums? As 
you know, in that legislation, which Congressman Vento and I 
had something to do with that limitation, you indicate the two 
variables--capital strength and examiner overall rating--do not 
capture all the risks that banks and thrifts could create for 
the insurer. The Board believes that FDIC should be free to 
establish risk categories based on well-researched economic 
variables and to impose premiums commensurate.
    But ``well-researched economic variables'' is a very vague 
term. I'm very hesitant to extract very large amounts of money 
out of the economy that is available for lending in our 
institutions. And I'm very concerned about keeping our 
commercial banks competitive with other kinds of financial 
institutions. Can you be a little more explicit in your 
opposition to the current 1996 Act's limitation on premiums?
    Mr. Meyer. Maybe the way to think about this is to make a 
contrast with what Congress did in 1991, when it passed the 
Federal Deposit Insurance Corporation Improvement Act (FDICIA), 
and what it did in 1996, because in 1991, Congress passed a 
bill that mandated that the FDIC implement a risk-based 
structure of premiums.
    Now what's valuable about such a system is, it's more 
equitable, because then, safer banks are not subsidizing 
riskier banks as they are when everybody pays the same premium, 
and it avoids the problem with the zero premium giving away the 
Government guarantee. Everybody should pay an appropriate 
amount related to their risk for the insurance coverage.
    Mr. Bereuter. Why should every bank pay some? The least 
risky, why should they?
    Mr. Meyer. Because every bank, no matter what their risk 
is, imposes some risk to the fund, and therefore should pay 
some premium. It should pay a lower premium when it imposes 
very little risk, and it should pay a higher premium when it 
imposes more risk, and it should pay a considerably higher 
premium when it imposes a considerably higher risk. That's the 
    Now I understand the intent of the 1996 Act. The problem 
with FDICIA was that it set a designated reserve ratio, but 
then the question is, what happens if the fund rises above that 
reserve ratio? Should there be any limit to the fund?
    Mr. Bereuter. We made the assessment, Mr. Governor, that 
when you have capital strength and you have examiner overall 
ratings that are very good, that these banks therefore do not 
impose a high risk on the insurance fund. And we're just 
basically saying this is a category. Yes, we can believe in 
risk assessment and properly adjusted premiums, but by these 
two measures, the risk is so small that these banks ought not 
be assessed a premium at all.
    Mr. Meyer. That would be the view that there is no 
difference in the risk across those banks. We believe there is 
a difference in the risks across those banks. We believe even 
the safest banks impose some risk, and that's really what the 
issues are, I believe.
    Mr. Bereuter. I'll move to Secretary Bair and ask with 
respect to deposit insurance coverage, you say: ``It is not 
surprising, therefore, that we found no evidence of consumers 
expressing concerns about the existing deposit insurance 
limits.'' And I would just suggest that's not the relevant 
factor. Consumers can find other places to take their deposits. 
What the concern is that we see, because of the limits which 
have not been adjusted for quite some period of time, can go 
back to one of two dates, appropriately, that they are finding 
other places for their money, typically outside the community 
where the deposits are generated. At least that's the 
experience in my own State.
    And whether consumers can find a place or not is not really 
the relevant question. The relevant question is, is it 
inappropriate to adjust the levels so that these commercial 
banks can be competitive with other financial services 
institutions and whether or not you are in the process by not 
adjusting the limit, forcing money out of those communities 
that should be available for lending in those communities?
    And relatedly, I would ask you your views on whether or not 
there should be some change in requirements with respect to 
municipal or other political subdivision deposits, because that 
is particularly sensitive to small communities when they see 
that those funds are necessarily leaving the community when 
there is perhaps only one or two commercial banks in that 
particular community or region.
    Ms. Bair. There are many components to your question. One 
consistent theme in your question is the thought that funds are 
flowing out of community banks, because of the coverage limit, 
and I guess that's where we'll have to agree to disagree. We 
don't see evidence that that's the case that the coverage limit 
has anything to do with it. To the extent that it's happening, 
higher yields may be driving that dynamic.
    Number two is, as the Fed points out in its testimony and 
Governor Meyer in his oral statement as well, small banks are 
highly competitive right now. They are getting insured deposits 
and uninsured deposits. The number of uninsured depositors is 
only 2 percent of the universe of depositors, so presumably 
it's only those 2 percent that would benefit immediately from a 
rise in the coverage limit. Those people--they are higher 
income folks, there is no evidence that they are concerned that 
some measure of their deposits in federally-regulated banks is 
uninsured. To the extent we're dealing with those 2 percent, 
you're dealing with the higher income levels. The income level 
for that 2 percent is double the median income for those whose 
deposits are completely insured by the $100,000 limit.
    Again, to the extent people are uncomfortable with having 
uninsured deposits, there are so many ways to address this. You 
can go to multiple banks. You can open up multiple accounts in 
different legal capacities at the same bank.
    For all those reasons, Congressman, we just don't see a 
clear case has presented that this is going to help. I will say 
our door is open. We are happy to discuss this. I'm happy to 
discuss this further with you. Any additional data you may 
have, I'm happy to take a look at. But based on what has been 
presented to us at this point, we just don't see a convincing 
case has been made.
    Mr. Bereuter. Mr. Chairman, I know my time has expired. But 
I would just say the experience I have in visiting with the 
bankers in my district and to consumers and to depositors is 
not the same that you suggest. These consumers, these 
depositors are very smart, and they're taking their money out, 
and they're very risk-averse. And so if it's not covered beyond 
$100,000, they're taking it outside the area.
    Chairman Bachus. We appreciate that, Mr. Bereuter.
    Mrs. Maloney.
    Mrs. Maloney. I thank you, Mr. Chairman, and thank all of 
the panelists for joining the subcommittee today. I 
particularly want to mention Ellen Seidman's fine service to 
the country. This will probably be our last opportunity to hear 
your testimony. Personally, I regret that you are not allowed 
to fulfill your entire term. But believe me, we all appreciate 
your fine service.
    I believe ensuring the future safety and soundness of the 
banking system and the health of the insurance funds is the 
most important responsibility of this subcommittee. And I 
deeply believe that we all owe outgoing FDIC Chairwoman Tanoue 
a debt for beginning the debate on deposit insurance reform.
    I am, however, concerned that the FDIC proposal would lead 
to additional premiums on banks. Any additional premium, we all 
know, would have a direct impact on the amount of loans that 
institutions can make in all of our communities. Given the 
relative health of the banking industry and the prospect of a 
strengthened merged insurance fund, why should Congress 
consider raising deposit insurance premiums? I'd just like to 
ask all the panelists.
    Mr. Meyer. I think we have indicated that we think that 
insurance should not be priced at zero. Every bank poses a 
risk, riskier banks pose more risks. Every bank should pay for 
its insurance in relationship to the amount of risk that it 
implies for the fund.
    Now I think all industries would appreciate being 
subsidized, and all industries would be larger if they're 
subsidized. But we think that it is more equitable and it is 
more efficient that banks pay for insurance according to risk 
and that that behavior is a factor that helps to control the 
risk-taking of those institutions. If you support and want a 
safe and sound banking system, a risk-based structure of the 
premiums is a very important component of a program that 
supports that safety and soundness.
    Mrs. Maloney. Would you like to comment? Go right ahead.
    Ms. Bair. I would just say, to me the question is not so 
much whether, but when, they will have to pay. I think now you 
have a situation where 92 percent of all banks pay no premiums. 
But, as the Chairman pointed out in his opening remarks and his 
later follow-up questions, if we fall below that 1.25 percent, 
and it looks like we're going to be there beyond a year, 
there's going to be a 23 basis point cliff that's going to hit 
all banks square in the face, and at that point, they are going 
to be paying. You're going to be taking significant amounts of 
capital out of those banks and sending it to Washington to 
replenish the fund.
    We believe that system should be replaced with a system 
where you have a wide range as opposed to a DRR, small basis 
point premiums for all banks, gradually build up the fund to 
whatever that higher range should be with a system of rebates 
once you pass that higher range. And through that you will ease 
out the potential volatilities that you have with the current 
system where you go from paying no premiums to paying a really 
whopping sum.
    So I don't think it's a question of whether. I would like 
to say the fund is never going to fall below 1.25, but we all 
realistically know that we're running a danger here, and I 
think the question is whether we want a system where you have a 
cliff or whether you have a smoothing out of premiums over 
    Mrs. Maloney. Thank you.
    Mr. Hawke, in your testimony you have this report on 
reforming the funding of bank supervision. And you've mentioned 
in your testimony, and you've mentioned to me and others, your 
concern about the disparity in the cost of bank regulation 
between the State and national banks. Could you comment on the 
impact this has had on the State and national charters and on 
deposit insurance reform?
    And I must say that a number of colleagues and 
professionals in the industry have mentioned that reforming the 
funding of bank supervision should not be part of this debate 
or this particular bill. And if you believe it should be part 
of this debate and this particular bill, why do you believe it 
should be part of it?
    Mr. Hawke. Thank you, Congresswoman Maloney, for allowing 
me to address that issue.
    First of all, the basic problem is that there is a very 
significant disparity in what State and national banks pay 
today. The average $500-million national bank will pay about 
$113,000 in assessments, while a comparably sized State-
chartered bank in an average State that has strong supervision 
would pay only $43,000. That presents a constant incentive for 
national banks to consider converting to a State charter, and 
we see it all the time.
    We calculate that over the last year-and-a-half or two 
years, about $60 billion in assets have left the national 
banking system for State charters, motivated solely, or 
virtually entirely, by that cost saving. And that cost saving 
is attributable only to the fact that the FDIC and the Federal 
Reserve absorbed the cost of their supervision of State-
chartered banks while national banks have to pay the entire 
cost. Only a fraction of the cost of State bank supervision is 
recovered from State banks, whereas virtually the entire cost 
of national bank supervision is recovered directly from 
national banks.
    We think this is an issue that's integrally related to 
deposit insurance reform for a couple of reasons. First, it 
relates to what the optimum size of the fund should be. You 
can't, it seems to me, consider what the size of the fund 
should be without taking into account the fact that, at the 
present time, the FDIC takes about $600 million a year out of 
the fund to cover the cost of its supervision of State-
chartered banks. That has a direct relationship to what the 
size of the fund is or should be.
    Second, it relates to rebates. Today, national banks, in 
effect, pay 55 cents of every dollar that the FDIC spends on 
State bank supervision. If there are going to be refunds or 
rebates from the fund, we think that the inequity of national 
banks contributing to the cost of State bank supervision should 
be addressed; national banks should get rebates that make them 
whole, in effect, for their contribution to the subsidization 
of State-chartered banks, before rebates are paid to other 
    So I think these are issues that are integrally related to 
deposit insurance reform. One of the general principles 
underlying deposit insurance reform is eliminating some of the 
cross subsidies that exist today in the deposit insurance 
system, and this inequity in funding is clearly in that 
    Mrs. Maloney. My time is up. Thank you, Mr. Chairman.
    Chairman Bachus. Ms. Hart.
    Ms. Hart. Thank you, Mr. Chairman.
    My first question actually is for the Assistant Secretary, 
Ms. Bair. In the testimony that you gave, you questioned 
whether or not the Federal Home Loan Bank advances should have 
priority over other bank liabilities in the event of a failure 
of a bank. Do you recommend that the subcommittee should change 
this? And if so, in what way? Should we prioritize differently 
or do something else that you might suggest?
    Ms. Bair. I don't think we suggest that the priorities 
should be eliminated. What we suggest is that those advances 
should be included in the assessment base so that they're 
reflected in the premiums that are charged the depository 
    Ms. Hart. So the current priorities, as far as you're 
    Ms. Bair. Well, as you know, the fact that the Federal Home 
Loan Banks have a priority claim over a bank's assets over the 
FDIC, then to the extent a bank increasingly relies on advances 
from the Federal Home Loan Bank in lieu of insured deposits, it 
is increasing risk to the fund.
    So we think some consideration should be made as to whether 
you include those advances in the assessment base that's used 
to calculate premiums, whereas now it's just insured deposits.
    Ms. Hart. OK. And this is just for the panel in general, 
actually especially probably for Treasury and maybe the Fed. We 
had an earlier hearing on the issue of Gramm-Leach-Bliley's 
opening up the financial services market and perhaps allowing 
banks to be involved in real estate brokerages. In light of 
that change, if you would see that as it seemed that day of the 
hearing, which is basically it should be wide open, would you 
think that there should be some change regarding FDIC and 
coverages or any other thing in the market that would change, 
because of that pretty significant, as I would see it, change 
in the responsibilities of those institutions?
    Mr. Meyer. I wouldn't see any necessary change there. We 
are talking about an agency activity, which in our view would 
be a relatively low-risk activity. So I wouldn't see that that 
would have any implications for Federal deposit reform.
    Ms. Bair. I have nothing to add to that other than I was 
just sworn in as the new Assistant Secretary for Financial 
Institutions at six o'clock last night in my new office, where 
there are stacks of boxes containing 32,000 letters on that 
particular rule proposal. So assuming it's going to take me a 
while to filter through those, obviously I can't comment on the 
rule, because it's pending, but certainly it's an agency 
activity, so at least on that particular issue, I wouldn't see 
that it would impose excess risks.
    Ms. Hart. One more just sort of to clarify a little bit. I 
understand it's not necessarily just an agency activity, 
however. It goes beyond that. Would it not give them also the 
power of management and other powers that I know some of them 
are currently involved in and would be actually responsible for 
in the liability arena?
    Mr. Meyer. Well, management, but not the ownership of the 
assets. And the real risks come when you own assets whose value 
is variable and where you're subject to loss. So, again, I 
don't think that either of those activities would involve the 
kinds of risks that would make a material difference in the 
assessment of what the overall size of the fund should be or 
what the risk-based premium should be.
    Ms. Hart. Does anybody else on the panel have an opinion on 
that one? Sure.
    Mr. Hawke. I would just add that one of the objectives of 
bank supervision today is to try to help banks diversify the 
sources of their revenue. Banks have traditionally been very 
heavily dependent on net interest spreads as their source of 
revenue. One of the motivating features behind Gramm-Leach-
Bliley was to help diversify revenue streams within the area of 
financial and financially-related activities, to the extent 
that that can be done in a safe and sound way. We think an 
agency activity that doesn't present risk to the bank, but 
helps diversify the bank's income stream works toward the 
reduction of overall risk.
    Ms. Hart. Anybody else? OK. Thank you. I yield back my 
time, Mr. Chairman.
    Chairman Bachus. Thank you.
    Mr. Watt.
    Mr. Watt. Thank you, Mr. Chairman.
    Chairman Bachus. You get an extra 20 seconds of her time.
    Mr. Watt. I appreciate that very much. There seems to be a 
substantial amount of agreement in your testimony, and I want 
to go to one area where there, I guess, potentially is some 
disagreement, and that's this question of how you fund 
supervision. I know Mr. Hawke's opinion on that. I have not 
heard Mr. Meyer express any opinion on it. And I'm wondering 
whether you have an opinion on it and if you would care to 
share it?
    Mr. Meyer. Thank you. I think that Comptroller Hawke has 
made a very good case that there are problems associated with 
the current funding arrangements for bank supervision 
specifically affecting the OCC and the OTS. And I think there 
are two elements here. The first is the funding arrangements 
where the funds depend upon examination fees that come from 
your assessment base. That funding is potentially unstable, 
because it depends upon charter choice decisions. And second, 
there's a disparity across the various banking agencies in 
terms of how supervision is funded.
    Having said that, our view would be that, notwithstanding 
the fact that there's some relation to the FDIC fund, it would 
be a mistake to try to tackle this issue as part of deposit 
reform. And the reason for that is that we have reservations 
about the specific solution. We agree that there is a problem. 
We agree that we ought to work to resolve that problem, but we 
have reservations about the particular solution that the 
Comptroller has suggested.
    Mr. Watt. OK. I got that. Let me put a slightly different 
spin on this since we're at the very beginning stage of 
starting to talk about a solution to this disparity and maybe 
make a slightly different view about this.
    It seems to me that one can make the argument that the 
deposit insurance fund is about premiums for insuring the 
$100,000 of deposits that we are, in fact, insuring. The 
question of supervision of banks is a separate issue which--and 
it seems to me, if we are taking the general supervision cost 
out of the fund, the insurance fund, which is designed to pay 
for losses up to $100,000, basically you have lower income, 
lower amount depositors paying the full cost of supervision for 
banks and higher income people and other activities that really 
have nothing to do with the insurance fund.
    So one approach to this might be to take all of the 
supervision out, both your supervision and the national banks' 
supervision, and to create a separate supervision fund so that 
lower-level depositors, people who are depositing $100,000 or 
less, are not really paying the cost of the overall supervision 
of everything that the bank is doing.
    Now maybe I could get your preliminary reaction. I know 
this is kind of a radical theory. But maybe you could give me 
your preliminary reactions to that. And then I'd like to hear 
from Mr. Hawke on the same question and Ms. Seidman on the same 
    Mr. Meyer. First of all, our supervision costs are not paid 
out of the FDIC fund. They're paid from our earnings on our 
portfolio of securities.
    But second, that approach still encounters the following 
problem: You have to come up with a mechanism for funding. If 
that mechanism is Federal funding----
    Mr. Watt. But it's not on the backs of $100,000-or-less 
    Mr. Meyer. Right. That's fair. But you have to come up with 
a mechanism, and you have to deal with--if it is going to be 
Federal financing--can you maintain the viability of the dual 
banking system and have Federal financing of State 
    Mr. Watt. Mr. Hawke.
    Mr. Hawke. Mr. Watt, the most straightforward way of 
dealing with this problem would, of course, be for the Federal 
Reserve and the FDIC to impose assessments for the cost of 
their supervision, just as we do with national banks. National 
banks pay us the entire cost of their supervision. State-
chartered banks only pay assessments to their State regulators, 
which really accounts for only a small portion of the cost of 
their supervision. The predominant component of the supervision 
of State-chartered banks comes from the FDIC and the Fed.
    So the problem is created by the fact that State-chartered 
banks are not charged by their Federal supervisors. Year after 
year, OMB has sent to the Hill a proposal to require the Fed 
and the FDIC to charge assessments for their supervision, but 
that's basically been dead on arrival.
    Mr. Watt. So what you're saying is actually consistent with 
what I'm saying?
    Mr. Hawke. Yes. The most desirable way to do it doesn't 
seem to be politically feasible.
    Mr. Watt. Ms. Seidman.
    Ms. Seidman. It is an intriguing proposal. I would like to 
point out that currently, $600 million a year is taken out of 
the insurance funds to supervise State non-member banks. So 
currently, we have exactly the situation that you're talking 
about. It's just that we only have it with respect to one kind 
of charter.
    Mr. Watt. Mr. Meyer said that wasn't the case, though.
    Ms. Seidman. It isn't for the Fed. It is for the FDIC. The 
Fed just takes it out of, in essence, general revenues. Now the 
issue of whether supervision is related to insurance is one 
that, I think, is critical.
    Mr. Watt. I acknowledge that there is some relation--don't 
get me wrong. I know there is some relation--supervision of the 
insurance costs something, but it doesn't cost the whole 
insurance package is the point I'm making.
    Ms. Seidman. And that's why I think that as long as we're 
putting alternatives on the table, you'll notice that in my 
testimony there's another alternative, which is, in essence, 
that as soon as we get banks that get into trouble, 3-rated 
banks and lower, that at that point, all the supervisory costs 
should come out of the insurance fund. Because there you can 
say we are really running a risk here. We're running an 
insurance risk that is really immediately quantifiable in a 
much bigger way than the risk of 1- and 2-rated banks, as to 
which the risk is more attenuated. I support the notion that 
insurance should not be free. But we're talking about 1 basis 
point premium ideas for top-rated banks. When you get to 3- and 
4- and 5-rated institutions, you're talking about a much more 
immediate kind of risk.
    And I will tell you as a bank supervisor, our job is to 
keep those banks out of the insurance fund.
    Mr. Watt. Thank you, Mr. Chairman.
    Chairman Bachus. Mr. Tiberi.
    Mr. Tiberi. A quick question for the Assistant Secretary. 
On page 4 of your testimony, you suggest that we examine the 
assessment base for the payment of deposit insurance premiums. 
Could you explain what you mean and give us suggestions?
    Ms. Bair. That was mainly a reference to Congresswoman 
Hart's earlier question about the increasing reliance that some 
banks are placing on secured liabilities and also, because 
Gramm-Leach-Bliley gave community banks the ability to get 
advances from the Federal Home Loan Banks, regardless of 
whether they're using the money for any activity, not just home 
mortgage financing. Because the secured liabilities take 
precedence, take priority over the FDIC's claims in the case of 
a bank failure, they're posing additional risk to the fund.
    So the question is whether the secured liability should be 
included in the assessment base, which would, by broadening the 
assessment base, also increase the premium for the particular 
 [The following information was provided at a later time by 
Hon. Sheila Bair:
 [As a matter of clarification, a broader assessment base may 
be accompanied by lower premium rates to achieve the desired 
revenue for FDIC. Thus, a bank's premium may or may not rise 
with a change in the base.]
    Chairman Bachus. All right. Thank you. Let me ask this 
question. We're just going to keep going and hope that people 
come back. You had a lot of questions about the small community 
banks. And the concern is that they will be able to generate 
deposits. One source of funding has been the Federal Home Loan 
Bank. Assistant Secretary Bair, you mentioned that funding from 
that source may create a special risk or reliance on that 
funding they have a preference in case of a failure. At the 
same time, where do they go to generate deposits or funding? 
And that is one of the places they're going. But where do they 
go for growth?
    And I would like you to--maybe all of you ought to 
consider--and the small banks are telling us in this equation 
that they want an increase in deposit insurance. That is where 
they feel like the growth can be.
    Two other areas that they've suggested to us are municipal 
deposits and IRA or retirement accounts. Now let me say on 
municipal deposits that I don't think that's just speculation 
on their part. What we're talking about, and Governor Meyer, 
you talked about the whole universe of smaller or newer 
institutions, some of these institutions are in big cities. But 
when we talk about the institutions in the small towns, I doubt 
if you took those out of the universe that you came up with the 
growth of 12 or 13 percent, I'm not sure that that would be 
true. Because I think when you have a rural county with one 
hometown bank or one bank in the county, or in the county seat, 
that those banks are not tending to grow.
    This is a long question, but you can have a long answer. 
One possible suggestion concerns municipal deposits, because of 
the collateral requirement. And I can tell you that school 
boards, county school boards, city governments are saying we 
would like to do business with our only hometown bank, but we 
really are limited by insurance coverage. The State of 
Massachusetts, particularly, has a State program where they can 
buy additional insurance to cover municipal deposits. And I 
don't know whether it's just to increase their coverage. I'd 
just like your comments on what we could do to benefit these 
    Mr. Meyer. I think the first thing to do is let's not try 
to solve a problem that doesn't exist. You focus on an 
important area that many people are talking about of whether 
small banks are under competitive pressure and they can't fund 
their assets. So let's look at some of the facts: 1995 to 2000, 
insured deposit growth, how fast was it? 9.6 percent a year. 
Let's compare that to the largest banks. These are the small 
banks, 1,000 and below, OK? These are relatively small 
institutions. The 100 largest banks had average deposit growth 
of less than one-half a percentage point.
    Chairman Bachus. Let me interrupt you and just ask you, did 
you break that out into rural banks?
    Mr. Meyer. I didn't. These are small banks. We could look 
further at that. But if you say that there's a problem, what's 
the problem? Their insured deposits were growing at 9.6 
percent, but their assets were growing at 13 percent, OK? 
That's more than twice as fast, or about twice as fast, as 
larger banks were growing adjusted for mergers.
    So the problem--and we don't think this is a problem--is 
that small banks are growing very rapidly, and they're not able 
to fund all of that rapid growth from insured deposits. So what 
are they doing? That's the legitimate question. Well, they're 
funding a lot of it from uninsured deposits. How fast were they 
growing? At a 20.5 percent annual rate, again, twice as fast as 
they were growing at large banks.
    So now, the final analysis is that these small banks were 
funding almost 85 percent of their assets from their deposits, 
insured and uninsured deposits. But their amount of funding 
from total deposits did go down a little bit, 2 percentage 
points over this period, and that was made up by Federal Home 
Loan Bank advances. That's what filled the gap.
    Chairman Bachus. All right.
    Mr. Meyer. But, we just don't see that there's a problem to 
be solved here.
    Chairman Bachus. All right. I understand. Now you would be 
willing maybe to revisit that and see whether we're talking 
about urban institutions or----
    Mr. Meyer. It's a very good question, and I'll see what we 
can do to come up with some data there.
    Chairman Bachus. Madam Assistant Secretary.
    Ms. Bair. Well, we consider our primary role in this debate 
is the advocate of the taxpayer and I guess the concomitant to 
that is, you know, we want to minimize the risk exposure of the 
fund, because ultimately, that is the best way to represent the 
taxpayers' interest on this issue.
    So we go into the question of whether you should raise 
coverage limits with deep skepticism. However, if there's 
additional evidence to be presented that would show that there 
would be a competitive benefit, or a benefit to consumers 
pointing to the various proposals that have been on the table, 
we're willing to look at it.
    On the specific question of whether to provide 100 percent 
insurance for municipal deposits, I think that also raises some 
other policy issues that need to be considered. One is, I 
think, it kind of goes to what's the core purpose of deposit 
insurance? Is it to protect small depositors, or are we going 
to broaden that to specified categories that go beyond the 
traditional small depositors which the system was designed to 
    Second of all, I think there's an issue as to if you 
provide 100 percent coverage, do you decrease incentives on the 
part of municipal officials to make sure that the institution 
where they're putting the taxpayers' money is a safe 
institution? So I think those are two things that need to be 
    That said, we are deeply skeptical, but if there's data or 
evidence, we'd be interested to know what the rural bank 
breakout on the statistics is that this would help consumers or 
improve competition. But we're open to hearing those arguments. 
But right now, we just have not heard them.
    Chairman Bachus. Yes. And let me say this. When we're 
talking about municipal deposits or governmental deposits, what 
in my mind we're also talking about, at least I can't express 
the sense of the Congress, but public policy behind a county 
government or a city government being able to keep more than 
$100,000 worth of their deposits in a local-based financial 
institution. I think there is a certain public policy argument 
that that option ought to be open to them. If we can create--
and I'm not talking about unlimited. Obviously I understand 
moral hazard. I'm not talking about uninsured. But if we can 
create an insurance fund for municipal deposits of some amount, 
and whether we're talking about half-a-million, or a million, 
but I would at least like us to look at that, particularly in 
that the small banks--and what you've proposed also is that we 
look at part of the risk basis, how much they rely on the 
Federal Home Loan Bank, and obviously, we're going to probably 
find that the small banks may be impacted by that, although I 
don't know.
    But I would approach it from a public policy standpoint and 
see what remedy could be fashioned.
    Ms. Bair. That suggestion extends to all secured 
liabilities. Federal Home Loan Bank advances were given as an 
example because it is a recent change. But we're talking about 
all secured liabilities.
    Chairman Bachus. OK.
    Mr. Hawke. Mr. Chairman, we regulate more than 2,200 
community banks, so we have a very strong interest in the 
welfare of community banks. And I must say that as our 
community bankers come through and visit with us, for every 
community banker who thinks he or she would be advantaged by 
raising deposit insurance limits, there's another one who 
thinks that it might be disadvantageous. I don't think anybody 
really knows with certainty what the consequences would be for 
community banks of a significant increase in deposit insurance 
limits. It may simply result in a very disruptive shuffling of 
deposits among banks with no net winners or losers.
    One of the facts that affects my thinking about this is 
that today there are more than $2 trillion invested in money 
market mutual funds, and over $1 trillion in uninsured deposits 
in banks. That suggests that people who have liquidity and 
wealth to put out in reasonably safe investments are not being 
highly motivated by deposit insurance. Today, with a minimum of 
inconvenience, anybody who wants to maximize deposit insurance 
coverage can do so by going to multiple institutions or 
multiplying accounts within a single institution.
    But there's so much uninsured liquidity outside the banking 
system today that I think one has to be skeptical about what 
the consequences would be of increasing coverage limits in 
terms of bringing new deposits into the system.
    Chairman Bachus. Even your proposal that we balance the 
examination fee, I think, will result in more smaller banks or 
State-chartered in these communities. So we're again talking 
about a thing----
    Mr. Hawke. Our proposal would be a significant benefit for 
State-chartered banks. It would relieve them of the burden of 
having to pay assessments to their State supervisor. Today, 
State-chartered banks pay roughly $160 million in assessments 
to their State supervisors throughout the country. Our proposal 
would shift that expense to the FDIC fund. So it would result 
in significant benefits to State-chartered banks, as well as 
relieving the inequity for national banks.
    Chairman Bachus. And that would probably be the smaller 
banks you think would benefit?
    Mr. Hawke. Any State-chartered bank that's paying 
assessments today--and they all pay assessments to their 
States--would be relieved of that burden.
    Chairman Bachus. Let me ask you one final question. Is 
there any policy prescription that you could offer the 
subcommittee that might address--and I know, Governor Meyer, 
you're saying there aren't any liquidity problems with the 
small banks--but with the smaller banks? Can you offer any 
possible solutions or proposals which might help them raise 
    Mr. Hawke. I think, Mr. Chairman, that there's room for the 
market to work here. Today, the $2 trillion in money market 
mutual funds suggests that people who have wealth to put out to 
work don't see a significant difference in the risk 
characteristics between banks and money market mutual funds and 
are willing to take whatever that risk differential is to get 
the higher yield. So, I think, as Assistant Secretary Bair 
suggested, this may really be a question of yield.
    Ms. Seidman. May I also suggest something else? Your 
questions have been focused on the liability side of the 
balance sheet--on deposits and Federal Home Loan Bank advances. 
The bigger question, I think, that all small institutions, and 
particularly small institutions in relatively small communities 
face, how to fund loans in general. I go out there and see this 
happening with respect to home loans for some of the smaller 
rural thrifts. That is the big question. How do I fund these 
loans? And so I think to some extent one of the issues that we 
all ought to be working on is whether there are techniques that 
some of these very traditional smaller institutions can begin 
to use that some of the bigger ones have been using to make it 
possible to fund more lending activity with less on the 
liability side.
    Now I'm not suggesting that all of them should get into 
massive asset securitization, or should all go into commercial 
and industrial loan syndications. But we work a lot putting 
together consortia of small institutions to participate in 
larger multifamily lending, or even in some of the riskier 
kinds of single-family lending. There are opportunities to do 
things like that.
    That's not as quick and widespread a solution as raising 
the deposit insurance level seems to be, but I will say that 
one of my real concerns about whether raising the deposit 
insurance level could possibly be as effective as some of the 
institutions think it is--and certainly some of the 
institutions we regulate have said this to me--if you don't fix 
the problem of multiple accounts in multiple banks, there's no 
particular reason to believe that raising the level will 
benefit the community banks more than it will benefit the 
larger banks. And in fact, it might lead to some further 
consolidation away from the smaller banks.
    Chairman Bachus. Governor Meyer.
    Mr. Meyer. Mr. Chairman, I think there is one thing that 
the Congress could do that would benefit small banks, and that 
is to allow the payment of interest on demand deposits. As you 
know, this is an issue that affects small banks relative to the 
larger banks, because the larger banks have found a way to in 
effect pay interest on demand deposits through sweeps. Allowing 
small banks to pay interest on demand deposits would make them 
more competitive not only with larger banks, but also with non-
bank financial institutions.
    So as you think about this problem and keep in mind the 
health of our small banks in this country, I think that's very 
much something that would be a benefit to the broader economy, 
but also would accrue specifically and especially to smaller 
    Chairman Bachus. And, that measure has passed the House and 
is awaiting action in the Senate.
    Mr. Meyer. I appreciate that.
    Chairman Bachus. I would----
    Ms. Bair. Mr. Chairman, if you don't mind, if I could add 
one thing? I would come full circle to where you started this 
hearing, which is the 23 basis point cliff. I think getting rid 
of that--I think that, in particular, is a tremendous threat to 
smaller banks, and replacing that with some type of system 
where you have a smoothed out system of premiums would be 
tremendously helpful.
    I also want to clarify, after going back and reading the 
written testimony on this Federal Home Loan Bank advance 
question, I don't want anyone to think that the Treasury is 
suggesting that we don't think a bank should have Federal Home 
Loan Bank advances as a source of capital. We do. We just note 
it in context of other secured liabilities.
    Chairman Bachus. I didn't see any suggestion that you did.
    Ms. Bair. OK, good. Treasury has long had the position--the 
previous Administration had urged Congress in the context of 
insurance reform to take a look at the whole question of what 
should be in the assessment base and how you treat secured 
liabilities in the assessment base.
    Chairman Bachus. One comment I would add to your comment. 
And I think all of you have more or less said that raising the 
insured amount of deposits might not help small banks. But the 
small banks are telling the Members of Congress where those 
banks reside that it would help them. So we have the regulators 
saying it wouldn't help them, but we have the people that own 
the banks and operating them telling us that it would help 
    Mr. Meyer. Mr. Chairman, if you price insurance at zero, I 
think banks are going to want the most that they can get, and I 
don't blame them.
    Chairman Bachus. Thank you. Maybe we ought to quit on that.
    Chairman Bachus. I'm not sure that I want to adjourn the 
hearing. I was hoping Members might come back.
    We very much appreciate your testimony today. I would ask 
that this be a continuing process, that we continue to meet 
informally, continue to try to build a consensus.
    One thing that we all agree is that the Federal deposit 
insurance system needs to be reformed, and there is a consensus 
around certain measures. My caution would be--and sometimes 
there are Members of Congress that are saying to you, ``address 
this limited issue''--but let me give you some inconsistent 
advice with that.
    We don't want to overcomplicate any regulatory scheme, 
because no bank or no institution is going to benefit from a 
complicated formula, one that's hard to interpret and has 
tremendous discretion, which they will all assume works to 
their disfavor.
    Mr. Hawke. Mr. Chairman, wait until you see the Basel 
    Chairman Bachus. I think that is why we ought to keep it as 
simple as we can. Keep it as workable as we can without 
additional paperwork and requesting all sorts of information 
that we don't presently request and actually end up stepping up 
the regulation above what needs to be done.
    We will leave the record open for 30 days to allow Members 
to submit questions for the record and appreciate your 
testimony. The hearing is adjourned.
    [Whereupon, at 11:50 a.m., the hearing was adjourned.]

                            A P P E N D I X

                             July 26, 2001