[Senate Hearing 107-]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 107- 595
 
                    COMPREHENSIVE DEPOSIT INSURANCE
                        REFORM: RESPONSES TO THE
                   FDIC'S RECOMMENDATIONS FOR REFORM
=======================================================================


                                HEARING

                               before the

                 SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                                   ON

    THE FEDERAL DEPOSIT INSURANCE CORPORATION'S RECOMMENDATIONS FOR 
                 IMPROVING THE DEPOSIT INSURANCE SYSTEM

                               __________

                             AUGUST 2, 2001
                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs






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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut     PHIL GRAMM, Texas
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia                 CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware           RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan            JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey           MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii              JOHN ENSIGN, Nevada

           Steven B. Harris, Staff Director and Chief Counsel
             Wayne A. Abernathy, Republican Staff Director
                  Martin J. Gruenberg, Senior Counsel
           Sarah Dumont, Republican Professional Staff Member
   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
                       George E. Whittle, Editor

                                 ______

                 Subcommittee on Financial Institutions

                  TIM JOHNSON, South Dakota, Chairman
                ROBERT F. BENNETT, Utah, Ranking Member
ZELL MILLER, Georgia                 JOHN ENSIGN, Nevada
THOMAS R. CARPER, Delaware           RICHARD C. SHELBY, Alabama
DEBBIE STABENOW, Michigan            WAYNE ALLARD, Colorado
CHRISTOPHER J. DODD, Connecticut     RICK SANTORUM, Pennsylvania
JACK REED, Rhode Island              JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
JON S. CORZINE, New Jersey

                  Naomi Gendler Camper, Staff Director
         Michael Nielson, Republican Professional Staff Member

                                  (ii)








                            C O N T E N T S

                              ----------                              

                        THURSDAY, AUGUST 2, 2001

                                                                   Page

Opening statement of Senator Johnson.............................     1
    Prepared statement...........................................    29

Opening statements, comments, or prepared statements of:
    Senator Gramm................................................     3
    Senator Bunning..............................................     4
    Senator Sarbanes.............................................     5
        Prepared statement.......................................    30
    Senator Bennett..............................................    12
    Senator Reed.................................................    25
        Prepared statement.......................................    30
    Senator Miller...............................................    27
    Senator Allard...............................................    31

                               WITNESSES

Robert I. Gulledge, Chairman, President & Chief Executive 
  Officer, Citizens Bank, Inc., Robertsdale, Alabama, Chairman of 
  the Independent Community Bankers of America, on behalf of the 
  Independent Community Bankers of America.......................     7
    Prepared statement...........................................    31
    Response to written questions of Senator Miller..............    54
Jeff L. Plagge, President & Chief Executive Officer, First 
  National Bank of Waverly, Iowa, on behalf of the American 
  Bankers Association............................................     9
    Prepared statement...........................................    41
    Response to written questions of Senator Miller..............    64
Curtis L. Hage, Chairman, President & Chief Executive Officer, 
  Home Federal Bank, Sioux Falls, South Dakota, First Vice 
  Chairman, America's Community Bankers, on behalf of America's 
  Community Bankers..............................................    10
    Prepared statement...........................................    48
    Response to written questions of Senator Miller..............    71
    Response to oral questions of Senator Johnson................    74

                                 (iii)









                    COMPREHENSIVE DEPOSIT INSURANCE
                       REFORM: RESPONSES TO THE
                   FDIC'S RECOMMENDATIONS FOR REFORM

                              ----------                              


                        THURSDAY, AUGUST 2, 2001

                               U.S. Senate,
  Committee on Banking, Housing, and Urban Affairs,
                    Subcommittee on Financial Institutions,
                                                    Washington, DC.

    The Subcommittee met at 10:03 a.m., in room SD-538 of the 
Dirksen Senate Office Building, Senator Tim Johnson (Chairman 
of the Subcommittee) presiding.

            OPENING STATEMENT OF SENATOR TIM JOHNSON

    Senator Johnson. I would like to call the Subcommittee to 
order.
    Good morning. I am pleased to convene the first meeting of 
the Financial Institutions Subcommittee of my Chairmanship on a 
topic that has been of great interest to me for a great many 
years. Federal deposit insurance is one of the cornerstones of 
our banking and financial system. This insurance gives 
depositors the confidence they need to fully utilize America's 
financial institutions. Since I began service in Congress in 
1987, we have seen some real ups and some real downs in the 
banking industry, and it is a great privilege today to Chair a 
hearing on a matter of such importance to our Nation's bankers, 
and indeed, to our country as a whole.
    I would first like to recognize Ranking Member Bennett, who 
I am told has a hearing conflict right now and, hopefully, will 
be able to join us later. I am pleased that Senator Gramm is 
able to join us here this morning. But I do want to thank 
Ranking Member Bennett in particular for working with me on a 
great range of banking issues. He has a very distinguished 
business background. I value his insights. Obviously, I 
appreciate Chairman Sarbanes, who conducts all of his hearings 
in a dignified and thoughtful manner and I aspire to live up to 
the high standards that he has set for the Senate Banking 
Committee.
    As everyone in the room knows, or surely will find out in 
short order, comprehensive deposit insurance reform is an 
enormously complex issue. I will resist the opportunity today 
to recite a history of banking reform, and steer clear of too 
many statistics--at least until the question and answer period. 
While the body of literature on deposit insurance is vast, I 
would note that there appears to be more consensus than there 
is disagreement on potential reforms.
    At today's hearing, the financial services industry will 
respond to the FDIC's recommendations for comprehensive reform 
of the Federal Deposit Insurance System. The FDIC, in my view, 
has identified some significant weaknesses in the current 
system.
    In particular, it is hard to argue with the FDIC's 
observation that the current system is procyclical. That is, in 
good times, when the funds are above the designated reserve 
ratio of 1.25 percent, 92 percent of the industry pays nothing 
for coverage. But in bad times, institutions could be hit with 
potentially crushing premiums of up to 23 basis points. I think 
that most industry members agree that this so-called ``hard 
target'' presents a very real threat to their businesses.
    Of course, this means that any movement in the funds down 
toward 1.25 percent increases the anxiety level of bankers and 
regulators alike, whether that movement comes from fast growth 
of certain institutions, or from institutional failures like we 
saw last Friday in the case of Superior Bank of Illinois. The 
numbers are still preliminary, but cost estimates of the 
failure start at around $500 million, which would reduce the 
SAIF ratio by seven basis points. I say this not to be 
alarmist, but I would urge caution against becoming simply 
complacent in good times and resisting changes that make sense 
over the long term and have the potential to enhance the 
overall stability of our system.
    I am particularly interested in hearing from the witnesses 
about their positions on premiums. I would note that there is 
unanimity among the Federal banking regulators that 
institutions should pay regular deposit insurance premiums, 
though not with respect to how we should determine those 
premiums.
    Now, I understand that 92 percent of the industry is free 
from current premium payments, and it certainly presents an 
interesting psychological and political challenge to persuade 
folks to pay for something that they currently get for free. On 
the other hand, I am not the first to note that very few things 
in life are, in fact, free. If you are getting something of 
value, eventually, you have to pay for it. The question is not 
whether you will have to pay up; it is when and how much.
    I am also interested in hearing comments about the erosion 
in value of deposit insurance. I think my position is well 
known. I believe that we need to increase, and index, coverage 
levels. Over the last 20 years, coverage values have decreased 
by more than half, and previous increases were unpredictable 
both in terms of amount and timing. I expect to hear a spirited 
debate on that topic, and I believe it should be included in 
any discussion of comprehensive reform.
    I would urge everyone involved in this debate to take a 
step back and recognize that when we talk about deposit 
insurance, we are talking about the foundation of our financial 
system. I think it is simply irresponsible to take a short-term 
approach, or to politicize these issues. And while I am open to 
persuasion on just about every component of reform, I am firm 
in my belief that we all share the common goal of a safe and 
sound banking system.
    As many of you know, I am committed to ensuring that our 
small banks and thrifts--which play such an important role in 
rural States such as mine, South Dakota--have the tools they 
need to survive. I am also well aware of the value that our 
larger banks, thrifts, and bank holding companies bring to this 
country. I believe my strong support of financial modernization 
speaks for itself, and would simply add that I am committed to 
finding a reform package that considers the needs and interests 
of all members of our financial services community.
    Now some might argue that it will be impossible to craft 
changes to our deposit insurance system that will bring all the 
interested parties together, but I reject that argument. First, 
every single bank and thrift in this country benefits from our 
world-class deposit insurance system, and it is in everyone's 
interest to find an acceptable set of changes. Second, I 
believe that our witnesses will tell us that the industry is, 
in fact, close together on many of the core reform issues. 
Finally, the regulators themselves have said that they are 
approaching consensus on a great many of these issues. I am 
optimistic that we will be able to develop a sound and 
comprehensive reform policy.
    I am looking forward to hearing what my colleagues and our 
witnesses have to say and I will now turn to my good friend and 
colleague from Texas, Senator Gramm, for any opening statement 
that he may have.

                STATEMENT OF SENATOR PHIL GRAMM

    Senator Gramm. Well, Mr. Chairman, first of all, I want to 
thank you for this hearing. It has been my great pleasure to 
work with you on banking issues now for several years. I have 
appreciated your interest in small banks.
    Let me say that, without question, I represent more small 
banks and bankers than any other Senator, other than my 
colleague, Senator Hutchison. And if there is a small banker in 
Texas who does not support me, I do not know him.
    So, I am very concerned about the health of small banks. I 
am not one of these people who believes the future of America's 
financial system is going to be dominated by large banks. There 
are a lot of niches where small banks can be very successful, 
and I think that people are finding these niches in my State.
    I do believe we need a comprehensive reform of deposit 
insurance, and I want to congratulate you for your interest and 
leadership in this area. I want to pledge to you that I am 
willing and eager to work with you to try to deal with the 
problem we have.
    We need to keep in mind that we have two different 
insurance systems. We have two types of institutions with very 
different charters and powers, that for all practical purposes 
have the same deposit insurance. And this is something that 
needs to be looked at very closely. Should we merge the funds, 
and if we do, should we change charters so that all financial 
institutions within the same insurance fund have the same 
powers? I think these are the issues that ought to be looked 
at.
    I would say that my experience with the S&L crisis 
convinces me that we should not raise the insurance limit.
    I remember vividly from those terrible days of the S&L 
crisis where institutions were broke, and it was obvious that, 
at some point, they were going to be closed. But because of 
deposit insurance, deposits would come into a failing 
institution by the tens of millions of dollars and seize a 
higher rate of return with absolute certainty that the taxpayer 
was going to pick up the bill--if and when that institution 
failed.
    I believe that this created tremendous instability in the 
system. I do not want to add to that by adding to these limits.
    I think I am in good company with Alan Greenspan. I have 
not yet talked to the new Secretary of the Treasury or the new 
FDIC Chairman about this issue in any great detail, and I do 
not remember whether the Comptroller of the Currency joined the 
Secretary of the Treasury and Alan Greenspan in opposing last 
year's proposals to raise deposit insurance limits.
    There are a lot of issues here that we do have agreement 
on, and I think this is an important area. I want to thank our 
witnesses for their time today.
    I have to go to a Budget Committee thing. We have some 
people downstairs that want to take back the tax cut and they 
need to be beaten into submission.
    [Laughter.]
    I want to thank you, Mr. Chairman, for holding this 
hearing, and to pledge to you that I have an open mind on these 
issues and I hope and believe we can work together.
    Thank you.
    Senator Johnson. Thank you, Senator Gramm.
    Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman, for holding this 
very important hearing and I would like to thank our witnesses 
for testifying today.
    It is good to have the industry represented here on the 
topic of Federal deposit insurance reform. A little while back 
we had the regulators here and we touched upon many of the same 
issues that we will be talking about today. It will be very 
helpful to have your take on these issues.
    Last April, the FDIC issued its paper, ``Keeping The 
Promise--Recommendations for Deposit Insurance Reform.'' There 
are many ideas in that paper that I believe there were a great 
deal of support for. Merging the BIF and the SAIF funds is an 
idea that has been around a long time. In fact, it has been 
around since I started in the House Banking Committee in 1987.
    There is a great deal of support for merging the funds. But 
it seems it has always been caught up in the bigger plans for 
overall deposit insurance reform. Because of the desire for 
reform, the funds have not been merged. I also believe there is 
a consensus to adjust the reserve ratios. The current 1.25 hard 
cap with 23 basis points under capitalization could very likely 
be imposed in a time of great concern to the banking industry 
when banks could least afford a readjustment.
    By giving the FDIC some flexibility, we can prevent turning 
hard times into crisis times. I also believe there is a lot of 
consensus to price premiums on a risk basis. I do not believe, 
however, there is a consensus on raising and indexing for 
inflation the insurance levels. When the regulators were here 
on June 20, Chairman Greenspan hesitated to speak for the Fed. 
But in the past, he says he opposes raising the insurance 
levels.
    The OCC has also expressed concern about raising the 
levels. The FDIC and the OTS have supported indexing the levels 
for inflation. I also have concerns about raising the deposit 
insurance levels. I am leery of putting the taxpayer on the 
hook for higher levels of coverage.
    I am also skeptical that raising the levels will lead to a 
great deal of increased deposits for smaller banks. I believe 
the deposits have shrunk in the smaller banks because those 
deposits have been going to higher returning uninsured 
vehicles. I do not believe those deposits would be put into 
banks.
    Mr. Chairman, once again, thank you for holding this 
hearing and I look forward to our witnesses' testimony.
    Thank you.
    Senator Johnson. Thank you, Senator Bunning.
    I am pleased that our Chairman, Senator Sarbanes, could 
join us this morning at this initial hearing of our 
Subcommittee.
    And on very short notice, Chairman Sarbanes, do you have 
any opening comments that you would like to share with us?

             STATEMENT OF SENATOR PAUL S. SARBANES

    Chairman Sarbanes. I would just like to make a few remarks, 
Mr. Chairman.
    First of all, I want to thank you as Chairman of the 
Financial Institutions Subcommittee for holding this morning's 
hearing on the very important subject of possible Federal 
Deposit Insurance System reform. Obviously, any reform effort 
will require thorough analysis of the issues and today's 
hearing is an opening contribution to that effort.
    As we are all of course aware, the FDIC in April published 
a report on reforming the deposit insurance system, which 
included, among other things, merging the two funds, charging 
insurance premiums based on the institution's risk to the 
insurance fund, so-called ``risk-based premiums,'' shifting 
from a fixed reserve ratio of 1.25 percent of insured deposits 
to a target range of reserve ratios, to avoid sharp swings in 
insurance premiums and to counter the cyclical economic 
movements.
    At the moment, the way it works, it often ends up pushing 
the cycle along rather than countering the cycle.
    Rebating premiums based on an institution's historical 
contributions to an insurance fund when the fund grows above a 
target level. And indexing deposit insurance coverage levels to 
the inflation rate.
    Last week, the various Government agencies, in a hearing on 
the other side, announced their views on the FDIC's various 
recommendations, and they picked some and left others by the 
wayside. Obviously, we need to review their positions very 
carefully.
    Let me say, I think today's hearing is particularly timely 
in light of last Friday's failure of a major thrift, Superior 
Bank of Illinois. It is the eleventh largest depository 
institution to fail in our history. Reports suggests that it 
may cost the SAIF as much as $500 million. Furthermore, 
customers with uninsured deposits--in other words, amounts over 
and above the $100,000 figure--may lose over $40 million.
    I am very much concerned about this failure and have taken 
steps to inquire into its causes. We have asked the GAO, under 
the leadership of the Comptroller General, to examine the 
situation, not as much the specific one, as a general 
examination, because the specific one will be examined by the 
Inspector General of the Treasury Department, which has 
authority over the Office of Thrift Supervision, and by the 
Inspector General of FDIC. And we have asked both of them to 
submit their reports to us so that we may have an opportunity 
to review them.
    The statute actually requires the Inspector General at 
Treasury to write a report when the deposit insurance fund 
incurs a material loss. The statute also requires that the 
report be made available to Congress upon request and it 
requires the IG's report to review the agency's supervision of 
the institution, including the agency's implementation of 
prompt corrective action, to discuss why the institution's 
problems resulted in a material loss to the deposit insurance 
fund. And it also calls for recommendations for preventing such 
losses in the future.
    Pursuant to that statute, I have already requested of the 
Inspector General that the report be made available to the 
Congress upon its completion.
    We look forward to receiving these two IG reports and the 
study from the GAO as we examine this situation. And in a 
sense, it is a timely reminder of the role of the insurance 
fund. It is a timely reminder of the potential exposure 
eventually to the taxpayer, if things really go amiss, as we 
experienced in the savings and loan crisis when we ended up 
footing a very large bill.
    So, Mr. Chairman, I am pleased to join you and I am looking 
forward to hearing from the witnesses.
    Thank you very much.
    Senator Johnson. Thank you, Chairman Sarbanes.
    I am pleased that we are able to have a very distinguished 
panel with us here this morning.
    Mr. Robert Gulledge is here on behalf of the Independent 
Community Bankers of America. He is Chairman of the ICBA. Mr. 
Gulledge is Chairman, President, and CEO of Citizens Bank of 
Robertsdale, Alabama.
    Mr. Jeff Plagge is here on behalf of the American Bankers 
Association. Mr. Plagge is President and CEO of the First 
National Bank of Waverly, Iowa.
    Mr. Curt Hage is here on behalf of America's Community 
Bankers. Curt is the First Vice Chairman of the ACB. Curt is 
Chairman, President, and CEO of Home Federal Bank in Sioux 
Falls, South Dakota, and a good friend of mine. And I might 
note that David Bochnowski, the Chair of the ACB, graciously 
stepped aside and is allowing Curt to come before the 
Subcommittee today. I know the Subcommittee is very well served 
by Mr. Hage's testimony.
    Welcome to the Subcommittee. Rather than using the 
formality of the 5 minute clock because we have a relatively 
small panel and just one panel, we will forego that.
    I would invite panel members to summarize their statements 
if they so wish. Their full statements will be placed into the 
record.
    With that, why don't we begin with Mr. Gulledge.

                STATEMENT OF ROBERT I. GULLEDGE

         CHAIRMAN, PRESIDENT & CHIEF EXECUTIVE OFFICER

           CITIZENS BANK, INC., ROBERTSDALE, ALABAMA

             CHAIRMAN OF THE INDEPENDENT COMMUNITY

                       BANKERS OF AMERICA

                        ON BEHALF OF THE

            INDEPENDENT COMMUNITY BANKERS OF AMERICA

    Mr. Gulledge. Good morning, Chairman Johnson, Senator 
Sarbanes, and Senator Bunning. I am Bob Gulledge and I am 
President of Citizens Bank, an $80 million asset community bank 
in Robertsdale, Alabama. I am also the Chairman of the 
Independent Community Bankers of America, on whose behalf I 
appear today.
    Mr. Chairman, I want to commend you for moving this 
important issue forward. It has been 10 years since Congress 
last took a systematic look at the deposit insurance program. 
Now is the time, during a noncrisis atmosphere, to modernize 
our very successful Federal Deposit Insurance System, by 
adopting a package of interrelated reforms.
    First, deposit insurance coverage levels have been badly 
eroded by inflation and must be increased and indexed for 
inflation. Today, in real dollars, deposit insurance is worth 
less than half of what it was in 1980, and even less than what 
it was worth in 1974, when coverage was raised to $40,000.
    Higher coverage levels are critical to meet today's savings 
and retirement needs. A recent Gallup poll showed that nearly 
four out of five consumers think that deposit insurance should 
keep pace with inflation. Higher coverage levels are critical 
to support the local lending of community banks as they 
increasingly face liquidity pressures in trying to meet loan 
demand for our small business and agricultural customers.
    Community banks' funding sources other than deposits are 
scarce. Consumers and small businesses shouldn't have to spread 
their money around to get coverage they deserve. They should be 
able to support their local banks, and local economies, with 
their deposits.
    Meanwhile, the examiners and the U.S. Treasury are warning 
against our growing reliance on Federal Home Loan Bank advances 
and other noncore funding sources such as brokered deposits.
    We do not have access to the capital markets like the large 
banks do. In troubled times, we, unlike large banks, are many 
times ``too small to save.''
    A recent Grant Thornton survey revealed that nearly four 
out of five community bank executives say higher coverage 
levels will make it easier to attract and keep core deposits.
    The growing concentration of deposits and of financial 
assets in fewer and fewer organizations, not an increase in 
coverage, presents the greatest systemic risk and ``moral 
hazard'' in our financial system and to the loss exposure of 
FDIC.
    Chairman Johnson, ICBA strongly supports your legislation, 
S. 128, which would substantially raise coverage levels and 
index them in the future. This feature of deposit insurance 
reform is essential for our support of legislation. The ICBA 
also supports full FDIC coverage for municipal deposits and 
higher coverage for IRA's and other retirement accounts.
    Second, we must address the free-rider issue. Over the 
course of last year or so, Merrill Lynch and Salomon Smith 
Barney have moved around $100 billion into insured accounts 
without paying a penny in insurance premiums, thereby reducing 
the reserve ratio.
    Further, by owning multiple banks, they offer their 
customers higher coverage levels than we can. This is a double-
barreled inequity that we think must be addressed.
    Third, a risk-based premium system must set pricing fairly. 
Currently, 92 percent of banks pay no premiums. The FDIC says 
that this is because the current system underprices risk.
    The proposal to charge all banks premiums, even when the 
fund is fully capitalized, faces controversy in our industry. 
But we believe that as part of an integrated reform package, 
which includes a substantial increase in the deposit insurance 
limit, most community bankers would be willing to pay a small, 
steady, fairly priced premium in exchange for increased 
coverage levels and less volatility in the premiums. This is 
also one way to make sure that the ``free-riders'' pay their 
fair share, also.
    Fourth, the 1.25 percent hard-target reserve ratio and the 
requirement of a 23 percent premium when the fund is below 
target should be eliminated. The U.S. Treasury and the 
regulatory agencies recommend using a flexible range, with 
surcharges as the ratio gets too low and rebates if the ratio 
gets too high.
    We believe that the current system is dangerously 
procyclical with premiums the highest when banks and the 
economy can least afford it. Using a more flexible target would 
help to eliminate substantial fluctuations in premiums and 
avoid intensifying an economic downturn by diverting lending 
funds out of the banking industry.
    We also strongly support the FDIC proposal to base rebates 
on past contributions to the fund rather than on the current 
assessment base. This would avoid unjustly rewarding those who 
haven't paid their fair share into the fund.
    Fifth, the FDIC proposes to merge the BIF and the SAIF. The 
ICBA supports the merger only so long as it is a part of an 
overall comprehensive reform package.
    In conclusion, Mr. Chairman, now is the time to consider 
these important FDIC reforms. Thousands of communities across 
the country and millions of consumers and small businesses 
depend on their local community banks. And without 
substantially increased FDIC coverage levels, indexed for 
inflation, community banks will find it increasingly difficult 
to meet the credit needs of our communities and consumer, 
agriculture, and small business customers.
    The less that deposit insurance is really worth due to 
inflation erosion, the less confident Americans will be about 
their savings in banks. Thus, the soundness of our financial 
system will then be diminished.
    Congress must not let this happen and we urge Congress to 
adopt an integrated reform package as soon as possible.
    I thank you for the opportunity to comment and I will be 
happy, Mr. Chairman, to answer questions.
    Senator Johnson. Thank you, Mr. Gulledge.
    We will turn next to Mr. Plagge.

                  STATEMENT OF JEFF L. PLAGGE

              PRESIDENT & CHIEF EXECUTIVE OFFICER

              FIRST NATIONAL BANK OF WAVERLY, IOWA

                        ON BEHALF OF THE

                  AMERICAN BANKERS ASSOCIATION

    Mr. Plagge. I want to thank you, Mr. Chairman, for holding 
this hearing. We certainly appreciate your long-term support of 
a strong banking system and the financial system in general and 
your leadership on this particular issue.
    Assuring that the FDIC remains strong is of utmost 
importance to the banking industry and the consumers 
nationwide.
    Over the past decade, the industry has gone to great 
lengths to assure the insurance funds are strong. In fact, with 
$42 billion in combined financial resources, the FDIC is 
extraordinarily healthy. The outlook is also very good.
    The banking industry is extremely well-capitalized, 
profitable, and reserved for potential losses. Thus, now is a 
great time to consider how we might improve an already-strong 
system on a comprehensive basis.
    A consensus is key to any bill being enacted. To fulfill 
this goal, we have held extensive discussions with bankers, 
Members of Congress and staffs, and the FDIC. And as you noted, 
some differences remain between our three organizations, but in 
most cases, our positions are very similar.
    Our three associations have agreed that it is imperative to 
discuss these issues together and work together with this 
Committee to develop legislation that would have broad support.
    Just this weekend, this issue was again brought before our 
organization's bankers at the ABA summer meeting. This meeting 
brings together our board of directors, government relations 
council, and the leadership of all State banking associations 
and others. My testimony today reflects the conclusions reached 
during this meeting.
    I must add, however, that while there is a willingness to 
go forward, we do have deep concerns about legislation that 
might increase bank costs or become a vehicle for extraneous 
amendments. If that were to be the case, support amongst many 
of our banks and bankers would quickly dissipate.
    Indeed, the consensus at our summer meeting was more so 
than ever that the ABA will oppose any FDIC reform legislation 
that results in increased premiums when the insurance funds are 
already above the 1.25 percent ratio as they are today. 
Fortunately, we also believe, however, that by working 
together, a consensus bill could be developed that would have 
broad support.
    In my testimony today, I would like to make several key 
points that are also in the written testimony that was 
submitted.
    First, today's system is strong and effective, but some 
improvements could be made. The current system of deposit 
insurance has the confidence of depositors and banks. Strong 
laws and regulations buttress this financial strength. Even 
more important is that the bank industry has an unfailing 
obligation to meet the financial needs of the insurance fund.
    Second, as you have noted, a comprehensive approach is 
required. Because insurance issues are interwoven, any changes 
must consider the entire system. We are pleased that all the 
issues are now on the table. We recognize that any final bill 
might not cover all of these issues in full, but we certainly 
appreciate the comprehensive process that the Congress and this 
Committee is pursuing.
    The issues that we feel should be considered include: 
Number one, the impact inflation has on the $100,000 insurance 
level and how it can be addressed in the long term; number two, 
the fact that very fast growing institutions can dilute the 
fund ratios without paying any premiums; number three, the 
current counterproductive and procyclical premium requirement 
when the fund falls below the 1.25 percent ratio; number four, 
the need to cap the growth of the fund at some point and 
provide rebates; number five, the possibility of basing rebates 
on the history of bank payments into the fund; number six, 
insurance levels on municipal deposits; and number seven, 
merger of the insurance funds in general.
    Our summer meeting participants emphasized that caps and 
rebates need to be included in the deposit insurance 
legislation.
    My third and final point is that the changes should only be 
adopted if they do not create new material costs or burdens to 
the industry. The example used by the FDIC in its report would 
result in unacceptable premium increases for many banks. The 
current system is strong and we see no justification for such 
increases when the insurance funds are above the required 
reserve ratio.
    Banks have paid for their insurance and, in fact, they have 
prepaid and they continue to pay almost $800 million a year to 
cover the FICO interest payments, even though the current 
institutions that are paying these bills had nothing to do with 
the S&L crisis.
    We thank you, Mr. Chairman, for this opportunity to express 
our views and we look forward to working with the Committee to 
find workable and comprehensive solutions.
    Senator Johnson. Thank you, Mr. Plagge.
    Mr. Hage.

                  STATEMENT OF CURTIS L. HAGE

         CHAIRMAN, PRESIDENT & CHIEF EXECUTIVE OFFICER

          HOME FEDERAL BANK, SIOUX FALLS, SOUTH DAKOTA

        FIRST VICE CHAIRMAN, AMERICA'S COMMUNITY BANKERS

                          ON BEHALF OF

                  AMERICA'S COMMUNITY BANKERS

    Mr. Hage. Mr. Chairman and Members of the Subcommittee, I 
am Curt Hage, Chairman, President, and CEO of Home Federal Bank 
in Sioux Falls, South Dakota. I am representing America's 
Community Bankers today in my capacity as First Vice Chairman. 
We are pleased to have this opportunity to present our views on 
deposit insurance reform.
    America's Community Bankers welcomes your interest in 
comprehensive reform. At the same time, we believe there are 
serious potential problems facing the deposit insurance system 
that Congress must act on immediately.
    Last week's failure of Superior Bank and the failure of the 
First National Bank of Keystone in 1999 should remind us of the 
importance of strengthening the Federal Deposit Insurance 
System. If the list of comprehensive reform proposals is too 
long for Congress to pass this year, we ask that you set 
priorities, enact what you can this year, and then return to 
the rest of the issues next year.
    America's Community Bankers urges Congress to enact three 
major deposit insurance reform provisions this year:
    First, merge the BIF and the SAIF into a single, stronger 
deposit insurance fund.
    Second, give the FDIC flexibility in recapitalizing the 
deposit insurance fund if the fund falls below the 1.25 percent 
reserve requirement. Current statute requires the FDIC to 
impose a 23 basis point premium if a fund dips below the 
required reserve ratio level for longer than a year.
    The real dollar cost of this arbitrarily set premium would 
be significant. For my bank alone, that premium would cost $1.4 
million. For all banks in the State of South Dakota, that would 
be $31 million-- enough capital to support over $300 million in 
additional lending. In a rural State like South Dakota, $300 
million would make a big difference in helping our State 
continue to grow.
    We recommend that Congress allow the FDIC to recapitalize 
the fund using a laser-beam approach, not a sledgehammer.
    Third, allow the FDIC to impose a special premium on 
excessive deposit growth, if such growth would threaten the 
health of the deposit insurance fund.
    A few companies have shifted tens of billions of dollars 
from outside the banking system into insured accounts at banks 
that they control. While legal, this has diluted the deposit 
insurance funds and reduced the reserve ratio of the BIF by 
three to four basis points. It is time to give the FDIC 
authority to counter this free-rider problem.
    Fortunately, there is already legislation introduced in the 
House to address these three priority issues. H.R. 1293, the 
Deposit Insurance Stabilization Act, introduced by 
Representatives Bob Ney and Stephanie Tubbs Jones. ACB asks 
Congress to either pass this legislation immediately or to make 
it the centerpiece of comprehensive reform legislation that can 
be enacted this year. In any case, the provisions found in H.R. 
1293 should be enacted before either the BIF or the SAIF falls 
below the 1.25 percent reserve ratio level.
    We agree with the incoming FDIC Chairman Don Powell that 
Congress need not deal with all deposit insurance issues at 
once. But ACB's strong support for addressing the most pressing 
matters certainly does not rule out adding other provisions if 
a consensus can be quickly developed.
    In the area of coverage, ACB strongly believes that 
Congress should focus on increasing protection for retirement 
savings and also urges substantially increasing coverage for 
retirement savings plans, such as IRA's and 401(k) accounts.
    With respect to general increases in deposit insurance 
coverage, ACB supports indexing coverage levels from 1974, 
which, according to the FDIC, would bring the coverage limits 
to approximately $135,000. This would help maintain the role of 
deposit insurance in the Nation's financial system.
    ACB also recommends that Congress set a ceiling on the 
deposit insurance fund's designated reserve ratio, giving the 
FDIC the ability to adjust that ceiling using well-defined 
standards after following full notice and comment procedures.
    In determining the actual ceiling level, Congress should 
consult the FDIC. Once a ceiling has been set, reserves in the 
fund that exceed the ceiling should be returned to insured 
institutions based on their average asset base measured over a 
reasonable period and based on premiums paid in the past. For 
example, S. 2293, introduced by Senators Santorum and Edwards 
in the 106th Congress, provides one approach that Congress 
might take.
    Finally, ACB strongly supports preserving the current 
statutory language preventing the FDIC from imposing premiums 
on well-capitalized and well-run institutions when reserves are 
above the required levels. These institutions have already paid 
dearly for their coverage.
    Mr. Chairman, let me sum up by reiterating ACB's strong 
belief that Congress should address the most pressing needs of 
the deposit insurance system immediately--acting quickly to 
give the FDIC the flexibility it needs to deal with the strains 
imposed by the free-rider problem.
    If a consensus can develop around other deposit insurance 
reform measures, we welcome their consideration and inclusion.
    Deposit insurance is an essential part of our banking 
system. While a variety of opinions exist on the issues, 
general consensus exists that any reform should leave the FDIC 
stronger. It should continue and strengthen the original 
mission of the FDIC to protect depositors.
    America's Community Bankers is committed to working with 
you and your Committee, and others in the industry, to help 
forge a bill that can move expeditiously through Congress.
    Again, Mr. Chairman, thank you for this opportunity to 
testify on behalf of America's Community Bankers. I welcome any 
questions that you or any Member of the Subcommittee might 
have.
    Senator Johnson. Thank you, Mr. Hage.
    My able colleague and friend, Senator Bennett, is able to 
join us now. And what I would suggest is that Senator Bennett 
share with us some opening thoughts, and then with the 
permission of the remainder of the Subcommittee, we would move 
directly on to questioning at that point.
    Senator Bennett.

             COMMENTS OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you very much, Mr. Chairman. I 
appreciate your holding this hearing.
    When I first joined this Committee as a very freshman 
Member and sat at the end of the table on the other side, I had 
no idea what BIF and SAIF were. I would go home filled with the 
excitement of a new Senate election and my appointment to the 
Banking Committee and have bankers sit me down and say, where 
are you on the issue of BIF and SAIF? And I said, well, I am in 
favor of SAIF. Everybody likes to be safe.
    [Laughter.]
    What is BIF? That sounds like a statement on a Saturday 
morning cartoon.
    So, I now have been immersed in BIF and SAIF issues for 
nearly 8 years and had thought they had gone away. I thought 
that the problems had all been solved. But as you hold this 
hearing, I realize that I was wrong. The problems have not all 
been solved. They have simply changed. We are no longer dealing 
with the issue of bailing out savings and loans. We are now 
dealing with the issue of prosperity and too much money in BIF 
and SAIF.
    I am grateful to you, Mr. Chairman, for highlighting the 
issue again and bringing it back up in the next context so that 
we do not simply ignore it.
    I think that is a salutary thing for you to be doing. I 
appreciate the witnesses and the information they have shared 
with us here today. And I hope that, maybe with your 
leadership, Mr. Chairman, we finally can get to the point where 
we can forget it and let it go on. But life being what it is 
around this town, I am not sure we will ever do that.
    Thank you.
    Senator Johnson. Thank you, Senator Bennett.
    If it is all right with Senators Allard and Reed, we will 
proceed on with questioning. But certainly, your statements 
will be placed into the record.
    In the process of trying to find how much consensus is 
possible on FDIC reform, we had an opportunity to seek out the 
opinions of a wide range of authorities, not the least of all 
the panel before us here today.
    We also looked to the viewpoints of the FDIC itself, the 
Fed, the Treasury, the OCC, and the OTS. And I thought it might 
be useful to display a chart, which we have on the stand here, 
which demonstrates a great many of the key components of FDIC 
reform. There actually is a great deal of consensus, 
admittedly, a bit less consensus on the indexation issue. 
Certainly on the other issues, there is a great deal of general 
consensus among these agencies.
    I would ask Mr. Plagge and Mr. Hage that, with the FDIC, 
the Fed, the Treasury, the OCC and OTS in unanimous position, 
recommending that banks and thrifts, in fact, pay annual 
premiums for deposit insurance coverage, it is my take on their 
perspective that they are suggesting that a steady premium 
system would not necessarily require banks and thrifts to pay 
more. They would pay a steady amount each year rather than 23 
basis points into the hard target, and that variability in 
premiums would be reduced, not increased. Their attitude 
appears to be making an assumption that these institutions will 
never have to pay premiums because we will never break 1.25 
percent, which may not be a realistic position to take.
    I wonder if you would share again with me a bit of 
deliberation about why your organization is right and these 
institutions are wrong on the issue of premiums.
    Mr. Plagge.
    Mr. Plagge. Okay. I will start that. It is an interesting 
discussion. And having served on the ABA board level and then 
also on the Government Relations Council at the ABA, as well as 
at the State level, what we find with our bankers that have 
been brought into the discussion is they become almost more 
emphatic about the fact that we have prepaid into the fund.
    The combined funds today are extremely strong--1.37 
percent, I believe is the ratio when you look at them combined. 
In fact, congratulations to Congress for designing a system 
that has worked.
    We put the fund together. We have been far above the 1.25 
percent, and we continue to pay $800 million a year toward the 
$12 billion obligation for the FICO interest. So, we look at it 
as, we have paid. We want to continue to make sure that the 
fund is extremely strong. And at this point, it just seems to 
us that the system in that regard is working.
    Every dollar that comes out of our institutions, and I am 
in a small, $140 million institution in rural Iowa, is money 
that we cannot loan back into the economy, cannot do the kinds 
of things that we are doing. And as one banker told me, we 
already bought this car. It is paid for. The system is working 
in that regard. Let's not continue to put more money into that 
fund.
    Last, our bankers tell us, and I agree, that right now, the 
fund is building at approximately $1.5 billion more each year 
just based on the excess earnings in the fund over and above 
the operating cost to the FDIC. So in fact, the fund will 
continue to grow as it stands today over and above the FICO 
premiums and so forth that are being paid.
    Senator Johnson. Mr. Hage.
    Mr. Hage. Thank you, Senator Johnson.
    I think we need to put a couple of pieces into perspective 
to make this puzzle look like a whole picture.
    I do not know of any of our members who are suggesting that 
we shouldn't pay any premium for deposit insurance. 
Historically, we have paid for those premiums and have paid for 
that coverage and I think it has been appropriate.
    The situation we are in today is that we have overpaid or 
prepaid for the present insurance level required. And so, our 
members are concerned about the equity of getting that 
prepayment back where it belongs.
    Normal conditions without the aberrations of huge inflows 
of free-rider deposits probably wouldn't raise the issue to the 
level it is today. But they are linked.
    We have a number of beneficiaries who are not paying for 
any coverage, yet getting full coverage at the expense of those 
of us who have prepaid. And I think that is unfair and wrong. 
So an important ingredient of getting back to paying a correct 
premium is to rebalance who should pay and how much should they 
pay.
    Second, there seems to be a growing notion, as I get 
reports of conversations around Capitol Hill and perhaps around 
the country, that somehow this is a free system that we are 
living off of.
    It is not free at all. We have paid for this deposit 
premium. We have accumulated those balances. My company alone 
since 1991 has paid over $10.4 million in premiums. I have 
gotten value for that. But a lot of that is prepaid and I would 
like it back. And let those who are now putting uninsured money 
into the system pay their fair share like the rest of us have.
    That is really the key ingredient, to get it rebalanced and 
get it fairly structured so all participants are paying 
appropriately for participation in the deposit insurance fund.
    Senator Johnson. Thank you, Mr. Hage.
    I am going to suggest that Members of the Subcommittee 
abide by the 5 minute clock, so that everybody gets a fair 
opportunity. And having my time expire here, I will try and 
behave myself and set a good example. So, I would turn next to 
Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    This is for any of the panelists. Do you believe that 
deposits are down in smaller banks because insurance reform has 
not kept up with inflation or because depositors are putting 
their money in other uninsured vehicles that have the potential 
for higher returns? Anyone who would like to speak on that 
would be fine.
    Mr. Gulledge. I do believe that deposits are down in the 
smaller banks. I think that customers are in many instances 
following the rates that they are getting for other nonbank 
products. But also, there are quite a number of people who are 
leaving community banks to take their funds simply because we 
are not in a day when $100,000 coverage is indicative of a 
person being rich.
    Some of these people who are taking their retirement 
accounts, their life event funds are being taken to other banks 
and other products simply because we do not have the insurance 
coverage to give them the protection that they are seeking and 
that they expect from the FDIC coverage.
    Mr. Hage. Senator Bunning, I think we saw in the last 5 to 
6 years, maybe longer, a huge disintermediation or shift from 
commercial bank deposits, thrift and community bank deposits, 
because of higher rates of return and a high confidence level 
in equity markets and mutual fund markets. I think that it had 
relatively little to do with the deposit insurance coverage 
limit itself as a stand-alone concept.
    Today, with the lack of confidence given the recent market 
readjustment, we have seen new inflows of deposits back into 
community banks. Whether that will stay or not, I do not know.
    I do know that people have and are accumulating higher 
balances on an individual basis, particularly in their 
retirement funds. And I think as we see the baby boomers reach 
retirement age, their appetite for risk is going to decrease. 
They are going to pay more attention to how much insurance 
coverage they can get to assure return of their principle 
rather than return on their principle.
    Senator Bunning. During the Chairman of the FDIC's 
testimony, she addressed the FDIC's concerns regarding the 
issue of rapid deposit growth and its impact on the rest of the 
industry. Do you see a trade-off between reform in this area 
versus stifling the very initiative of practices that Gramm-
Leach-Bliley was intended to encourage?
    Mr. Hage. Senator Bunning, I would draw a distinction and 
definition of rapid deposit growth that I think is important. 
If we are talking about deposit growth----
    Senator Bunning. Those are her words, not mine.
    Mr. Hage. I understand. But just to clarify the issue, if 
we are talking about deposit growth, meaning one bank gives up 
its deposits by competitive forces to another bank, that is 
deposit growth for the bank, but it has no change on the fund 
itself because both sides of that transaction were insured. So 
bank-to-bank deposit growth has no effect, effectively, on the 
insurance funds.
    Funds like we see today that are in money market funds that 
were not previously insured now moving into the deposit 
insurance system through banks and thrifts that have been 
properly chartered, that has an impact. It may well be a one-
time impact given the environment we have come from and the 
environment we are into today. But it nevertheless is a very 
significant impact today.
    Over $50 billion have moved into the insured deposit funds 
with no premium attached. That is significant.
    Senator Bunning. How does the ABA feel?
    Mr. Plagge. I would echo that. In fact, from a personal 
example standpoint, we started a new bank in a close-by 
community. Literally, all the money that has come into the 
growth of that bank has come from other banks within the 
system. And so, the impact is basically a neutral impact to the 
FDIC.
    The funds that are flowing in from the money market funds 
and so forth, obviously have had an impact. As my counterpart 
mentioned, it looks like it may be coming to an end as far as 
the amount of that impact. Most of that money that would flow 
in in the large amounts has. But it certainly can move the 
percentages a lot greater than anything that happens within the 
industry itself, the banking industry.
    Senator Bunning. In meeting with the community bankers in 
my area, Kentucky and most of the area that surrounds the 
greater Cincinnati area, I have not heard one complaint, not 
one, from any of them about merging the funds or charging too 
much or increasing the amount of insured deposits. Not one of 
them have ever come to me and said, this is something that we 
really think is strongly needed.
    So unless we can really see a great improvement, it is 
going to take a lot of momentum to get this done. And I have a 
personal banker who is a community banker and they are so 
happy, it is unbelievable how happy they are. They are making a 
lot of money.
    Mr. Hage. Senator, I think that you have issued a challenge 
for all three of our industry trade groups to awaken the issues 
to your bankers.
    Chairman Sarbanes. Well, I am sure that you will be hearing 
from them now.
    [Laughter.]
    Senator Bunning. All right.
    [Laughter.]
    Senator Johnson. Thank you, Senator Bunning.
    Senator Sarbanes.
    Chairman Sarbanes. Examination of this issue actually 
raises a lot of, in a sense, basic questions, and I would like 
to ask a couple of those on the way to sort of gaining an 
analytical framework. What do you think the deposit coverage 
should be and what is the rationale for it?
    And in answering that question, I would like you to abandon 
the rationale that simply takes an old figure and then adjusts 
it for inflation because that assumes that the old figure was 
correct, or under changing circumstances, even today, 
represents an appropriate base off of which to work. I do not 
know whether that is the case or not.
    What should the figure be and what is the rationale for 
that figure? Should there be no limit? And if the answer to 
that is no, why should there be a limit? If there should be a 
limit, at what level? Why? What is the underlying rationale for 
arriving at that figure?
    Mr. Hage. Senator, I would offer that I do not know that 
there is a clear, single number answer to your question. The 
foundation of the question I think reflects the real heart of 
the issue here. What is it that we as a society should protect 
in terms of individual's wealth accumulation? What was magical 
about $5,000 coverage at the beginning, going to $15,000, to 
$20,000? I do not really know.
    The related facts are that through incentives in the 
currently passed tax act, we have encouraged individuals to 
accumulate more wealth for retirement. We have a generation of 
baby boomers coming into retirement that will be unprecedented 
in the numbers of people. We know there is a strain on Social 
Security.
    So, I think there is a connection between how much deposit 
insurance coverage we should provide and how much at-risk 
wealth accumulation we should permit.
    More than getting to a very specific number I think is an 
active process which I think has been and can continue to be 
actively administered through FDIC. Giving them some more 
flexibility to continually look at the insurance coverage ratio 
limit would be a strength. Giving them some flexibility in 
setting the premiums that would be necessary to maintain 
various ratio coverages that might be determined based on the 
risk profile of our public depository institutions I think 
would be a very healthy start. But I do not know that I could 
give you a specific number that would be any more legitimate 
than the numbers we have today.
    Chairman Sarbanes. Should it be part of the rationale to 
look at what percentage of the American people may, in fact, 
have savings at a certain level, where we would say, well, for 
ordinary people, we want to provide them the safety net. But we 
are not going to provide a safety net without limit. And for 
people of greater wealth, they presumably have their own 
investment strategies and they are used to putting their money 
at risk and so forth. Therefore, we are not going to cover 
everything for everybody. Is that a reasonable factor to 
include in the evaluation?
    Mr. Hage. I would agree with that, Senator. I do not think 
it is important that we provide 100 percent coverage. I think 
there is some healthiness to having segments of wealth at risk. 
I think it is a balance for public policy.
    As you as an elected body make policies that may put our 
Nation in positions of debt or not, the balance of how much 
risk that puts on deposit accumulation and protection I think 
is an integral ingredient of that.
    Chairman Sarbanes. Obviously, if we start examining the 
whole range of this, we put in the statute of the 1.25 percent 
figure that the FDIC is supposed to work off of. But I guess I 
would have to start looking at what the rationale is for that 
figure.
    Actually, you point out, Mr. Plagge, in your statement: 
``As a result of failure last week, the FDIC's SAIF will 
reportedly lose $500 million, 5 percent of the total in the 
fund. A loss that size would reduce the SAIF's reserve ratio 
from 1.43 percent of insured deposits to 1.36 percent.'' Now 
that means that just two more failures of this magnitude would 
bring that deposit fund below the 1.25 percent, and would then 
kick in a mandated 23 basis point premium on all institutions 
in the fund.
    People are seeking not to have that fall off the cliff, so 
they do not want the automatic mandatory premium when you go 
below 1.25 percent. And of course, one argument made for that 
is you may well be going below the 1.25 percent because of 
worsening economic circumstances.
    So, you are imposing an additional burden that is 
countercyclical--I mean, it is procyclical. The press is on not 
to do that, to do--I think you say later, a laser effect. And I 
think there is some argument for that. But it would seem to me 
that would seem to carry with it the proposition that the 
figure would have to be higher in good times in order to build 
up the fund.
    You, of course, have addressed the so-called free-rider, 
people that are sweeping in the deposits, and I think that is a 
reasonable issue to be looked at, and I am appreciative of 
that.
    But again, what is the magic of the 1.25 percent? Maybe 
that is not an adequate figure, particularly if we are going to 
raise the amount of coverage.
    This thing can erode very quickly. And those of us who went 
through the S&L's are still scarred by the experience. We ran 
out of the fund. It was all gone. In the end, there was, what, 
$160 billion? I forget the figure. The figure was so enormous, 
I have forgotten how much it was. What is the response on that 
point?
    Mr. Plagge. I might comment on that. I think, especially in 
particular to the failure last week, there is a little bit of 
an issue of what caused the failure and is it a bigger-picture 
issue going on or is it more like a Keystone issue, where there 
was particular issues with an institution?
    Chairman Sarbanes. Well, we are going to look at that. And 
of course, they were very heavy into high-risk lending and so 
forth.
    Mr. Plagge. I think the other thing is it is always 
important to remember that both funds have the ability to set 
aside another fund within the fund for reserves. And from what 
I understand, approximately $250 million had already been 
reserved in the subfund for that particular failure.
    Time will tell us what the actual loss is. I think the 
percent I have heard in the past over historical purposes is 
approximately 13 percent is the average loss. Now if you get 
into unusual situations like this one or Keystone where there 
are other issues going on, obviously, that percent can change.
    But the 1.25 percent, for whatever reason they came to that 
number, whether it was historical discussion at that time or 
long-term discussion, that is up for debate, obviously.
    The fact remains that we are almost 1.37 percent today. So 
even the 1.25 percent, which was considered the right number 
back in previous discussions, we have exceeded that now and it 
appears that, based on past failures, for instance, the 
Keystone case, the numbers were large as a percentage as well. 
But, again, it was an individual situation and there hasn't 
been a lot of follow-up behind it. We hope that is the case in 
this S&L failure as well.
    Chairman Sarbanes. Mr. Chairman, I see my time is up. I 
would just close with this observation.
    If you increase the amount of coverage, you obviously 
increase the extent to which you are placed at risk, ultimately 
the taxpayer. It seems to me that then raises the question of 
what is a proper figure for the fund, particularly if we are 
going to move in the direction of not replenishing the fund 
quickly if it drops below whatever the established level is.
    So if you do not replenish it on the downside--or replenish 
it more slowly, I guess--it raises a question of whether you 
have to boost it more to have more of a margin to absorb these 
losses.
    Now, we have been through a pretty good period in terms of 
failures and so forth. And so that tends to shape your 
thinking. But the system is not in a sense there for the good 
times. The system is there for the bad times. Therefore, we 
have to be thinking in those terms.
    Mr. Chairman, thank you and I want to thank the panel.
    Senator Johnson. Thank you, Chairman Sarbanes.
    Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman.
    Let me do what you are not supposed to do--ask a question 
to which I do not know the answer.
    What happens to the extra money? Are we setting up another 
Social Security trust fund here where the money is beyond the 
1.25 percent level or whenever it gets invested and earns 
interest, the money that is not needed to run the FDIC? Does it 
just go into the Treasury Department? Does anybody know?
    Mr. Hage. It stays in the insurance fund, Senator.
    Senator Bennett. What is it invested in?
    Mr. Hage. I do not know the investment portfolio. But that, 
I believe, is under the administration of FDIC.
    Senator Bennett. I understand that it stays in the 
portfolio. But what is it invested in? Is it invested in 
Government bonds?
    Mr. Hage. We believe, yes.
    Senator Bennett. So from a cashflow standpoint, just like 
Social Security, if you have a big run on the fund and people 
present those bonds for payment, the Government has to come up 
with the cash from some place else to pay off those bonds.
    Mr. Hage. Those bonds would have to be sold in a 
marketplace environment. They would not be called by the FDIC 
against the Government.
    Senator Bennett. I understand that.
    Mr. Plagge. I guess I might add that it actually gets kind 
of to the heart of some of the concerns of our bank members. It 
is really the question of what doesn't happen to it? Do we keep 
building the fund up over and above and it takes money out of 
my institution in Iowa, it takes money out of other banks 
around the country, especially in rural areas where liquidity 
is already tight and loan to deposit ratios are high? How much 
do we keep putting into a fund that appears to be, by all 
accounts, very safe and sound and meeting the needs of the 
insurance fund itself ?
    Senator Bennett. If it becomes too tempting because the 
Government gets the revenue by selling the bonds, it becomes 
almost a form of taxation to fund other governmental programs. 
And we love that around here. But we are not sure that is the 
thing that ought to be.
    Mr. Plagge, institutions get rated as 1-A and therefore, 
they do not have to pay anything into this fund. So in a very 
real sense, that rating is worth something financially.
    Mr. Plagge. Yes.
    Senator Bennett. And you are at the mercy of the bank 
examiner as to whether you get rated or not rated. So that just 
raises the question of how objective is the bank examiner? Do 
you feel good about the process that says, okay, this bank 
doesn't have to pay and this bank does? Or do you have some 
problems with it?
    Mr. Plagge. Well, we have concerns, as you look at some of 
the recommendations in the FDIC proposal of changing the 
assessment system and changing the rating system. We are a 
national bank. Both of our banks are national banks, so I 
strictly deal with OCC. But I have been in a State bank before 
where I have had FDIC and State regulators.
    I like the system the way we have it. I think, again, 
congratulations to the designers. It has worked. It has put 92 
percent of the banks in the top category. I look at that as a 
good thing.
    The incentive has been to be in the top-rated, well-
capitalized category, which is exactly where you want banks in 
any economic downturn. It puts more capital behind the whole 
system, let alone the $42 billion that is sitting in the fund. 
You have the $600 plus billion that is sitting behind it in 
bank capital. I think the more you try to break that down, when 
I see the assessment, the proposal where it is 1-A plus, 1-A, 
1-A minus, 1-B, 1-C, and then going down the ladder into the 
other categories, the subjectivity of that is somewhat 
dazzling.
    Bank regulators, and we have always had a good relationship 
with our bank regulators, but they do have a lot of discretion. 
There is a lot of subjectivity in that system, whether it is on 
the overall rating or the individual ratings that make that up.
    I guess I have not seen anything broke with the current 
system that would dictate to me or suggest to me that we need 
to keep breaking that down even further.
    So, I think it trends into areas that would put, quite 
honestly, a lot more pressure on the individual field 
examiners, let alone the systems themselves. Again, I do not 
see that the system has broken down in any fashion that would 
suggest we need to go that route.
    Senator Bennett. I see. Thank you. One final question.
    You all talked about the free-riders, and nobody likes a 
free-rider. But at the same time, the institutions that pay no 
premiums, pay no premiums because they fall into the safest 
risk category. And you just talked about the process by which a 
bank gets into the safest-risk category. Should we change the 
category in order to pick up the free-riders? Or are you saying 
that there should be an entry fee to get into this business 
regardless of how safe you are?
    Free-rider is almost a pejorative--it is a pejorative term. 
And it may very well be an earned pejorative term. But when you 
look at it from the standpoint of, well, the safest banks now 
do not pay anything, how do you specifically propose that these 
institutions coming in that are very, very safe should pay 
something? What should the ticket to the dance be, or how 
should it be structured in your view, any of you?
    Mr. Hage. Senator Bennett, I would suggest to you that 
free-rider, as we would define it in our terminology, means 
those institutions that have paid no premium in the past, yet 
are dumping huge sums of deposit money into the insurance fund.
    Senator Bennett. I understand that. But they come in 
dumping this into the fund, as you say, and they have very, 
very safe capitalization.
    Mr. Hage. Yes. And what I was about to say is that, going 
forward, I do not think any of us are proposing that there 
would be a category of membership or participation in the fund 
that would pay no premium, but that there would appropriately 
be categories or grades of premium paid based on the risk 
profile of individual institutions. That risk profile or 
grading would be determined by FDIC as a result of their 
examination process.
    What is happened today in banking that is relatively new is 
that balance sheets can today be constructed with different 
risk profiles more in a broader range of business plans that 
have perhaps historically been true.
    You asked about the impact of regulation and examination. I 
think regulators have grown in their sophistication of being 
able to understand these instruments as have managements of 
banks.
    It is really critical that management in a bank understand 
the risk profile that they are taking on into a balance sheet. 
That risk profile is the investments and the loans that a bank 
makes. That is where the risks come from, not the deposit.
    When we talk about deposit insurance, we have to be careful 
that we understand that difference. By and of itself, the 
amount of a deposit in a bank has meaning only as the basis for 
what we are insuring. But it is separated from the risk profile 
of the bank, which is driven by the assets it has. So it is 
really important that we measure the risk of the use of the 
deposits and have a premium that reflects that risk on an 
ongoing basis.
    That underscores what we are talking about in terms of the 
need for flexibility. Over time, as, cumulatively, bank balance 
sheets would change, the FDIC should have some flexibility to 
determine whether 1.25 percent or some other number is the 
right minimum threshold for coverage. And if we gave that 
flexibility, theoretically, any way, there would be an 
opportunity to adjust premiums that would be less dramatic than 
the all-or-nothing base that we have today, all of 23 basis 
points or zero.
    That is really the hard-core, not-working part of the 
premium structure today. It is the all-or-nothing idea.
    But the notion of having the ability over time to adjust 
the appropriate level of reserve ratio to be able to accelerate 
that in reasonable time frames, to be able to have a mix of 
premium assessments based on risk profiles of institutional 
members makes for a much healthier, stronger system.
    Senator Bennett. Thank you.
    Chairman Sarbanes. The FDIC, as I understand it, at least 
is proposing indirectly to address this issue by providing 
rebates that would be based on what you had paid into the fund. 
So that at least if you are an institution, over time, the very 
point you were making earlier, as I understood it, which had 
paid into the fund, you would get a rebate, and if you were an 
institution that had not paid into the fund, you would not get 
a rebate.
    Now that is addressing it at the other end, so to speak. 
But I think it did reflect some sensitivity on their part.
    Mr. Chairman, can I ask one question?
    Senator Johnson. Yes, Chairman Sarbanes.
    Chairman Sarbanes. I am interested in the fact that 92 
percent of the institutions are well-capitalized. Now, if you 
heard about a teacher who was giving 92 percent of the students 
in her class an A, presumably, you would say, I do not know 
about that marking system. I am not sure exactly what standard 
the teacher is using.
    Senator Bennett. Pretty smart class.
    Chairman Sarbanes. Yes. She needs to make more 
differentiations. I take it that is what the FDIC is perhaps 
searching to do on this risk-based approach. So that you 
wouldn't have all but 8 percent that passed the post, so to 
speak, and were in the same risk category.
    Mr. Plagge. I understand that as well. The incentive has 
been placed where the regulation wants banks to be, and that is 
in the well-capitalized area.
    Breaking that down to the level that is being discussed, 
where I looked at one chart where the potential premium charge 
for, I think it was a 1-C bank, which is still in the well-
capitalized area, would essentially be the same as the premium 
requirement for one that was in the low category. It would be 
the 3-A category.
    It seems to me that the risk to the system is certainly 
much better protected when you still have that well-capitalized 
bank.
    Again, to try to break that down and micromanage that at 
the kind of levels that are being discussed to me, becomes 
very, very subjective. And I think we should look at the 
positive side of that and the fact again that the system was 
designed in a fashion that has moved banks to be exactly where 
regulators hoped they would be in the well-capitalized 
category.
    Especially as we look at times like today, especially in 
agriculture and so forth, in the part of the country where we 
live.
    It is good that banks are in that category. It does give 
them the ability to stand the risk of a downturn and so forth, 
long before the insurance fund would ever be tapped.
    Chairman Sarbanes. Mr. Chairman, thank you again for the 
hearing. This has been a very thoughtful panel and we 
appreciate their testimony very much.
    I am not sure how far the statement that the system is 
working gets us because you are talking about making changes in 
the system. Therefore, we have to consider what the 
consequences of those changes should be. Again, I repeat the 
fact that we are at the end of an extremely good economic 
period. We haven't gone through the stress and strain that we 
would experience in more difficult economic circumstances. And 
that is what we have to evaluate because that is why all these 
protections have been set up, to be able to carry us through 
such a period.
    But thank you very much and I very much appreciate the 
thoughtfulness that is reflected in your statements and in your 
responses at the table.
    Senator Johnson. Thank you, Mr. Chairman.
    It is my ongoing effort to try to find consensus wherever 
we can find it. I have a couple of questions I want to ask.
    Let me start by asking the entire panel, from what I 
understand from your testimony today, you all appear to support 
a significant increase in coverage for retirement accounts, 
which, as you note, are likely to exceed $100,000 in fairly 
short order and fairly commonly. Is it fair to say, at least on 
this panel, that there is an industry consensus that we should 
consider a significant increase on retirement accounts 
independent of any disagreements that we might have about a 
general coverage increase?
    Mr. Plagge.
    Mr. Plagge. We actually haven't centered in on that. The 
one concern that seemed to be expressed about increasing 
insurance in general is the fact that it would attract hot 
money, and relating back to the comments that were made during 
the S&L crisis.
    I think the reason that bankers have talked about, well, at 
least let's look at the retirement funding, is because it falls 
out of that category of hot money. It is stable funding for 
banks and so forth.
    So as you look at the different areas where insurance could 
be increased, whether it is municipal deposits or just 
insurance in general, or IRA's and retirement funds, it seems 
to be the one category that kind of deals directly with the hot 
money, concern that resulted from the S&L crisis.
    Senator Johnson. Mr. Hage.
    Mr. Hage. Senator Johnson, I think that when you look at 
the public policy directions that are articulated increasingly 
today where citizens of this country are asked and encouraged 
to be prepared to carry a larger amount of their retirement 
well-being, increasing deposit insurance coverage to those 
retirement accounts makes all the sense in the world. It 
supports that philosophy.
    The critical thing about when you reach the age of 
retirement, I am told, although I am getting close, is that 
your tolerance for risk, because you cannot replace funds lost, 
goes down.
    I think we need to recognize that in the nature of how we 
encourage people to accumulate wealth and how we allow them to 
protect its value. It makes a lot of sense to increase coverage 
specifically for retirement type of instruments to encourage 
people to add to that saving. That also provides a stable base 
of funding for community banks to continue to play the 
important role of providing growth through lending in our local 
communities.
    Senator Johnson. Mr. Gulledge, of course, ICBA supports a 
generalized increase and catch-up with inflation. I would 
assume that, obviously, a retirement component would be 
something that you would support in the context of a larger 
comprehensive increase.
    Let me ask you, Mr. Gulledge, obviously, we do have a bit 
less consensus on this issue than on some of the others in FDIC 
reform. And we have heard some observe that increasing the 
level from $100,000 to $200,000 would create the potential for 
a moral hazard of the kind last seen in the banking system 
during the savings and loan crisis of the 1980's.
    The Fed and the Treasury, among others, have expressed to 
this point adamant opposition to the concept of doubling 
because of the risk issue. I wonder if you would share your 
observations on that point.
    Mr. Gulledge. Well, we do not agree that this would have a 
great effect on the moral hazard issue. We feel that, for the 
increase and the doubling of coverage under the provisions of 
your bill for individual coverage, we think that consolidation 
is bringing about, is creating more risk to the FDIC fund than 
would be on an individual raising of the coverages.
    Senator Johnson. I appreciate your observation on that, Mr. 
Gulledge.
    In the brief amount of time that I have left on the clock 
for myself, let me ask Mr. Hage, because of your experience 
with the Federal Home Loan Bank System, the Treasury has 
suggested that Federal Home Loan Bank advances and other 
secured capital be considered in the deposit insurance 
assessment base. The FDIC's report said that a bank's reliance 
on noncore funding, which may include these advances, should be 
considered risky. How would you respond to those 
recommendations?
    Mr. Hage. I would oppose the inclusion of the Federal Home 
Loan Bank advances as a part of the deposit insurance premium 
base. Federal Home Loan Bank advances are an alternative source 
of funding. They are fully collateralized by other collateral 
that we offer to offset that. They provide no risk to a 
consumer and there is no direct benefit to a consumer. To 
include Federal Home Loan Bank deposits would increase the cost 
of bank funding without any economic value whatsoever.
    So, to me, there is no correlation at all to including the 
Federal Home Loan Bank advances with the deposit premium.
    Senator Johnson. There is agreement from the ABA, Mr. 
Plagge.
    Mr. Plagge. Yes. I can speak to a little different path on 
that.
    As you know, in your State, and at least in Iowa, community 
banks are using the Federal Home Loan Bank System pretty 
readily. With the new advances allowed for ag and small 
business loans, it has become an important source of funding 
for us.
    We just went through a regulatory exam in the last 4 or 5 
months. I think the thing to keep in mind on that is the 
examiners already take that into account. As they look at our 
liquidity, as they look at our balance sheet, as they look at 
all the things that they look over when they do an exam, they 
take that into account in how we are structuring our balance 
sheet and how we are structuring our organization.
    And so, I would hope and caution against that kind of stuff 
being taken to equation because I think it really would have a 
pretty exasperating impact on community banks.
    Senator Johnson. Mr. Gulledge, are you in concurrence?
    Mr. Gulledge. First of all, I would like to say that we 
appreciate very much the expansion of the membership in the 
Federal Home Loan Bank System because it has been very 
meaningful to the community banks in our country. It has helped 
in the liquidity problems that we do have. And it is also true 
that the regulatory agencies are warning us about over-use of 
advances from the Federal Home Loan Bank. And we understand 
some of this warning because the rates are higher. It is 
creating a shrinking of net interest margins.
    But we feel that the cure for that and the need for using 
these lines is increased coverage so that we will have the 
liquidity that we need and we do not have to go to the Home 
Loan Bank for these advances.
    Senator Johnson. Thank you. My time is expired.
    Senator Reed.

                 COMMENTS OF SENATOR JACK REED

    Senator Reed. Thank you very much, Mr. Chairman.
    Let me first commend you and the Ranking Member for holding 
this hearing and beginning the careful deliberation about 
deposit insurance reform. It has been an issue, as Senator 
Bennett said, that has been with us for a long, long time. We 
hope, with your leadership, that we can move forward and reach 
some type of satisfactory conclusion.
    Let me also thank the witnesses for their excellent 
testimony.
    I would just like to address initially a general question 
to all the panelists. You have had the occasion to look at the 
FDIC's proposals for reform. Is there any major element that 
they have neglected to leave out that you would suggest in 
terms of issues that should be considered in a comprehensive 
reform package by the Senate?
    Mr. Hage.
    Mr. Hage. Senator Reed, as I have read that, I think it is 
a very well-written report and reflects a lot of good, thorough 
study on the part of the FDIC staff. I do not have anything 
excluded that I would want to be included.
    On behalf of ACB's position, I would remind you that we 
think that the three points of our position of getting those 
things done urgently and quickly are important, not as an 
alternative of no additional reform, but simply get those done 
first, they are right now urgent, continue the debate and the 
dialogue on the rest of the proposal, and then enact it 
appropriately.
    Senator Reed. Again, without pinning you down to an hour 
and a day, how fast do you feel that this should be done in 
terms of the continued soundness and safety of the banking 
system? And if you say yesterday, I will understand.
    [Laughter.]
    Mr. Hage. Well, since we all have a lot of money invested 
in terms of prepaid premiums, yesterday would be a little 
sooner----
    Senator Reed. I have been listening to this discussion and 
I am going to call my insurance agent because I believe I have 
lots of prepaid premiums, also.
    [Laughter.]
    I have been behaving reasonably safely for years now.
    [Laughter.]
    But I appreciate your point.
    Mr. Hage. Senator Reed, they are only charging you a year 
in advance. This is a multiyear prepayment.
    Senator Reed. All right.
    [Laughter.]
    Mr. Plagge.
    Mr. Plagge. We agree as well. I think the FDIC has 
presented a very good package. Obviously, we are not in 
agreement on all elements of it, but we feel it is good to have 
all those elements on the table.
    The only thing that we think maybe has been left out is 
giving more of an independent nature to the FDIC board going 
back to the three independent seats to make sure that there is 
continuity through transition of parties and so forth. But, 
otherwise, we agree that they have done a comprehensive look at 
things and hopefully, we can find those areas that we can agree 
on.
    Senator Reed. Thank you very much.
    Mr. Gulledge.
    Mr. Gulledge. We too feel that the FDIC proposals were 
good. They were well thought-out, very thoroughly put together. 
They established five areas or five points for consideration. 
We believe that all of those are important.
    Former FDIC Chairman Tanoue, I believe in her testimony 
previously, has stated, and the report indicates that it is not 
felt that there should be a separation or a segregation of any 
of those points. For comprehensive coverage, all of those 
should be taken into consideration.
    Senator Reed. Thank you very much. The final point--related 
to the size of the fund and the size of premiums is the 
effectiveness of regulation. If we do not have effective 
regulation, then we are going to need a lot of money in that 
fund because we would be paying lots of failed institutions.
    And so I would just ask for your comments with respect to 
your sense of, at this juncture, the adequacy of the 
regulation, the resources available for regulators, because I 
think that is inextricably bound up in this whole discussion.
    Mr. Hage. Senator Reed, I think you are on to a very 
important point. Effective regulation certainly is the base 
upon which any system like this would ever work.
    Again, observing from our personal experience, I think that 
the sophistication of the regulators in terms of being able to 
model different financial instruments, getting more savvy about 
management's preparedness and proactiveness in being able to 
model the impact of different risk profiles that they might 
take has improved significantly.
    The system will never be 100 percent fail-safe. It is just 
the nature of our economy and the instruments themselves. But I 
think the process has gotten much better.
    Senator Reed. Thank you.
    Mr. Plagge.
    Mr. Plagge. I agree with that as well. Again, we are a 
national bank and we have gone through recent exams. In fact, I 
would say the safety and soundness portion of the exams have 
stepped up, which I consider positive. I think it is back to 
the basics.
    The other thing that I would point out is that the 
regulators have so much more authority to take actions than 
they used to have, which I think makes the fund safer by its 
own nature. And so, I feel good about the exam process that we 
currently have.
    Senator Reed. Mr. Gulledge.
    Mr. Gulledge. Well, I am examined by the FDIC and I think 
the FDIC is doing a very adequate job of examination. I hear no 
complaint of that. I have no complaint of their assessment 
ratings, the CAMEL ratings of the bank.
    They are, however, saying that the current system is such 
that they have some difficulty. And this goes back I think to 
the question earlier on the 92 percent of the banks that pay no 
premiums.
    I believe it was not because of the capital, it was because 
of the CAMEL ratings that exists. So that speaks to the 
strength of the industry.
    As relates to the capital, however, there is a requirement 
under FDICIA that banks remain at certain capital levels, and I 
think that speaks to those levels that we have today.
    Senator Reed. Thank you very much.
    Thank you, Mr. Chairman.
    Senator Johnson. Thank you, Senator Reed.
    Senator Miller.

                 COMMENTS OF SENATOR ZEL MILLER

    Senator Miller. First, I apologize for not being here at 
the beginning of this hearing. I was presiding in the Senate. 
And I also apologize if I am asking you something which you 
have already covered.
    I am curious about how you feel about this. Mr. Powell 
indicated that perhaps all the FDIC-proposed reforms did not 
have to be all in one package. I would like to know what any of 
you think would be a must-have in the bill if you were making 
it up, and what needs to be done most immediately.
    Mr. Plagge. If it is okay, I will start with that.
    Senator Miller. All right.
    Mr. Plagge. Actually one of our concerns is that if it is 
not a comprehensive approach, maybe one or two things happen 
and then the rest of it is never visited again. And so, we 
really feel that it is the time. It is good public policy time. 
The fund is strong. It is a great time to look at the whole 
package.
    Obviously, there is a lot of things in that package, in the 
comprehensive bill, and we understand fully that something may 
come out as a result of these discussions, that it probably 
won't include everything. But we will have to look at that at 
that particular time.
    I guess we do caution that one or two things should not be 
picked out of that and run through, with the rest of them set 
aside for a later date, that unfortunately, may never come. We 
want to see the comprehensive discussion, even if it goes on 
longer and takes longer to reach consensus.
    Senator Miller. Do you feel the same way, Mr. Gulledge?
    Mr. Gulledge. I surely do. I think that the FDIC comes with 
a very good report and our association and our membership is 
very supportive of all the provisions of that report.
    We think it is also important to look at the whole package 
while this is being done at this time. Frankly, we hope that 
Mr. Powell will get a better view of this after he has come on 
board and has been at the helm of the corporation for a period 
of time.
    Senator Miller. Mr. Hage.
    Mr. Hage. Senator Miller, ACB agrees with Mr. Powell, they 
do not all have to be looked at at once. But I think, 
eventually, they all should be looked at.
    From my opening remarks, the first importance to us is the 
merger of the BIF-SAIF funds. We think that ought to be done 
immediately. Second, give the FDIC appropriate flexibility to 
set the correct premium levels in balance with the coverage 
ratio, so that can be corrected on a smooth basis rather than a 
catastrophic, all-or-nothing basis. Third, allow for the 
special premiums for the free-riders to rebalance and reset the 
appropriate funding for the deposits that have come into the 
system.
    Senator Miller. Thank you very much.
    Senator Johnson. Senator Bennett, anything further?
    Senator Bennett. No, Senator.
    Senator Johnson. Well, let me thank the panel again for 
what I think has been excellent testimony. We have had good 
participation on the part of the Subcommittee as well. I am 
appreciative of Senators Gramm and Sarbanes joining us for 
this, and obviously, Senator Bennett's good work with me on the 
Subcommittee.
    We want to continue to move this issue forward. And as was 
noted in Senator Miller's last line of questioning, I 
acknowledge that it may be that we cannot find consensus on 
every single issue here. But, on the other hand, I think it is 
important that we begin this debate as comprehensively as 
possible and recognize that a balanced meal involves both the 
spinach and the dessert, and that some of that is part of 
reality.
    We will see what components we can move ahead with. But I 
do want to see us work in conjunction with Representative 
Bachus on the House side, with whom I met yesterday. I would 
like to see what we can do to find bicameral and bipartisan 
consensus on these issues. I think that our panel has 
contributed very significantly to our progress in that regard 
and again, I thank you for your participation.
    The Subcommittee hearing is adjourned.
    [Whereupon, at 11:40 a.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF SENATOR TIM JOHNSON
    Good morning. I am pleased to convene the first meeting of the 
Financial Institutions Subcommittee of my Chairmanship on a topic that 
has been of great interest to me for many years. Federal deposit 
insurance is one of the cornerstones of our banking and financial 
system. This insurance helps give depositors the confidence they need 
to participate in America's financial institutions. Since I began 
service in Congress in 1987, we have seen some real ups and downs in 
the banking industry, and it is a great privilege today to chair a 
hearing on a matter of such importance to our Nation's bankers, and 
indeed to our Nation as a whole.
    I would first like to recognize Ranking Member Bennett, and thank 
him for his participation at today's hearing. It is a great pleasure to 
work with Senator Bennett on banking issues. He has a very 
distinguished business background, and I value his insights. I would 
also like to recognize Chairman Sarbanes, who conducts all his hearings 
with such dignity and thought. I hope I can live up to the high 
standards that he sets for the Senate Banking Committee.
    As everyone in this room knows, or will surely find out in short 
order, comprehensive deposit insurance reform is enormously complex. I 
will resist the opportunity to recite a history of banking reform, and 
steer clear of too many statistics--at least until the question and 
answer period. While the body of literature on deposit insurance is 
vast, I would note that there appears to be more consensus than 
disagreement on potential reforms.
    At today's hearing, industry will respond to the FDIC's 
recommendations for comprehensive reform of the Federal Deposit 
Insurance System. The FDIC, in my view, has identified some significant 
weaknesses in the current system.
    In particular, it is hard to argue with the FDIC's observation that 
the current system is procyclical: that is, in good times, when the 
funds are above the designated reserve ratio of 1.25 percent, 92 
percent of the industry pays nothing for coverage; but in bad times, 
institutions could be hit with potentially crushing premiums of up to 
23 basis points. I think most industry members agree that this so-
called ``hard target'' presents a real threat to their businesses.
    Of course, this means that any movement in the funds down toward 
1.25 increases the anxiety level of bankers and regulators alike, 
whether that movement comes from fast growth of certain institutions, 
or from institutional failures like we saw last Friday in the case of 
Superior Bank of Illinois. The numbers are still preliminary, but cost 
estimates of the failure start at $500 million, which could reduce the 
SAIF ration by seven basis points. I say this not to be alarmist. But I 
would urge caution against becoming complacent in good times, and 
resisting changes that simply make sense over the long term and have 
the potential to enhance the stability of our system.
    I am particularly interested in hearing from the witnesses about 
their positions on premiums. I would note that there is unanimity among 
the Federal banking regulators that institutions should pay regular 
deposit insurance premiums, though not with respect to how we should 
determine those premiums.
    Now, I understand that 92 percent of the industry is free from 
current premium payments, and it certainly presents an interesting 
psychological and political challenge to persuade folks to pay for 
something they currently get for free. On the other hand, I am not the 
first to note that very few things in life are, in fact, free. If you 
are getting something of value, eventually you have to pay for it. The 
question is not whether you will have to pay up; it is when and how 
much.
    I am also interested in hearing comments about the erosion in value 
of deposit insurance. My position is well known: I believe we need to 
increase, and index, coverage levels. Over the last 20 years, coverage 
values have decreased by more than half, and previous increases were 
unpredictable both in terms of amount and timing. I expect to hear a 
spirited debate on this topic, and believe it should be included in any 
discussion of comprehensive reform.
    I would urge everyone involved in this debate to take a step back 
and recognize that when we talk about deposit insurance, we are talking 
about the foundation of our financial system. It is simply 
irresponsible to take a short-term approach, or to politicize the 
issues. And while I am open to persuasion on just about any component 
of reform, I am firm in my belief that we all share the common goal of 
a safe and sound banking system.
    As many of you know, I am committed to ensuring that our small 
banks and thrifts--which play such an important role in States like 
South Dakota--have the tools they need to survive. I am also well aware 
of the value that our larger banks, thrifts and bank holding companies 
bring to this country. I believe my strong support of financial 
modernization speaks for itself, and would simply add that I am 
committed to finding a reform package that considers the needs and 
interests of all members of our financial services community.
    Now some might argue that it will be impossible to craft changes to 
our deposit insurance system that will bring all the interested parties 
together. I reject this argument. First, every single bank and thrift 
in this country benefits from our world-class deposit insurance system, 
and it is in everyone's interest to find an acceptable set of changes. 
Second, I believe that our witnesses will tell us that the industry is, 
in fact, close together on many of the core reform issues. Finally, the 
regulators themselves have said they are approaching consensus on many 
issues. I am optimistic that we will be able to develop a sound 
comprehensive reform policy.
    I would like to hear what my colleagues and our witnesses have to 
say, and would invite Ranking Member Bennett to make an opening 
statement.
                               ----------
             PREPARED STATEMENT OF SENATOR PAUL S. SARBANES
    I thank Senator Johnson, Chairman of the Financial Institutions 
Subcommittee, for holding this morning's hearing on the important 
subject of possible Federal Deposit Insurance System reform. Any reform 
effort will demand a thorough analysis of the issues and today's 
hearing contributes to that effort.
    On April 5, 2001, the FDIC published a report on reforming the 
deposit insurance system. The FDIC recommended:

 Merging the Bank Insurance Fund (BIF) and Savings Association 
    Insurance Fund (SAIF) to reduce risk.
 Charging insurance premiums based on an institution's risk to 
    its insurance fund, or ``risk-based premiums.''
 Shifting from a fixed reserve ratio of 1.25 percent of insured 
    deposits to a target range of reserve ratios to give FDIC 
    flexibility and to eliminate sharp swings in insurance premiums.
 Rebating premiums based on an institution's historical 
    contributions to an insurance fund when the fund grows above a 
    target level.
 Indexing deposit insurance coverage levels by the amount of 
    inflation.

    Last week, the Treasury Department, Federal Reserve Board, 
Comptroller of the Currency, and the Office of Thrift Supervision 
announced their views on the FDIC's recommendations. They all supported 
merging the funds. They also supported the concept of giving the FDIC 
greater flexibility to allow a range of reserve ratios. The Treasury 
Department, Fed, and Comptroller did not support raising the amount of 
Federal deposit insurance coverage.
    Today's hearing is particularly timely in light of last Friday's 
failure of a major thrift, Superior Bank, FSB, of Illinois. The failed 
institution is projected to be the 11th most costly loss to the 
insurance fund in U.S. history. Reports suggest that the failure may 
cost the SAIF $500 million. In addition, customers with uninsured 
deposits may lose over $40 million.
    I am very concerned about this failure and have taken steps to 
inquire into its causes. I have sent letters to the Comptroller General 
of the United States, Inspector General of the Treasury Department, 
which has authority over the Office of Thrift Supervision, and the 
Inspector General of the FDIC and asked them to report on the reasons 
for the failure with recommendations for preventing future losses. I 
look forward to their responses.
    I look forward to hearing the testimony from representatives of the 
banking and the thrift industries on their views of the deposit 
insurance system and the FDIC's recommendations.
                               ----------
                PREPARED STATEMENT OF SENATOR JACK REED
    First of all, I want to commend Senator Johnson for holding this 
hearing. This is a very timely issue now, particularly with the House 
Financial Services Committee already holding several hearings on the 
subject. I am pleased that the Senate Banking Committee, within the 
appropriate Subcommittee, now has an opportunity to discuss the issue 
from our own perspective. I also understand from Senator Johnson that 
he intends to hold several hearings on this topic once Congress has 
returned from the August recess.
    Second, I want to thank all of the witnesses who are appearing 
before us this morning. I know that this is an important issue to all 
of you, and for those that you represent, so we are appreciative of 
your time and work in this effort, in order to better explain your 
positions to us at this time.
    Third, I want to just briefly speak of my feelings toward deposit 
insurance reform, and the importance I believe it holds in the context 
of this Committee's attention, and possible future action.
    The FDIC's Options Paper that it produced in April provides much 
sound advice on how Congress should proceed with reforming our deposit 
insurance system. Most importantly I think, it needs to be done sooner 
rather than later, and I certainly commend former FDIC Chairwoman Donna 
Tanoue for having the foresight to work on this issue and produce such 
a worthy product for discussion.
    It has been said many times before by others, including the 
distinguished Chairman of the Subcommittee, that the current system is 
procyclical and will harm the banks it seeks to assist by charging 
higher premiums during more difficult economic times. Therefore, it 
seems to behoove us to work together to enact a system that will have 
the opposite effect. In other words, we should change the system now 
during strong and healthy economic times, by potentially charging 
minimal premiums to institutions, based on their risk of course, and 
lessening the burden in the leaner years.
    Obviously, there are many complicated issues inherent in taking on 
a matter as complex as our deposit insurance system, and there are many 
different sides to the issue as well. That is why I am pleased that we 
are able to hear today from the major banking trade associations, and 
that we will hear from other interested parties in the weeks to come. I 
also look forward to working with Senator Johnson and others on the 
Committee on deposit insurance reform legislation in the near future. 
We have a long road and task ahead of us, but I am confident that we 
will produce thoughtful and comprehensive legislation at the end of the 
day.
    Thank you, Mr. Chairman.
                               ----------
               PREPARED STATEMENT OF SENATOR WAYNE ALLARD
    I want to thank Subcommittee Chairman Tim Johnson for holding this 
important hearing. I am a cosponsor of his legislation to index deposit 
insurance and I look forward to working on this and on the broader 
issue of deposit insurance reform. I think we have some excellent 
witnesses here today and I am looking forward to their testimony.
                               ----------
                PREPARED STATEMENT OF ROBERT I. GULLEDGE
             Chairman, President & Chief Executive Officer
               Citizens Bank, Inc., Robertsdale, Alabama
        Chairman of the Independent Community Bankers of America
                            on behalf of the
                Independent Community Bankers of America
                             August 2, 2001
    Good morning, Chairman Johnson, Ranking Member Bennett, and Members 
of the Subcommittee. My name is Robert I. Gulledge, and I am Chairman, 
President, and CEO of Citizens Bank, a community bank with $75 million 
in assets, located in Robertsdale, Alabama. I also serve as Chairman of 
the Independent Community Bankers of America (ICBA) \1\ on whose behalf 
I appear today. Thank you for this opportunity to testify on the very 
important issue of deposit insurance reform.
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    \1\ ICBA is the primary voice for the Nation's community banks, 
representing 5,000 institutions at nearly 17,000 locations nationwide. 
Community banks are independently owned and operated and are 
characterized by attention to customer service, lower fees and small 
business, agricultural and consumer lending. ICBA's members hold more 
than $486 billion in insured deposits, $592 billion in assets and more 
than $355 billion in loans for consumers, small businesses, and farms. 
They employ nearly 239,000 citizens in the communities they serve. For 
more information, visit www.icba.org. 
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    I want to commend you, Chairman Johnson, for scheduling this 
hearing and giving this matter priority attention. Deposit insurance is 
of enormous importance to community banks and their customers--and to 
the safety and the soundness of our financial system.
    Few would dispute that Federal deposit insurance has been an 
enormously successful program, enhancing financial and macroeconomic 
stability by providing the foundation for public confidence in our 
banking and financial system. It has done what it was established to 
do--it has prevented bank runs and panics, and reduced the number of 
bank failures. Even at the height of the S&L crisis, there was no panic 
or loss of confidence in our financial system. The financial system and 
our economy are stronger and less volatile because of Federal deposit 
insurance.
    But it has now been more than 10 years since the last systematic 
Congressional review of our deposit insurance system, and it should be 
modernized and strengthened. In the past two decades since deposit 
insurance levels were last increased, inflation has ravaged the value 
of this coverage. Inflation has eroded the real level of deposit 
insurance coverage to less than half what it was in 1980. The less 
deposit insurance is really worth due to inflation erosion, the less 
confidence Americans will have in the protection of their money, and 
the soundness of the financial system will be diminished. Rejecting an 
inflation adjustment to deposit insurance levels, as the Federal 
Reserve and Treasury Department did in testimony last week before a 
Subcommittee of the House Financial Services Committee, is a 
prescription for weakening a vital and successful U.S. Government 
program.
    The deposit insurance system currently remains strong, the industry 
is strong and the overwhelming majority of institutions are healthy, 
but as the FDIC states in its report ``Keeping the Promise: 
Recommendations for Deposit Insurance Reform'' (FDIC Report), there are 
emerging problems and room for improvement.
    Now while we can do it in a noncrisis atmosphere, is the time to 
consider comprehensive improvements to enhance the safety and the 
soundness of our Federal Deposit Insurance System and ensure that the 
effectiveness of this key element of the safety net is not undermined.
Emerging Issues
    The major deposit insurance reform issues that have emerged and 
should be addressed in a comprehensive legislative package include:

 Preserving the value of FDIC protection and coverage for the 
    future by substantially increasing coverage levels and indexing 
    these new base levels for inflation.
 Establishing a pricing structure so that rapidly growing 
    ``free-riders'' pay their fair share into the deposit insurance 
    funds (these free-riders like Merrill Lynch and Salomon Smith 
    Barney have also used multiple charters to offer coverage levels 
    well beyond the reach of community banks).
 Smoothing out premiums to avoid wild swings caused by the hard 
    target reserve ratio (so banks do not pay unreasonably high 
    premiums when they and the economy can least afford it).
 Providing appropriate rebates of excess fund reserves.

    These issues, plus others addressed in the FDIC Report, are 
discussed below.
Deposit Insurance Coverage Has Been Eroded By Inflation and Should
Be Increased and Indexed for Inflation to Maintain Its Real Value
    For community bankers, the issue of increased deposit insurance 
coverage has been front and center in the deposit insurance reform 
debate. More coverage would benefit their communities, and their 
consumer and small business customers. It would help address the 
funding challenges and competitive inequities faced by community banks 
and ensure that they have lendable funds to support credit needs and 
economic development in their communities. For community bankers, any 
reform package will fall far short if it does not include a substantial 
increase in coverage levels and indexation.
    The ICBA strongly supports legislation introduced by Chairman 
Johnson and Representative Joel Hefley (R-CO) to raise Federal deposit 
insurance coverage levels. Both bills (S. 128 and H.R. 746) would 
increase FDIC coverage levels to around $200,000 and provide for 
automatic inflation adjustments (based on an IRS index) every 3 years 
rounded up to the nearest thousand dollars. Both bills have garnered 
substantial bipartisan support. Thirteen Senators are on the Johnson 
bill, 7 Democrats and 6 Republicans. Sixty-six Representatives have 
signed onto the Hefley bill, including 28 Democrats, 37 Republicans, 
and one Independent.
Coverage Levels Ravaged By Inflation
    The general level of income, prices, and wealth in the United 
States has been steadily increasing for decades. As a consequence, 
inflation is severely eroding the value of FDIC protection. The current 
deposit insurance limit is economically inadequate and unacceptable for 
today's savings needs, particularly growing retirement savings needs as 
the baby-boomer generation reaches retirement age.
    The real value of $100,000 coverage is only about half what it was 
in 1980 when it was last increased. Chart 1, which is attached, shows 
that simply adjusting for inflation, the $100,000 limit set in 1980 
represents only $46,564 in coverage today. Worse yet, as Table 1 shows, 
today's deposit insurance limit in real terms is worth $20,000 less 
than it was in 1974 when the deposit insurance limit was doubled to 
$40,000.
    Looked at another way, in 1934, when Federal deposit insurance was 
established, the coverage level was 10 times per capita annual income. 
Today, it is only four times per capita income. During the last two 
decades, while deposit insurance levels remained unchanged, financial 
asset holdings of American households have quadrupled, from $6.6 
trillion in 1980 to $30 trillion in 1999.
    Deposit insurance coverage levels have been increased six times 
since the program was created in 1934. But the increases have been made 
on an ad hoc basis with no predictability either on timing or the size 
of the increase. We need to first adjust coverage levels not touched in 
20 years and move away from ad hoc increases to a system that is 
predictable and grows automatically with inflation.
    The ICBA strongly supports the FDIC proposal to increase coverage 
levels to make up for inflation's devaluing effects by automatically 
adjusting the levels based on the Consumer Price Index. Using 1980 as 
the base year would raise coverage levels to nearly $200,000 (see Chart 
2 attached); using 1974 as the base year--the year coverage levels were 
raised to $40,000 --and would boost coverage to around $137,000 today.
Gallup Poll Shows Consumers Want Increase
    A recent survey conducted by The Gallup Organization \2\ on behalf 
of the FDIC revealed that Federal deposit insurance coverage is a 
``significant factor'' in investment decisions, especially to more 
risk-averse consumers and those making decisions in older and less 
affluent households. Fifty-seven percent of respondents said deposit 
insurance is ``very important'' in determining where to invest.
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    \2\ The Gallup Organization conducted telephone interviews with a 
randomly selected, representative sample of 1,658 adults who identified 
themselves as the people most knowledgeable about household finances 
age 18 or older, living in households with telephone service in the 
continental United States. The interview period ran from November 20 to 
December 23, 2000. The margin of error is plus or minus 3 percent.
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    Six in ten respondents said they would be likely to put more of 
their household's money into insured bank deposits if the coverage 
level of deposit insurance were raised. Six in ten said they would move 
their money into insured accounts as they neared retirement age or 
during a recession. The survey also showed that one in eight households 
keep more than $100,000 in the bank, and about one-third of all 
households reported having more than $100,000 in the bank at one time 
or another.
    Importantly, the Gallup survey indicated that nearly four out of 
five (77 percent) respondents thought deposit insurance coverage should 
keep pace with inflation.
Small Business Customers Support Increase
    Small businesses are key customers of the community banks, which in 
turn are premier providers of credit to these businesses. A recent 
study commissioned by the American Bankers Association (ABA) \3\ found 
that half of small business owners think the current level of deposit 
insurance coverage is too low. When asked what actions they would take 
if coverage were doubled, 42 percent said they would consolidate 
accounts now held in more than one bank; 25 percent would move money to 
smaller banks; and 27 percent would move money from other investments 
into banks.
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    \3\ ``Increasing Deposit Insurance Coverage: Implications for the 
Federal Insurance Funds and for Bank Deposit Balances,'' Mark J. 
Flannery, December 2000 (study was commissioned by the ABA).
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    Consumers and small businesses should not be forced to spread their 
money around to many banks to get the coverage they deserve. As more 
and more institutions base pricing on the entire customer relationship, 
consolidating accounts enables customers to reap the benefits of 
pricing and convenience when holding more of their financial ``wallet'' 
at one institution. For small businesses, especially, aggregating their 
business with one bank can enhance their banking relationship. And 
equally important, customers should be able to support their local 
banks, and local economies, with their deposits.
Increased Deposit Insurance Will Help Support Local Lending
    An adequate level of deposit insurance coverage is vital to 
community banks' ability to attract core deposits, the funding source 
for their community lending activities. Many community banks face 
growing liquidity problems and funding pressures. It is hard to keep up 
with loan demand as community banks lose deposits to mutual funds, 
brokerage accounts, the equities markets, and ``too-big-to-fail'' 
banks.
    Deposit gathering is critical to community banks' ability to lend 
because alternative funding sources are scarce. Due to their small 
size, unlike large banks, community banks have limited access to the 
capital markets for alternative sources of funding. As a consequence, 
community banks must rely more heavily on core deposit funding than 
large banks. To illustrate, at year end 1998, core deposits represented 
72 percent of assets for banks of less than $1 billion in size, and 
only 43 percent of assets for banks over $1 billion.
    The Federal Reserve's recent observation that small banks have 
enjoyed higher rates of asset growth and uninsured deposit growth than 
large banks misses the point. Since 1992, deposit growth has lagged the 
growth in bank loans by about half--hence small banks are finding it 
harder to meet loan demand that supports economic growth. Average loan-
to-deposit ratios are at historical highs and the ratio of core 
deposits to assets is declining as community banks fund a growing share 
of their assets with noncore liabilities such as Federal Home Loan Bank 
advances and other more volatile, less stable sources of funds such as 
brokered deposits. Federal Home Loan Bank advances are not a substitute 
for deposits. Bankers must pay higher rates for advances and other 
nontraditional funding than they do for deposits, putting pressure on 
net interest margins. Examiners are warning community banks against 
over-reliance on FHLB advances and other noncore funding sources.
    Some banks have seen a surge in deposit activity during the last 
two reported quarters. The instability of the stock market has caused 
some weary investors to pull out of the equities market and return to 
the safety and stability of banks. But most observers believe this is 
an aberration that may not continue when the market turns back up. 
Moreover, this phenomenon provides deposits to banks in a down economy 
when loan demand is weakened; it does not help address the need for 
funding when loan demand is strong.
    Large complex banking organizations (LCBO's) are acknowledged as 
presenting greater systemic risk to our financial system.\4\ The 
systemic risk exception to the least cost resolution requirement in 
FDICIA has never been tested. It is our belief, based on the historical 
record that LCBO's will never be allowed to fail because of this 
systemic risk factor. Government policy has fostered the establishment 
of ever-larger financial institutions further concentrating our 
financial system. Uninsured depositors in such institutions benefit 
from too-big-to-fail.\5\
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    \4\ In a speech before the National Bureau of Economic Research 
Conference on January 14, 2000, Federal Reserve Board Governor Laurence 
H. Meyer said, ``. . . the growing scale and complexity of our largest 
banking organizations . . . raises as never before the potential for 
systemic risk from a significant disruption in, let alone failure of, 
one of these institutions.''
    \5\ Thomas M. Hoenig, President of the Federal Reserve Bank of 
Kansas City, noted in a speech on March 25, 1999, ``To the extent that 
very large banks are perceived to receive governmental protection not 
available to other banks, they will have an advantage in attracting 
depositors, other customers and investors. This advantage could 
threaten the viability of smaller banks and distort the allocation of 
credit.''
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    The Federal Reserve spokesmen reject the notion that any bank is 
too-big-to-fail. The historical record, however, is to the contrary. 
Notably, the Secretary of the Treasury--not the Federal Reserve--has 
authority under FDICIA to make systemic risk determinations (after 
consultation with the President).
    In our judgment, the issue is not that FDICIA does not require that 
uninsured depositors and other creditors be made whole, as the Federal 
Reserve testified last week, but rather that the determination of 
systemic risk does permit all uninsured depositors to be made whole--as 
they have been made whole during previous banking crises.
    Increasing deposit insurance coverage would help level the playing 
field for community banks with large banks and large securities firms 
offering FDIC-insured products, while protecting the funding needs of 
Main Street America.
    According to Grant Thornton's ``Eighth Annual Survey of Community 
Bank Executives,'' \6\ 77 percent of community bankers favor raising 
the insurance coverage from its current level of $100,000 in order to 
make it easier to attract and retain core deposits.
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    \6\ ``The Changing Community of Banking,'' 2000 Seventh Annual 
Survey of Community Bank Executives, published by Grant Thornton LLP, 
March 2001.
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Full Coverage for Public Deposits
    The ICBA also supports full deposit insurance coverage for public 
deposits. Most States require banks to collateralize public deposits by 
pledging low-risk securities to protect the portion of public deposits 
not insured by the FDIC. This makes it harder for community banks to 
compete for these deposits with larger banks. Many community banks are 
so loaned-up that they do not have the available securities to use as 
collateral. And those that do have to tie up assets in lower yielding 
securities which could affect their profitability and their ability to 
compete. In addition, collateralizing public deposits takes valuable 
resources away from other community development and lending activities.
    As the FDIC noted in its report, ``Raising the coverage level on 
public deposits could provide banks with more latitude to invest in 
other assets, including loans. Higher coverage levels might also help 
community banks compete for public deposits and reduce administrative 
costs associated with securing these deposits.''
    Providing 100 percent coverage for public deposits would free up 
the investment securities used as collateral, enable community banks to 
offer a more competitive rate of interest in order to attract public 
deposits, and enable local governmental units to keep deposits in their 
local banks as a valuable source of funding that can be used for 
community lending purposes.
    ICBA strongly supports legislation, S. 227 and H.R. 1899, 
introduced by Senator Robert Torricelli (D-NJ) and Representative Paul 
Gillmor (R-OH) respectively, to provide 100 percent coverage of public 
deposits.
Full Coverage for IRA's and Retirement Accounts
    Today's retirement savings needs require a deposit insurance limit 
higher than $100,000. Retirement accounts are long-term investments 
that over time can reach relatively large balances that exceed the FDIC 
coverage limit. Today, accumulating $100,000 in savings for education, 
retirement, or long-term care needs is not a benchmark of the wealthy. 
With the graying of the population, safe savings opportunities are 
needed more than ever and an insured savings option is becoming even 
more crucial now that budget surpluses are reducing the supply of 
Treasury securities. Thus, raising the coverage level on IRA's and 
other long-term savings accounts could encourage depositors to invest 
more of these savings in insured bank deposits.
FDICIA Reforms Minimize Taxpayer Exposure
    Critics of proposals to substantially increase and index coverage 
levels contend that the 1980 increase to $100,000 was unjustified and 
increased the resolution costs of the S&L crisis. Overlooked, perhaps, 
is the fact that the Federal Reserve Board advocated this increase at 
the very time its monetary policies were driving the prime rate over 20 
percent to wring inflation out of the economy and Congress passed 
legislation deregulating interest paid on deposits. Also overlooked is 
the fact that the new $100,000 coverage limit helped stem depositor 
panic as thousands of the thrifts holding long-term, fixed-rate loans 
failed from the resulting severe asset liability mismatch.
    Higher coverage limits will not necessarily increase exposure to 
the FDIC or taxpayers as some fear. A variety of factors serve to 
minimize any increase in exposure to the FDIC or taxpayers from bank 
failure losses due to an increase in deposit insurance coverage levels.
    The reforms in bank failure resolutions instituted by the Federal 
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)--
including prompt corrective action, least cost resolution, depositor 
preference, and a special assessment when a systemic risk determination 
is made--are designed to reduce losses to the FDIC.
    Prompt corrective action helps ensure that swift regulatory action 
when a bank becomes critically undercapitalized so that losses do not 
increase while the bank's condition further deteriorates. Least cost 
resolution requires that--except in the case where the systemic risk 
exception is invoked--the FDIC uses the least costly method when a bank 
fails to meet its obligations to pay insured depositors only. And 
depositor preference minimizes the FDIC's losses by requiring that 
assets of the failed institution are first used to pay depositors, 
including the FDIC standing in the shoes of insured depositors, before 
other unsecured creditors are paid. And when a systemic risk 
determination is made, the FDIC must charge all banks an emergency 
special assessment to repay the agency's costs for the rescue.
    It is ironic indeed to hear policymakers talk about the moral 
hazard of increasing deposit insurance coverage to account for 
inflation when the trend of greater and greater deposit concentration 
in fewer and fewer banks that are likely too-big-to-fail because of 
systemic risk continues.\7\ The moral hazard, if any, created by 
inflation-indexing coverage pales in comparison to that presented by 
the increased number of LCBO's whose failure could have serious adverse 
effects and thus trigger the systemic risk exception of FDICIA. 
Systemic risk presents much greater loss exposure to the FDIC, and 
ultimately taxpayers, than does an increase in the coverage limit.
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    \7\ In 1980, 14,000 banks with less than $500 million in assets 
accounted for about 50 percent of total core deposits, and 11 banks 
with more than $20 billion in assets accounted for 15 percent of core 
deposits. By 1999, 7,800 banks with less than $500 million in assets 
accounted for only 20 percent of core deposits and 46 banks with more 
than $20 billion in assets accounted for 50 percent of core deposits.
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``Free Riders'' Must Pay Their Fair Share
    Currently, the FDIC is restricted from charging premiums to well-
capitalized, highly rated banks so long as the reserve level remains 
above the 1.25 percent designated reserve ratio. As a result, 92 
percent of the industry currently does not pay premiums, rapidly 
growing institutions do not pay their fair share for deposit insurance 
coverage, and the more than 900 banks that were chartered within the 
last 5 years have never paid premiums. According to the FDIC, this 
system underprices risk and does not adequately differentiate among 
banks according to risk.
    By the end of the first quarter of 2001, Merrill Lynch and Salomon 
Smith Barney had moved a total of $83 billion in deposits under the 
FDIC-BIF umbrella through two banks that Merrill owns and six banks 
affiliated with Salomon Smith Barney, without paying a penny in deposit 
insurance premiums. This dilutes the FDIC-BIF's reserve ratio, which is 
already lagging behind the FDIC-SAIF's, which doesn't face a similar 
inflow problem. Every $100 billion of insured deposit inflows drops the 
reserve ratio of the FDIC-BIF--which stood at 1.32 percent on March 31, 
2001 (down from 1.35 percent on December 31, 2000)--about six basis 
points.
    Once the 1.25 percent reserve ratio is breached, FDIC is required 
by law to assess all banks a minimum average of 23 cents in premiums 
unless a lower premium would recapitalize the fund within 1 year. How 
long it will be before the 1.25 percent designated reserve ratio is 
breached and premiums are triggered for all banks is not known. But 
today, past assessments on banks are subsidizing the insurance coverage 
for Merrill Lynch and Salomon Smith Barney! This inequitable situation 
must be remedied.
    Because Merrill Lynch and Salomon Smith Barney own multiple banks, 
they can offer their customers more than $100,000 in insurance 
coverage. Merrill with two banks can offer $200,000 in FDIC coverage, 
and Salomon Smith Barney is offering each of its customers $600,000 in 
FDIC protection. This could have a significant negative impact on the 
funding base of community banks. Most community banks cannot offer 
their customers more than $100,000 in deposit insurance coverage in 
this manner. Additionally, these huge institutions are too-big-to-fail, 
giving them another advantage over community banks in gathering 
deposits.
    If the FDIC were able to charge premiums to all banks, even when 
the reserve level is above 1.25 percent, it could collect premiums from 
Merrill Lynch and Salomon Smith Barney as they move deposits under the 
insurance umbrella. As it now stands, the FDIC is prohibited from 
charging them anything. Furthermore, if rapidly growing banks grew at a 
particularly fast rate, posing a greater risk, they could be charged 
premiums at a higher rate.
Regular Premiums
    The FDIC, Federal Reserve and Treasury have all recommended that 
the current statutory restriction on the agency's ability to charge 
risk-based premiums to all institutions be eliminated, and that the 
FDIC be allowed to charge premiums, even when the fund is above the 
1.25 percent designated reserve ratio.
    The recommendation to charge premiums to all banks, even when the 
fund is fully capitalized, faces controversy in the industry. However, 
we believe that in a carefully constructed, integrated reform package 
which includes substantial increases in deposit insurance coverage 
levels, bankers would be willing to pay a small, steady premium in 
exchange for increased coverage levels and less volatility in premiums. 
With a small, steady premium, bankers will be better able to budget for 
insurance premiums and avoid being hit with an unexpectedly high 
premium assessment during a downturn in the business cycle. Also the 
premium swings will be less volatile and more predictable. It is also 
one way to extract some level of premiums from the free riders and 
reduce the dilution of the reserve ratio.
Risk-Based Premium System Should Set Pricing Fairly
    The current method of determining a bank's risk category for 
premiums looks at two criteria--capital levels and supervisory ratings. 
The FDIC argues that this risk-weighting system is inadequate since it 
allows 92 percent of all banks to escape paying premiums when the fund 
is fully capitalized. The FDIC says that it cannot price risk 
appropriately under this method.
    The FDIC has proposed a sample ``scorecard'' to charge premiums 
based on a bank's risk profile. The FDIC is quick to point out that 
this example is not etched in stone, and the factors to be used to 
stratify banks by risk deserves more analysis and discussion. But the 
model can be used as a starting point.
    The FDIC proposes to disaggregate the highest-rated category of 
banks that currently do not pay insurance premiums (92 percent) into 
three separate risk categories based on a scorecard using examination 
ratings, financial ratios and, for large banks, possibly certain market 
signals as inputs to assess risk.
    Under this system, three premium subgroups would be created-- 42.7 
percent of the currently highest-rated institutions would pay a 1 cent 
premium, 26.5 percent would pay 3 cents, while another 23 percent would 
pay a 6 cent premium. The 8 percent of institutions that are currently 
charged premiums under the current system would fall into higher-risk 
categories and pay premiums ranging from 12 to 40 cents, as contrasted 
to the 3 to 27 cents they pay now. Under this example, the FDIC would 
collect $1.4 billion in annual premiums for an industry average of 3.5 
cents.
    The Treasury Department and the OCC have cautioned against making 
the risk-based premium structure unduly complex at this time, both in 
terms of assigning banks to risk categories and in setting premium 
rates for the various categories.
    The ICBA and community bankers generally support a risk-based 
premium system. However, we believe more study is needed to determine 
the appropriate risk factors, risk weighting, and complexity to be used 
in the matrix. Reaching consensus on the factors to be used to stratify 
banks into risk categories and the premiums to be charged in the 
various categories will take more thought and discussion.
    We are concerned that under the FDIC proposal, nearly 50 percent of 
banks that do not pay insurance premiums now would be paying either a 3 
or 6 cent premium (before rebates) during good times. We are also 
concerned about charging unduly punitive premiums against weak 
institutions. We are concerned as well that this system could create a 
reverse-moral hazard by encouraging banks to squeeze risk out of their 
operations and in the process reduce the amount of lending they do in 
their communities. Banking is not a risk-free enterprise.
    We do recommend, however, that while it would be appropriate for 
Congress to establish parameters or guidelines for the risk-based 
premium structure, the details of the structure should be set by the 
FDIC through the rulemaking process with notice and comment from the 
public. The FDIC is in a better position to judge the relative health 
of the insurance funds and the industry and can react more quickly to 
make changes in the premium structure as necessary.
Assessment Base
    The Treasury Department has recommended that deposit insurance 
reform consider whether the existing assessment base, which is domestic 
deposits, be modified to account for the effect of a bank's liability 
structure on the FDIC's expected losses. The Treasury notes that in the 
event of bank failure, secured liabilities including Federal Home Loan 
Bank advances have a higher claim than domestic deposits on bank 
assets, and may increase the FDIC's loss exposure.
    If consideration is to be given to changing the assessment base at 
this time, then Congress should look beyond assessing deposits and 
secured liabilities, which discriminates against community banks, and 
consider all liabilities (excluding capital and subordinated debt). For 
years, community banks have paid assessments on close to 90 percent of 
their liabilities, since domestic deposits are their primary funding 
source, while the largest banks--the too-big-to-fail banks--pay on less 
than 40 percent of liabilities since their funding comes in large part 
from nondeposit liabilities. Experience has shown that all nonassessed 
liabilities, not just deposits and secured liabilities, have funded 
excess growth and troubled loans of banks that subsequently failed. If 
the assessment base were to be expanded, it must be done so equitably.
Premiums Should Be Smoothed Out and Volatility Reduced
    The current statutory requirement of managing the funds to the hard 
1.25 percent DRR can lead to volatile premiums with wide swings in 
assessments. As noted above, under the current system, well-capitalized 
and well-run banks cannot be charged premiums so long as the reserve 
ratio is above the DRR of 1.25 percent. However, when the reserve level 
falls below 1.25 percent, the law requires the FDIC to charge an 
average of 23 cents in premiums unless the fund can be recapitalized at 
a lower premium in 1 year.
    This means there could be substantial fluctuations in premium 
assessments, depending on the extent of bank failure losses. The 
current system is dangerously procyclical with premiums the highest 
when banks and the economy can least afford it. Premiums could rise 
rapidly to 23 cents when economic conditions deteriorate, potentially 
exacerbating the economic downturn, precipitating additional bank 
failures and reducing credit availability by removing lendable funds 
from banks.
    The FDIC, Federal Reserve, and Treasury Department all recommend 
that the 1.25 percent hard target be eliminated, and the reserve ratio 
be allowed to fluctuate within a given range. The FDIC argues that the 
deposit insurance system should work to smooth economic cycles, not 
exacerbate them. For example, maintaining the current DRR of 1.25 
percent as a target, the reserve ratio could be allowed to fluctuate 
between 1.15 percent and 1.35 percent. Regular risk-based premiums 
would be charged so long as the ratio is within that range.
    However, in years when the ratio is below 1.15 percent, the FDIC 
suggests a ``surcharge,'' for example, equal to 30 percent of the 
difference between the reserve ratio and 1.15 percent. Alternatively, 
in years when the ratio is above 1.35 percent, there would be a rebate 
equal to 30 percent of the difference between the reserve level and 
1.35 percent. This would ensure that premiums rise and fall more 
gradually than under the current system.
    The ICBA supports eliminating the hard 1.25 percent DRR and 
instituting a range within which the funds can fluctuate without 
penalty or reward as part of a comprehensive reform package. Under the 
current system, banks could be faced with steep deposit insurance 
payments when earnings are already depressed. Such premiums would 
divert billions of dollars from the banking system and raise the cost 
of gathering deposits at a time when credit is already tight. This in 
turn could cause a further cutback in credit, resulting in a further 
slowdown of economic activity at precisely the wrong time in the 
business cycle. The agency says it would be preferable for the fund to 
absorb some losses and for premiums to adjust gradually, both up and 
down, around a target range.
    The FDIC also makes a strong case for maintaining 1.25 percent as 
the mid-point of such a range. The FDIC report showed that under 
various loss scenarios (no loss, moderate loss, and heavy loss), the 
fund never drops below .80 percent and it never goes above 1.5 percent. 
Gradual surcharges and gradual rebates help to keep the fund within 
this range.
Rebates
    Pricing and rebates go hand-in-hand. If premiums are charged to all 
institutions regardless of the fund's size, rebates represent a 
critical safety valve to prevent the fund from growing too large. The 
FDIC notes that in the best years, the rebate could result in a bank 
receiving a net payment from the FDIC. In an economy as relatively 
strong as we have today, more than 40 percent of banks would receive a 
net rebate.
    Importantly, under the FDIC proposal, the rebates would be based on 
past contributions to the insurance fund, and not on the current 
assessment base. This would have two advantages. It would not create a 
moral hazard that would encourage banks to grow just to get a higher 
rebate. And it would not unjustly enrich companies like Merrill Lynch 
and Salomon Smith Barney, which have transferred large deposits under 
the insurance umbrella without paying any premiums.
    We very strongly support this recommendation on rebates. It is only 
fair to those institutions that have paid into the insurance fund for 
years. And it would prevent free riders like Merrill Lynch and Salomon 
Smith Barney from earning rebates on premiums they never paid.
Merge the BIF and SAIF As Part of the Comprehensive Reform Plan
    Historically, banks and thrifts have had their own insurance funds. 
The BIF and the SAIF offer identical products, but premiums are set 
separately. Since the S&L crisis, when many banks acquired thrift 
deposits, many institutions now hold both BIF- and SAIF-insured 
deposits. More than 40 percent of SAIF-insured deposits are now held by 
banks.
    The FDIC, Federal Reserve, and Treasury Department all recommend 
merging the BIF and the SAIF as part of a deposit insurance reform 
package. They note that the lines between S&L's and banks have blurred 
to the point where it is difficult to tell them apart. They argue that 
merging the two funds would make the combined fund stronger, more 
diversified, and better able to withstand industry downturns than two 
separate reserve pools. The FDIC says costs also would go down since it 
would not need to track separate funds.
    The ICBA supports a merger of the BIF and the SAIF so long as it is 
part of a comprehensive and integrated deposit insurance reform package 
that includes an increase in coverage levels.
Conclusion
    In summary, Mr. Chairman, the ICBA believes it is critical to 
review the Federal Deposit Insurance System now in a noncrisis 
atmosphere. An ongoing strong deposit insurance system is essential for 
future public confidence in the banking system and to protect the 
safety and soundness of our financial system. The effectiveness of this 
key Government agency should not be permitted to be undermined or 
eroded away by a failure to preserve the value of its protection.
    Deposit insurance is critical to the thousands of communities 
across America that depend on their local community bank for their 
economic vitality. Without substantially increased deposit insurance 
coverage levels indexed for inflation, community banks will find it 
increasingly difficult to meet the credit needs of their communities 
and compete fairly for funding against the too-big-to-fail institutions 
and nonbank providers.
    We believe that deposit insurance reform should be comprehensive. 
The coverage levels should be raised and indexed for inflation. The 
hard 1.25 percent designated reserve ratio should be scrapped in favor 
of a flexible range. The statutory requirement that banks pay a 23 cent 
premium when the fund drops below the DRR should be repealed. A pricing 
structure that fairly evaluates the relative risks of individual banks 
without undue complexity should be instituted. Full deposit insurance 
coverage should be accorded to public deposits. And IRA's, education 
savings and retirement accounts should be accorded higher coverage 
levels. We urge Congress to adopt such an integrated reform package.
    We commend you, Mr. Chairman, for moving the debate forward. The 
ICBA pledges to work with you, the entire Committee, and our industry 
partners, to craft a comprehensive and an integrated deposit insurance 
reform bill that can work and can pass.
    Thank you, Mr. Chairman, for the opportunity to express the views 
of our Nation's community bankers.








                  PREPARED STATEMENT OF JEFF L. PLAGGE
                  President & Chief Executive Officer
                  First National Bank of Waverly, Iowa
                            on behalf of the
                      American Bankers Association
                             August 2, 2001
    Mr. Chairman, I am Jeff L. Plagge, President and CEO of First 
National Bank of Waverly, Waverly, Iowa, and a member of the Government 
Relations Council of the American Bankers Association (ABA). I am 
pleased to be here today on behalf of the ABA. ABA brings together all 
elements of the banking community to best represent the interests of 
this rapidly changing industry. Its membership--which includes 
community, regional, and money center banks and holding companies, as 
well as savings institutions, trust companies, and savings banks--makes 
ABA the largest banking trade association in the country.
    I would like to thank you, Mr. Chairman, for holding this hearing 
to examine some key issues related to the Federal Deposit Insurance 
Corporation (FDIC). We appreciate your long-held support of a strong 
banking and financial system, and in particular, your concern for 
community banks. We also greatly appreciate your leadership and your 
openness to working with the banking industry to develop reforms that 
enhance the deposit insurance system.
    Assuring that the FDIC's deposit insurance funds remain strong is 
of the utmost importance to the banking industry. Over the past decade, 
commercial banks and savings associations have gone to extraordinary 
lengths to rebuild the insurance funds, contributing $36.5 billion to 
ensure that the insurance funds are well-capitalized. With the Bank 
Insurance Fund (BIF) exceeding $31 billion and the Savings Association 
Insurance Fund (SAIF) at nearly $11 billion as of March 2001--
representing over $42 billion in financial resources--it is safe to say 
that FDIC is extraordinarily healthy.
    The outlook is also excellent. There have been few failures, and 
the interest income earned by BIF and SAIF (nearly $2.5 billion per 
year) is roughly three times the FDIC's cost of operation. As the 
current deposit growth rate moves back to the recent norm, as we expect 
it will, this interest income will likely continue to move the reserve 
ratio even further beyond the designated reserve ratio mandated by 
Congress. Moreover, the banking industry is extremely well-capitalized, 
adequately reserved for potential losses, and profitable.
    With the deposit insurance funds so strong, now is an appropriate 
time to consider how we might improve the overall system. To this end, 
the ABA has held extensive discussions with commercial banks and 
savings institutions, as well as with Members of Congress and their 
staffs and the FDIC, in order to facilitate the development of an 
approach that would both strengthen the system and be acceptable to a 
broad range of parties.
    Just this weekend, this issue was discussed in detail at ABA's 
Summer Meeting, which brings together our Board, Government Relations 
Council, the leadership of all the State Bankers Associations, and 
others. This testimony reflects the conclusions reached during that 
meeting.
    The FDIC has done an excellent job developing an approach that 
addresses many of the key issues. While we do not agree with everything 
in the FDIC's April 2001 report--and are particularly concerned about 
the possibility of increasing premiums--we believe it provides a basis 
for serious discussion.
    The ABA has stated for the past year and a half that a bill to 
strengthen the FDIC is likely to be enacted only if an industry 
consensus in support of such legislation can be developed. As you will 
see, while some differences remain, the positions of the ABA, America's 
Community Bankers, and The Independent Community Bankers of America are 
very similar. Our three associations have agreed that we should discuss 
the issues together on an ongoing basis and work together to develop 
legislation that would have broad support.
    I would add that while there is a general belief among most bankers 
that we should work with Congress to strengthen the FDIC, there is also 
deep concern that such legislation could evolve to increase banks' 
costs or to become a vehicle for extraneous amendments. If that were to 
be the case, we have no doubt that support would quickly dissipate and 
turn to opposition. Indeed, our Summer Meeting discussion emphasized 
that the ABA will have to oppose any FDIC reform legislation that 
results in a increase in premiums when the insurance funds (or a merged 
fund) are above the 1.25 percent designated reserve ratio, as they are 
today. Fortunately, we also believe working together, we can see a 
consensus bill develop that can have broad bipartisan support.
    In my testimony today, I would like to make several key points:

 Today's system is strong and effective, but some improvements 
    could be made. It is the position of the ABA that we have a 
    workable deposit insurance system that has the confidence of 
    depositors and banks. However, there are areas that can be 
    improved. Any reform should strengthen and improve the deposit 
    insurance system, enhance the safety and the soundness of the 
    banking system, and improve economic growth.
 A comprehensive approach is required. Because deposit 
    insurance issues are intrinsically interwoven, any changes must 
    consider the overall system. We are pleased that all the issues we 
    believe should be considered are on the table now. We recognize 
    that any final bill may not cover in full all of the issues given 
    political realities, but the Congress is engaging in a thoughtful 
    comprehensive process, which we appreciate.
 Changes should only be adopted if they do not create new costs 
    to the industry. The ABA will work to develop and support a 
    consensus position, but ABA will oppose deposit insurance 
    legislation that imposes new insurance costs or contains negative 
    add-on amendments not related to deposit insurance reform.

    I would like to discuss these points more fully, and in the 
process, discuss a few specific issues.
Today's System is Strong and Effective, But Improvements Could Be Made
    For over 65 years, the deposit insurance system has assured 
depositors that their money is safe in banks. The financial strength of 
the FDIC funds is buttressed by strong laws and regulations including 
prompt corrective action, least cost resolution, risk-based capital, 
risk-based premiums, depositor preference, regular exams and audits, 
enhanced enforcement powers and civil money penalties. Many of these 
provisions were added in the Financial Institutions Reform, Recovery 
and Enforcement Act of 1989 (FIRREA) and the FDIC Improvement Act of 
1991 (FDICIA).\1\ Taken together, these provisions should reduce the 
number of bank failures, lower the costs of those that do fail, and 
ensure that the FDIC will be able to handle any contingency. Even more 
important is that the banking industry has an unfailing obligation--to 
meet the financial needs of the insurance fund.
---------------------------------------------------------------------------
    \1\ See Apprendix A for details of these significant safeguards 
under current law that protect the FDIC funds.
---------------------------------------------------------------------------
    Simply put, the system we have today is strong, well-capitalized 
and poised to handle any challenges that it may encounter for decades 
to come. As with any system, there is room for improvement. We would 
propose three litmus tests for any reform: (1) it should strengthen and 
improve the deposit insurance system; (2) enhance the safety and 
soundness of the banking system; and (3) improve economic growth.
A Comprehensive Approach is Required
    The ABA firmly believes that any approach to reforming the FDIC 
should be done in a comprehensive manner. Since last year, support for 
a comprehensive approach has clearly grown. We are pleased that the 
FDIC's proposal released in April 2001 is comprehensive and basically 
has put most of the relevant issues on the table for discussion. In 
this section of my testimony, I want to give you ABA's perspective on 
what constitutes a comprehensive approach. Again, we recognize that any 
final bill may not cover in full all of the issues discussed below, but 
we respectfully suggest that all of them should be on the table.
Mutual Approach
    The ABA believes consideration should be given to the concept of 
including the current insurance program elements of a mutual approach 
in which banks are provided with some type of ownership interest. Under 
such an approach, dividends would be paid based on the ownership 
interest. This approach will help address the issue of new and fast 
growing institutions paying no premiums, since such institutions will 
not have the same dividend stream. A great deal more work needs to be 
done to develop a specific proposal. We believe, however, that when the 
fund reaches a designated cap (discussed below), dividends should be 
paid to banks and savings institutions based on a measure of their 
historic payments to the FDIC. The FDIC says it can track such payments 
and develop such a system. A dividend system based on previous 
contributions is fair because it is the accumulated interest income on 
those very contributions that boosted the fund beyond the cap. Thus, 
this represents a return on the significant sacrifices that were made 
to more than fully capitalize the insurance funds.
Deposit Insurance Limit
    As ABA stated last year, the current $100,000 insurance limit--set 
in 1980--has lost over half its value when adjusted for inflation. As a 
consequence, it is more difficult, particularly for smaller 
institutions, to raise sufficient amounts of funds to meet loan demand 
in their communities. For many banks, a source of funding is the number 
one issue. Recent increases in loan-to-deposit ratios demonstrate that 
many community banks are searching for funds to support loan demand. In 
discussing this issue, three items deserve consideration: (1) indexing 
the insurance limit to account for inflation; (2) raising the insurance 
limit above the current $100,000; and (3) providing additional coverage 
to IRA's and other retirement accounts held at banks. Let me briefly 
discuss each in turn.
Indexing
    There is general, although not unanimous, support within the 
banking industry for permanently indexing the level of deposit 
insurance coverage. Under an indexing system, the insurance limit would 
be automatically adjusted from time-to-time, based on changes in an 
appropriate index. These changes should be in level increments--that 
is, $5,000--to avoid consumer confusion. Without indexing, the 
insurance level constantly falls behind inflation, as Congress cannot 
be expected to regularly pass increases.
Base for Indexing
    There has been a great deal of discussion within the banking 
industry, as well as in the Congress and the regulatory agencies, about 
the appropriate year to use as the base for beginning any inflation 
adjustment. For example, as the FDIC has pointed out, if the base 
chosen were 1980 (when the limit increased from $40,000 to $100,000), 
the insurance level would be approximately $200,000 today to account 
for inflation; if 1974 were chosen (when the limit was increased from 
$20,000 to $40,000), the new limit would be approximately $140,000.
    In discussions with bankers over the last year on this topic, two 
questions have emerged about increasing the coverage level: (1) what 
are the potential economic costs; and (2) how many new deposits might 
flow into the banking system? To help answer these questions, ABA hired 
Professor Mark Flannery of the University of Florida. Dr. Flannery's 
study was extremely helpful in understanding the potential economic 
benefits and costs of various increases in the deposit insurance level.
    The study concluded--based on research conducted separately with 
bankers, individuals, and small business owners--that doubling coverage 
could result in net new deposits to the banking industry of between 4 
percent and 13 percent of current domestic deposits, with the lower end 
of the range more likely, in Flannery's opinion. Obviously, the amount 
of any increase would vary among individual banks, depending on their 
markets and business strategies. These hypothetical new deposits, plus 
the added protection that existing deposits (between $100,000 and 
$200,000) would receive, would lower the BIF-SAIF reserve ratio below 
the required 1.25 percent. This would eliminate the $3.2 billion 
cushion that exists today and would, under current law, require a 3-13 
basis point assessment on all domestic deposits to return the ratio to 
1.25 percent.\2\
---------------------------------------------------------------------------
    \2\ The full study is available at aba.com.
---------------------------------------------------------------------------
    This study--the first attempt to assign real numbers to a 
complicated and theoretical concept--stimulated considerable discussion 
in the banking industry. Several points of view emerged: First, there 
are many bankers who strongly believe a significant increase to 
$200,000 is important to improve their access to funding and that the 
benefit would exceed the potential cost. Second, there are also many 
bankers who are very concerned about the loss of the current buffer 
above the 1.25 percent reserve ratio and the potential for premium 
increases that would accompany a significant increase of the insurance 
limit. Third, there are bankers who expressed concerns about the 
acceptability of such an increase to Members of Congress, the Treasury, 
the Federal Reserve, and others.
    While there are differences of opinions in the industry, we believe 
that Congress should consider an increase in the current limit to the 
maximum possible that can be achieved without incurring significant 
costs that would outweigh the value of the increase. We appreciate your 
efforts, Mr. Chairman, to focus on this issue and the importance of 
attracting additional deposits into the banking industry to meet the 
credit needs of our communities. Of course, the bottom line is that we 
need to develop a comprehensive bill that addresses the key issues 
outlined in this statement that can also be enacted. We recognize that 
this is a controversial issue and therefore want to work with you to 
see what approach can be developed that can have the support necessary 
to be enacted.
Retirement Savings
    The ABA believes Congress should also consider the possibility of a 
higher level of insurance for long-term savings vehicles, such as 
IRA's, Keoghs, and any future private Social Security accounts if 
enacted. These are long-term investments that tend to grow considerably 
over time, frequently exceeding the current $100,000 limit. For 
example, at an interest rate of 6 percent, even an annual deposit of 
$2,000 in an IRA would grow with compounding to over $110,000 in 25 
years. And because stock market volatility may be particularly 
worrisome to retirees, the security of insured deposits is very 
appealing. Moreover, these deposits represent a very important, stable 
funding source for bank lending.
    A differential for retirement savings accounts is not a new 
concept. In fact, in 1978, the Congress passed the Financial 
Institutions Regulatory and Interest Rate Act that provided IRA and 
Keogh accounts coverage up to $100,000--two-and-a-half times the 
$40,000 limit that was in place at that time. The Senate Banking 
Committee Report on the Act supported the differential coverage in this 
way: ``The Committee believes that an individual should not have to 
fear for the safety of funds being saved for retirement purposes.'' 
Such a concern is as important today as it was then.
    We also note that some of the concern, expressed by some Members of 
Congress and others, about a general increase in the $100,000 limit is 
based on the problem of ``hot money'' moving to weak institutions, as 
occurred in the 1980's. However, this concern would not seem to apply 
to retirement savings, which are very clearly more stable.
Capping the Insurance Fund and Expanding the Rebate Authority
    The ABA has long advocated that the insurance fund should be capped 
and the rebate authority expanded. Not only are the BIF and SAIF 
currently fully capitalized, they are $3.2 billion over the 1.25 
percent designated reserve ratio (DRR) set by Congress following the 
difficulties in the 1980's. Moreover, with interest income exceeding 
the FDIC's operating expense by $1.5 billion a year, it is highly 
likely that the insurance funds will continue to grow, after deposit 
growth rates return to their norm, as we expect. The compounding effect 
will mean even greater rates of growth in the future. We believe the 
FDIC's proposal on this point--which for the first time acknowledges 
the importance of rebates as a check on excessive growth of the fund--
is a tremendous step forward. While in the past we have advocated 
direct rebates, a dividend approach, based on historic payments into 
the funds, accomplishes the same purpose and ABA supports that 
approach. The Federal Reserve and Treasury Department, in testimony 
before a House Financial Services Subcommittee last week, supported 
such an approach.
    The funds held in excess of the DRR are not necessary to ensure the 
soundness of the deposit insurance system. As I mentioned above, the 
FDIC has the authority to adjust premium levels and has significant 
regulatory powers over depository institutions to ensure that the FDIC 
can meet any funding contingency. Importantly, the FDIC also has the 
authority to set aside a reserve to cover anticipated future losses. 
The power of this reserve was clearly demonstrated in the early 1990's 
when the FDIC reserved $16 billion for future losses, $13 billion of 
which was never needed. Because this reserve is subtracted out of the 
funds' balances, the reserve ratios were dramatically understated at 
that time. This extra, and often overlooked, cushion provides an 
important tool for managing the funds resources. Perhaps most 
importantly, the banking industry is legally obligated to meet the 
financial needs of the insurance fund. Simply put, limiting the size of 
the fund and expanding the rebate or dividend authority will not affect 
the FDIC's ability to meet any future obligations to insured 
depositors.\3\
---------------------------------------------------------------------------
    \3\ See Appendix A for details of additional FDIC powers and 
authorities.
---------------------------------------------------------------------------
    The cost of FDIC holding excess reserves is very high. It 
represents a significant loss of lendable funds for banks in the 
communities they serve. I can tell you as a banker that I certainly can 
put rebates to good use in my community providing loans and services to 
my customers. This will have a far greater positive impact on economic 
conditions in Waverly, Iowa, than if that money sits in the 
Government's coffers in Washington.
    As noted above, we believe that viewing the FDIC more as a mutual 
insurer will naturally lend itself to a rebate system, through the 
payment of dividends. While the details of a cap and dividend system 
need to be worked out, we believe the 1.40 percent cap proposed in S. 
2293 (as introduced in the last Congress) and H.R. 4082 is a reasonable 
point at which to cap the funds. We thank Senator Santorum for his 
leadership on this issue.
    There is a precedent for this type of system. The National Credit 
Union Administration has provided over $500 million over the last 5 
years in dividends to credit unions. The dividend payment is designed 
to keep the National Credit Union Share Insurance Fund at 1.30 percent 
of insured deposits.
Premiums From Fast Growing Institutions
    Bankers believe there is an inherent unfairness in the current 
system that allows fast growing institutions to pay no premiums, even 
though their growth materially dilutes the coverage reserve ratio of 
the insurance funds. For many bankers this has become a top priority in 
FDIC reform. The problem of fast growing institutions can be addressed 
through a combination of a dividend/rebate system under the mutual 
approach and granting the authority to the FDIC to charge premiums in 
cases where institutions are growing by a defined percentage over 
average growth at banks.
Municipal Deposits
    In a number of States municipal deposits are a significant source 
of funding, particularly for community banks. However, collateral 
requirements for municipal deposits often entail a costly 
administrative burden and have a very large opportunity cost by tying 
up funds in securities that could otherwise be used for additional 
lending in the community. This situation varies by State. The ABA will 
continue to work on suggestions for addressing collateral requirements.
    A number of bankers advocate a 100 percent insurance on municipal 
deposits, or at least on local municipal deposits. They point to the 
huge administrative burden required to pledge bonds to collateralize 
these deposits, as well as the lost opportunities from holding excess 
bonds rather than making more loans. The ABA recognizes that 100 
percent has raised economic and political concerns with some Members of 
Congress due to ``moral hazard'' questions, and there is, frankly, no 
consensus within the industry on this issue at this point. There is, it 
is worth noting, precedent under current deposit insurance practices 
for a differentiation between municipal and other deposits. Therefore, 
we believe further work needs to be done on this issue. For example, 
consideration could be given to providing broader coverage or perhaps 
granting banks the option to purchase additional insurance for 
municipal deposits. Any such additional insurance should be limited to 
some definition of local deposits, and the cost of such additional 
insurance should fully cover any additional risk to the insurance fund.
Too-Big-To-Fail
    The ABA has long opposed the too-big-to-fail doctrine and worked 
with the Congress and regulators to include the limits on its use 
contained in FIRREA and FDICIA. Nevertheless, important aspects of this 
doctrine continue to exist. Deposit insurance reform provides an 
opportunity to revisit the too-big-to-fail doctrine, and hopefully, 
eliminate it fully.
Merger of the Funds
    In the context of comprehensive reform, a merger of the SAIF and 
BIF would be appropriate.
Smoothing Out Premiums
    The FDIC is recommending that the ``hard'' 1.25 percent 
``Designated Reserve Ratio'' (DRR) trigger be softened so that the 
industry would not be charged very high premiums all at once if the 
fund falls significantly below the 1.25 percent level. The ABA believes 
there is merit to smoothing premiums by eliminating the so-called ``23-
cent cliff '' as long as it does not result in additional net premium 
payments over the long run. The current system is, in effect, a major 
tax increase in a recession. It is procyclical and would undermine any 
economic recovery.
    We are, however, troubled by the suggestion in the FDIC's proposal 
that a band around the 1.25 DRR be established under which no rebate 
(if over-funded) or surcharge (if under-funded) would be provided. The 
FDIC would still charge regular premiums within this band. If the goal 
is always to return to the DRR level, then there should be no band 
around that level. Since the majority of the time there are few 
failures and losses, the fund will generally be above the upper level 
of the band. In effect, the broad approach would set a new de facto 
reserve level above 1.25 percent and would ignore the billions of 
dollars in lost lending opportunities of over-funding the FDIC.
Independent FDIC Board
    Consideration should be given to changing the FDIC Board to make 
sure it is truly independent, as it is designed to be. The most direct 
way to do that would be to have three independent board members. Since 
the board was expanded to five members in FIRREA, more often than not, 
there have been vacancies on the board. The vacancies tend to be the 
``outside'' seats because the seats held by the Comptroller of the 
Currency and the head of the Office of Thrift Supervision are always 
filled (either by the Comptroller or the head of OTS or acting 
directors of those organizations). Thus the Administration has 
generally had half of the Directors. Such an imbalance threatens the 
independence of the FDIC and could politicize decisions. Returning to a 
three-member independent board--which served the FDIC for well over 50 
years--should be considered as part of a comprehensive approach to 
reform.
Changes Should Only Be Adopted If They Do Not Create
New Costs To The Industry
    We must emphasize that we cannot support, and would oppose, any new 
approach that results in additional premium costs to those banks which 
are currently paying no premiums and which grow at normal rates. The 
example of a new premium structure used by the FDIC in its report 
would, for example, result in unacceptable premium increases for many 
banks. We see no justification for such increases when the insurance 
funds are above the required reserve ratio.
    There are several arguments made for charging premiums to at least 
some banks that now pay no premiums. First, it is argued that to charge 
no premiums means these banks are not paying for their insurance. We 
could not disagree more. Banks have paid for their insurance--they 
prepaid it. The billions of dollars in the BIF and SAIF are the result 
of premiums and interest on premiums. The fact that the FDIC is now 
self-funded is an extraordinary achievement.
    Moreover, banks are obligated to maintain the fund at 1.25 percent 
of insured deposits. If the fund falls below this level, all 
institutions pay to recapitalize the fund. This assures adequate 
funding of the insurance fund. Even more important is that the banking 
industry has an unfailing obligation--set in law--to meet the financial 
needs of the insurance fund. This means that the entire capital of the 
industry--over $600 billion--stands behind the FDIC funds.
    It is also worth noting that the commercial banks and savings banks 
are paying nearly $800 million each year to cover FICO and interest 
payments; despite the fact that these institutions had nothing to do 
with the crisis that led to the issuance of the FICO bonds. Therefore, 
we have fully paid up our insurance and more. We must remind Congress 
that the current premium system was a carefully negotiated compromise 
with our industry in exchange for the picking up of the FICO interest 
payments. We see no justification for Congresses' unilaterally 
reworking that ``agreement'' with our industry when the funds remain 
above the 1.25 percent reserve ratio.
    A second argument is that there must be gradations of risk in the 
upper category of banks. We are not at all persuaded that these 
gradations are significant or that the FDIC or anyone else has a system 
that can really make that differentiation with any degree of 
confidence. Furthermore, we believe there is a sort of ``grade on the 
curve'' implicit in this argument. The upper category is just that. 
Banks have worked hard to become stronger institutions, with strong 
capital; these banks are in the top category because they deserve to be 
there, as would be clearly shown by an historical perspective. We see 
no justification for changing the system now by arguing that there are 
too many banks in that category, after they have done what it takes to 
be strong, well-managed and well-capitalized.
    Of utmost importance, bank premiums are funds that otherwise could 
be lent and invested in local communities. Charging new premiums takes 
that money out of communities, undermining economic growth.
    Another potential cost that could severely impact bank lending 
would be a change in the assessment base related to Federal Home Loan 
Bank advances and other secured liabilities. This change was suggested 
in testimony last week by the Treasury Department. We believe that such 
actions are directly counter to the intent of Gramm-Leach-Bliley, which 
recognized the need for additional sources of funding for community 
banks, and the appropriate role that the Federal Home Loan Banks could 
play in filling that need. To alter the assessment base to now include 
Federal Home Loan Bank advances and other secured liabilities will 
hamper the ability of banks to fund themselves and their communities.
    We would also note that changing the risk-based premium system may 
trigger other problems and costs. For example, the scoring system 
suggested by the FDIC could impose additional regulatory burdens and 
may conflict with examination ratings of the OCC, the Federal Reserve, 
and State banking departments. The Federal Reserve, in testimony last 
week before a House Financial Institutions Subcommittee, raised 
questions about how this new system might work. The Treasury Department 
noted in the same hearing that the approach was complicated and 
suggested it not be included in this legislation.
Conclusion
    Mr. Chairman, we greatly appreciate the speed with which you have 
moved to hearings on this issue. We are prepared to work with you and 
the Members of this Subcommittee to find the best solution to these 
critical issues. We think this is an excellent time to begin that 
process--with the industry and the FDIC in excellent health. We sense 
there is a growing consensus on issues to be addressed and approaches 
to these issues. We look forward to working with you to see if we can 
develop and enact legislation to make the FDIC insurance system even 
stronger.
                               Appendix A
    Capping the insurance fund and providing rebates will not limit the 
FDIC's ability to meet any contingency. The FDIC has great flexibility 
to manage the funds to maximize effectiveness, and there are many 
existing laws that help protect the funds. For example, consider:
    Reserves for Future Losses: FDIC has great flexibility to adjust 
reserves for future losses. This reserve fund is subtracted from the 
fund balance when calculating whether the fund is fully capitalized--
for example, if the fund balance is at least 1.25 percent of insured 
deposits. Obviously, the larger the reserve for future losses, the 
smaller the fund balance. Once the fund balance falls below 1.25 
percent of insured deposits, premiums must be charged by the FDIC to 
fully capitalize the fund. Thus, if FDIC anticipates greater potential 
losses, it can merely set aside reserves, potentially creating a 
situation where banks would have to pay premiums to maintain the 
capitalization level of the fund. The FDIC has suggested that this 
``hard'' target of 1.25 percent be ``softened'' allowing a slower 
recapitalization than possible under current law. It is important to 
note that even with such a change, the FDIC still would be able to set 
aside reserves for future losses, thereby affecting the level of the 
fund relative to the 1.25 percent level.
    Authority to Raise the Designated Reserve Ratio (DRR): The FDIC has 
the authority to raise the DRR if it can document that it is justified 
for that year ``by circumstances raising a significant risk of 
substantial future losses to the fund.'' By raising the DRR, the FDIC 
would likely be raising the assessments necessary to maintain that new 
higher level. Thus, if the FDIC foresees problems, it has this 
additional authority to easily deal with the situation.
    Risk-Based Premiums: Risk-based premiums were authorized in 1991 by 
the Congress and implemented in 1993. Several important points should 
be made: First, the risk-based system provides an automatic self-
correcting mechanism. If industry conditions deteriorate and the banks' 
capital falls or supervisory concerns arise, a higher risk-premium is 
charged and more income is received in the fund. The FDIC has been 
critical of the fact that nearly 92 percent of the industry falls in 
the top-rated category and therefore pays no premiums. On the contrary, 
the incentives are such that nearly all banks want to be in this top 
category, and given the economic performance of the economy and the 
banking industry over the last decade, it is no wonder that such a high 
percentage enjoys the benefits of such a rating.
    Second, the FDIC has made additional changes to the risk-based 
system designed to identify patterns that signal future problems for 
individual banks. This should serve to improve the sensitivity of the 
risk-based system to changes, and build in the automatic adjustments 
sooner than would otherwise have been the case.
    Mandatory Recapitalization: If the reserve ratio falls below the 
DRR, the banking industry must immediately rebuild the fund back to the 
DRR. If the rebuilding is expected to take longer than one year, a 
mandatory recapitalization plan at very high assessment rates (minimum 
23 basis points of domestic deposits) must be established. Thus, if the 
industry continues to grow, the practical impact is that the fund 
balance will never fall below 1.25 percent of insured deposits for any 
length of time. In dollar terms, the fund would therefore always be 
over $35 billion. We agree with the FDIC that, in times of stress, the 
high premiums that would be required to maintain the DRR may be 
counterproductive. Moreover, a ``hard'' 1.25 percent level means that 
the benefits of such a large fund cushioning the shock of bank failure 
losses is lost. While maintaining a level of capitalization is 
important to preserving depositor confidence, proposals that would 
require a slower rebuilding would be beneficial to maintaining credit 
availability during difficult economic times. Again, it is worth noting 
that the reserves of future losses, mentioned above, provide a 
cushioning effect and should mitigate large upward swings in premiums.
Additional Authorities That Protect FDIC
    Beyond the flexibility to adjust the deposit insurance funds to 
meet any contingency, there are other important laws and regulations 
that have fundamentally changed the operating environment for FDIC. 
Taken together, these provisions lower the probability of banks failing 
and they reduce the cost to the FDIC from those that do fail.

 Prompt Corrective Action: This established mandatory 
    regulatory actions as capital levels fall below the minimum 
    requirements.
 Critically Undercapitalized Institutions: This requires 
    mandatory conservatorship or receivership of institutions with 
    capital less than 2 percent. Theoretically, if receivership takes 
    place, the FDIC should suffer no losses on the institution at all.
 Holding Company Guarantees /Cross Guarantees: This requires 
    the holding company to guarantee compliance with recapitalization 
    plans of the bank and puts losses on sister banking institutions of 
    a holding company in the event that one bank subsidiary fails. By 
    expanding the obligation to cover losses, the FDIC effectively 
    reduces its loss exposure.
 Depositor Preference: This law elevates the FDIC's claim above 
    general creditors (standing in place of the insured depositors that 
    it has made whole) in the receivership of any failed bank. This 
    superior claimant position will certainly lower resolution costs to 
    the FDIC.
 Rules Restricting Too-Big-To-Fail: FDIC may not take any 
    action, directly or indirectly, that causes a loss to the insurance 
    fund by protecting depositors for more than the insured portion of 
    deposits or by protecting creditors other than depositors.\4\
---------------------------------------------------------------------------
    \4\ There is a ``systemic risk'' exception to advance funds if 
needed to prevent a severe economic effect (upon a determination by the 
Secretary of the Treasury, in consultation with the President and 
written recommendation from the FDIC and the Fed). Any costs would be 
an obligation of the banking industry on a broader base of assets minus 
tangible capital and sub debt. Also, the Federal Reserve is restricted 
from providing discount window lending to ``undercapitalized'' 
institutions or those with CAMEL 5 ratings. This has the effect of 
preventing delays that would allow large, uninsured deposits to run 
before the bank was closed. This provision also extends discount window 
lending to other nonbank firms for emergencies.
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 Emergency Special Assessment Authority: This authority 
    requires the industry to repay any borrowing by FDIC and for any 
    other purpose deemed necessary.
 ``Least-Cost Rule:'' This requires the FDIC to resolve 
    failures in the least costly manner of all alternatives.
 Line of Credit Expanded: The 1989 law increased the FDIC's 
    line of credit to the Treasury from $5 billion to $30 billion and 
    made it mandatory for the industry to repay any borrowing.

    Simply put, limits on the size of the insurance fund and expanding 
the rebate authority poses no concern to the FDIC funds-- existing laws 
and regulations provide the needed flexibility to meet any financial 
obligation that may arise.
                               ----------
                  PREPARED STATEMENT OF CURTIS L. HAGE
             Chairman, President, & Chief Executive Officer
              Home Federal Bank, Sioux Falls, South Dakota
            First Vice Chairman, America's Community Bankers
                              on behalf of
                      America's Community Bankers
                             August 2, 2001
    Chairman and Members of the Committee, I am Curtis Hage, Chairman, 
President, and CEO of Home Federal Bank in Sioux Falls, South Dakota. I 
am here today representing America's Community Bankers (ACB) \1\ as 
their First Vice Chairman. ACB is pleased to have this opportunity to 
discuss with the Committee reform of the deposit insurance system. 
While the system is still healthy, rapid growth of insured deposits is 
highlighting the problems caused by an overly rigid statute that could 
result in damage to the banking system and the Nation's economy.
---------------------------------------------------------------------------
    \1\ ACB represents the Nation's community banks of all charter 
types and sizes. ACB members pursue progressive, entrepreneurial, and 
service-oriented strategies in providing financial services to benefit 
their customers and communities.
---------------------------------------------------------------------------
    Rapid growth is diluting the insurance funds as they stretch to 
cover more deposits. And inevitably, the FDIC must sometimes use those 
funds to protect depositors. As a result of a failure last week, the 
FDIC's Savings Association Insurance Fund (SAIF) will reportedly lose 
$500 million--5 percent of the total in the fund. A loss that size 
would reduce the SAIF's reserve ratio from 1.43 percent of insured 
deposits to 1.36 percent. The Bank Insurance Fund (BIF) had already 
fallen to 1.32 percent through a combination of rapid growth in insured 
deposits and similar losses.
    Both funds are still well above the statutory minimum of 1.25 
percent of insured deposits. However, under a statutory requirement 
imposed in 1989, if a fund falls below the 1.25 percent reserve 
requirement, the FDIC must impose premiums. If a fund is projected to 
take over a year to exceed 1.25 percent, the FDIC must impose a 
statutorily mandated 23 basis point premium on all institutions in that 
fund. For a community bank with $100 million in deposits, that equals 
$230,000. This premium would be like a targeted tax increase, 
threatening to drag the economy closer to recession, and inhibiting 
community bankers' ability to help their customers.
    Fortunately, there is a ready solution to this problem. The Deposit 
Insurance Stabilization Act (H.R. 1293), introduced by Representatives 
Bob Ney and Stephanie Tubbs Jones, would eliminate the arbitrary 23 
basis-point requirement. Eliminating the 23 basis-point premium would 
give the FDIC flexibility to recapitalize the fund under a more 
reasonable schedule. The bill would also do what everyone agrees should 
be done, merge BIF and SAIF. A merged fund is stronger and would be 
less affected by either rapid growth or losses from failures. The bill 
would also permit the FDIC to impose a special premium on excessive 
deposit growth.
    ACB strongly recommends that Congress act on the Deposit Insurance 
Stabilization Act this fall, before either BIF or SAIF might fall below 
1.25 percent. We agree with incoming FDIC Chairman Don Powell that 
Congress need not deal with all deposit insurance issues at once. Our 
position does not rule out adding additional provisions. If Congress 
can quickly develop a consensus on other issues, such as capping the 
fund, providing for rebates, and modestly indexing coverage, ACB would 
endorse an expanded bill.
    On the coverage issue, ACB believes that Congress should focus on 
increasing protection for retirement savings. We strongly urge you to 
provide substantially more coverage for retirement savings than for 
other accounts, as was done before 1980. This is needed to provide 
adequate coverage for the variety of tax-advantaged savings accounts 
that have grown substantially over the years, as well as prepare for 
any Social Security reform, including self-directed accounts should 
Congress adopt that concept.
    While ACB believes the FDIC should reform the risk-based premium 
system, we strongly oppose the agency's proposal to impose a premium on 
all insured institutions when the funds are over the statutory reserve 
ratio. Healthy institutions that are not paying a premium today paid 
extraordinary premiums in the 1990's -- in effect prepaying for today's 
coverage. Despite the rhetoric being used, they are not getting free 
coverage.
    Congress should not let the objective of comprehensive reform be 
the enemy of the necessary--stabilizing the deposit insurance system.
The Most Urgent Issue
    The most urgent deposit insurance issue that we face today stems, 
in part, from the strength of the system. Since both the BIF and SAIF 
are above their statutorily required 1.25 percent ratio, the FDIC does 
not currently charge a premium to healthy institutions. A few companies 
are taking advantage of that situation by shifting tens of billions 
from outside the banking system into insured accounts at banks they 
control. Unfortunately, the magnitude of these deposit shifts dilutes 
the deposit insurance funds and reduces the designated reserve ratio. 
The problem is not that the FDIC is holding too few dollars-- earnings 
have kept BIF and SAIF balances relatively stable --but that those 
dollars are being asked to cover a rapidly rising amount of deposits in 
a few institutions. As former FDIC Chairman Tanoue said, ``other banks 
can rightly say that they are subsidizing insurance costs for these and 
other fast-growing banks.'' \2\
---------------------------------------------------------------------------
    \2\ Speech, May 10, 2001 (p. 2).
---------------------------------------------------------------------------
    As last week's failure demonstrated, this situation could worsen 
very quickly. A combination of rapid growth and just a few failures 
could trigger a 23 basis point premium. For my bank the cost of such a 
premium would be $1.4 million annually. For all banks in South Dakota 
the cost would be $31 million. That much capital can support over $300 
million in lending. These premiums could come at the worst possible 
time --when the national economy and some local economies are shifting 
to a different pace. Whenever they might come, they would divert 
resources from communities and shift them to Washington.
    How large is this free-rider problem? In 2000, Merrill Lynch swept 
$36.5 billion from its Cash Management Accounts into insured accounts 
at its two affiliated banks, effectively reducing the BIF reserve ratio 
by 2.15 basis points. Merrill has swept an additional $11 billion into 
those banks this year.
    Another major firm, Solomon Smith Barney has swept a total of $17 
billion into its six BIF- and SAIF-insured affiliates this year, making 
this program especially attractive to large investors. The FDIC now 
estimates that all of this activity has lowered BIF's reserve ratio by 
at least 3 basis points.
    ACB does not object to growth in insured deposits. These firms' 
activities are permissible under the current law, which never 
anticipated the current scenario. But two companies' growth plans are 
diluting the funds and reducing the designated reserve ratio at the 
possible expense of all insured banks. Without this dilution, the BIF 
reserve ratio would have increased, rather than fallen. And the FDIC is 
faced with a statutory prohibition on assessing for this growth.
    Because of these high-growth programs, institutions in every State 
could be forced to pay premiums. These institutions collectively paid 
billions into the FDIC in the late 1980's and the 1990's. In the early 
1990's, all FDIC-insured institutions paid approximately 23 basis 
points each year--again, $230,000 for each $100 million in deposits--
$900,000 annually for my bank. And in 1996 SAIF-insured institutions 
paid an additional 66 basis points--a total of $4.5 billion. My bank's 
share was $2.6 million. Those substantial payments brought the FDIC 
back to health. Now these premiums are being used, in effect to cover 
new deposits at a few rapidly growing institutions.
    To correct this situation, Congress should quickly pass H.R. 1293, 
or similar legislation. The bill does three things:

 Permits the FDIC to impose a fee on existing institutions for 
    excessive deposit growth so that the required reserve ratio can be 
    maintained. Currently, the FDIC may impose an excessive deposit 
    growth fee on new institutions or new branches. By allowing the 
    FDIC to impose fees on existing institutions, H.R. 1293 would 
    address the current ``free-rider'' problem.
 Merges the BIF and the SAIF. According to the FDIC, merging 
    the BIF and the SAIF would create a more stable, actuarially 
    stronger deposit insurance fund. A single, larger fund would be 
    less affected by either rapid growth or losses from failures.
 Allows for flexible recapitalization of the deposit insurance 
    fund. If the reserve ratio of the merged fund falls below the 
    required level of 1.25 percent, the bill would give the FDIC 
    flexibility in recapitalizing the fund over a reasonable period of 
    time. By repealing the automatic assessment of 23 basis points, 
    H.R. 1293 would give the FDIC authority to use a laser beam 
    approach, rather than a sledgehammer, to recapitalize the insurance 
    fund.

    ACB believes that Congress should act quickly on this legislation 
to help ensure the continued strength of the FDIC and prevent the 
unnecessary diversion of billions of dollars away from community 
lending to homeowners, consumers, and small businesses.
How the Excess Growth Premium Would Operate
    Ironically, Congress permits the FDIC to impose special assessments 
on de novo institutions.\3\ Congress recognized that these institutions 
can be expected to grow at rates that exceed the industry average and 
impose other risks. However, because of their relatively small size, 
they cannot be expected to dilute a multibillion dollar deposit 
insurance fund. The same thing cannot be said about an existing 
institution--now effectively exempt from premiums--that embarks on a 
new business plan that could add tens of billions to the insured 
deposit base. So the law correctly recognizes that de novo institutions 
are relatively risky. However, the law forces the FDIC to ignore the 
risk to the institution and to the insurance fund posed by an existing 
institution that begins growing at a rate significantly above the 
industry average.
---------------------------------------------------------------------------
    \3\ 12 U.S.C. 1815(d)(1)(A).
---------------------------------------------------------------------------
    A growth premium would avoid dilution of the fund by making the 
fund whole with respect to any excess growth, preventing the imposition 
of unnecessary premium costs on other institutions. The special growth 
premium would apply only to those institutions whose growth imposed a 
material impact on the fund. It would also not apply to growth through 
merger or acquisition. By definition, these deposits are already 
included in the insured deposit base, so shifting them from one 
institution to another does not dilute the fund.
    Assessing a special premium only on significant growth would allow 
premium-free growth by an ordinary institution that had developed a 
particularly successful business plan. But it would address the case 
of, for example, a diversified financial firm that was simply 
transferring significant amounts of uninsured funds under its effective 
control into its insured bank.
    ACB believes that the special premium should compensate the fund at 
the then-current reserve ratio to avoid dilution of the fund. The FDIC 
should have the flexibility to collect this premium over a reasonable 
period to avoid imposing an undue shock on the affected institutions. 
While the premium might be collected over time, it should be booked 
immediately as a receivable in the fund to maintain its coverage ratio.
Additional Provisions
    While ACB urges you to take immediate action on legislation to deal 
with the free-rider issue and eliminate the 23 basis point ``cliff,'' 
we welcome consideration of some additional reforms to the deposit 
insurance system. Our positions on these issues are discussed in detail 
in our comprehensive report to the FDIC, which we released in January. 
A copy of that report was distributed to you along with this testimony. 
What follows is a summary of ACB's position on issues on which a prompt 
consensus might emerge.
Coverage
    The industry has a mixed reaction to proposals to change deposit 
insurance coverage levels. Most ACB members are skeptical that 
increases in general deposit insurance coverage levels would 
significantly increase funding. Former FDIC Chairman Helfer is even 
more skeptical. Last year, she said, ``There is very little evidence 
that doubling the coverage limits will expand the deposit base of 
smaller banks. Community bankers that I have talked to think that very 
little benefit will result from a significant increase in coverage 
limits.'' \4\ Depositors with large sums may shift insured deposits 
from one bank to another to consolidate balances or take advantage of 
higher interest rates. But one bank's gain may well be another bank's 
loss.
---------------------------------------------------------------------------
    \4\ The Deposit Insurance System: What Reforms Make Sense?; Ricki 
Helfer, December 4, 2000; Address to America's Community Bankers, pp. 
9-10 (Helfer, December 4, 2000).
---------------------------------------------------------------------------
    A better approach would focus on increasing coverage for retirement 
savings, such as IRA and 401(k) accounts. Coverage should be increased 
to an amount substantially above the general coverage level. This is 
not a new concept; in 1978 Congress provided for $100,000 coverage for 
retirement savings accounts, two and one-half times the then-current 
level for regular savings. Higher retirement account coverage would 
provide a stable funding source for community lending and is extremely 
important to retirees and those nearing retirement.
    Additional retirement account coverage would help implement an 
important national policy. Congress has just provided substantially 
enhanced tax incentives to encourage individuals to accumulate 
retirement savings. These individual savings are often replacing 
resources that employers previously provided through defined-benefit 
pension plans. This shift in retirement funding has increased the 
burden on individuals to manage their own assets. As individuals 
respond to tax incentives, their retirement assets often exceed by 
substantial amounts the current $100,000 coverage limit. Since planners 
generally recommend that individuals shift these savings into more 
secure and stable investments as they approach retirement, a 
substantial increase in deposit insurance coverage for retirement 
savings would be particularly helpful. These plans could be easily 
defined by requiring that they meet the standards of the Internal 
Revenue Code. The increased coverage would also be useful if Congress 
adopts some version of private accounts under the Social Security 
System.
    In addition to a substantial increase in retirement coverage, to 
help maintain the role of deposit insurance in the Nation's financial 
system ACB supports indexing coverage levels. Congress should use as a 
base the last time it adjusted coverage primarily for inflation, which 
was done in 1974. At that time, it increased coverage to $40,000. 
According to the FDIC, if adjusted for inflation since that time, the 
current coverage limit would be approximately $135,000.
    As long as the fund is above its statutory minimum of 1.25 percent 
of insured deposits, a modest increase in coverage should not require 
an additional minimal premium. If unacceptable premium increases are a 
condition for an immediate increase in coverage, Congress should at 
least index coverage from the current $100,000 level.
    Indexing on a going-forward basis would certainly not justify any 
premium increase. However, it would maintain ``the same relative 
importance of deposit insurance in the economy over time. . . .'' \5\ 
Indexing using the current level would also end the debate over what 
year and level should be the basis for indexing. Depository 
institutions and the economy have adjusted to the current level of 
coverage. Indexing would effectively maintain that level without the 
need for more Congressional action.
---------------------------------------------------------------------------
    \5\ FDIC Options Paper, August 2000, p. 44.
---------------------------------------------------------------------------
    To simplify and reduce the cost of implementation, as well as to 
promote consumer understanding, we recommend that any increases be 
instituted only in $10,000 increments. Some ACB members are especially 
concerned that frequent small adjustments and accompanying disclosures 
would be more costly than any benefit they might realize from increased 
deposit funding.
Congress Should Set a Ceiling on the Fund
    ACB recommends that Congress set a ceiling on the deposit insurance 
fund's designated reserve ratio (DRR), giving the FDIC the ability to 
adjust that ceiling using well-defined standards after following full 
notice and comment procedures. In deciding the actual ceiling amount, 
ACB recommends that Congress ask the FDIC to provide it with a firm 
recommendation on where it should set a statutory ceiling. The agency 
has already done considerable historical analysis on the level of the 
funds and income needed to maintain them.\6\ Clearly, the agency could 
adapt that analysis to determine a reasonable ceiling to recommend to 
Congress.
---------------------------------------------------------------------------
    \6\ 60 Fed. Reg. 42680 (August 16, 1995).
---------------------------------------------------------------------------
    ACB agrees with Former FDIC Chairman Helfer's comment:

          I believe it is possible for the FDIC to develop analytical 
        tools that will permit it to identify a ceiling on the funding 
        needs of the deposit insurance system at any particular time--a 
        DRR that would change as circumstances change. . . . The 
        purpose of establishing a ceiling DRR is so that insurance 
        funds will not grow beyond a size that can be justified on the 
        basis of the needs of the deposit insurance system, thereby 
        withdrawing capital from banks who could have contributed to 
        economic growth by leveraging those funds to meet the economic 
        needs of their communities. Amounts accumulated in the system 
        over and above the DRR ceiling should be rebated to banks to 
        facilitate economic activity, which benefits every one.\7\
---------------------------------------------------------------------------
    \7\ Helfer, December 4, 2000, p. 12.

    Before increasing the ceiling, the FDIC should be required to find 
that a higher level is needed to meet a substantial and identifiable 
risk to the fund or the financial system. In addition, Congress should 
require the FDIC to follow a full notice and comment process under the 
Administrative Procedure Act before making any change to the ceiling.
Excess Reserves Should Be Returned to Institutions That Paid Premiums
    Reserves in the fund that exceed the ceiling should be returned to 
insured institutions based on their average assessment base measured 
over a reasonable period and based on premiums paid in the past. 
Rebatable premiums would include the 1996 SAIF special assessment, but 
not the high-growth special assessments.
    During the 106th Congress, ACB supported legislation introduced by 
Senators Rick Santorum (R-PA) and John Edwards (D-NC) and Reps. Frank 
Lucas (R-OK) and Mel Watt (D-NC) that would have set a 1.4 percent 
ceiling and used the excess to pay interest on FICO bonds.\8\ After the 
FICO bonds mature, excess funds above the ceiling would be rebated. The 
bill would have given the FDIC authority to change the ceiling. Reps. 
Lucas and Watt have reintroduced that legislation in the current 
Congress (H.R. 557).
---------------------------------------------------------------------------
    \8\ S. 2293 and H.R. 3278.
---------------------------------------------------------------------------
    ACB continues to believe that this is a constructive solution to a 
serious potential problem that could be caused by a substantially 
overcapitalized insurance fund. However, a broader approach could lead 
to full rebates more promptly than provided in the Lucas / Watt bill.
    The FDIC should also consider risk factors when calculating any 
rebate. This would allow the FDIC to provide a risk-based incentive to 
institutions without imposing a premium on the healthy institutions. 
Under a broader rebate program, these incentives could come into play 
before the FICO obligation ends. The riskiest institutions would get no 
rebates, while the safest institutions would get higher than average 
rebates. Those in between could expect average rebates. These 
differential rebates would provide the same risk-reduction incentive as 
variations in premiums. All institutions would know that as the fund 
approached the ceiling, they could expect to benefit by operating in a 
less risky manner.
    Whatever the mechanism Congress provides, resources not needed for 
reasonably foreseeable deposit insurance purposes should not remain in 
Washington.
Risk-Based Premiums
    Just as ACB urges Congress to prevent the imposition of a 23 basis 
point premium, we also support the current statutory language that 
prevents the FDIC from imposing premiums on well-capitalized and well-
run institutions when reserves are above required levels. The FDIC and 
others have recommended that the Congress repeal this policy, 
contending that institutions are getting ``free'' deposit insurance 
coverage. This is like contending that a single-premium annuity policy 
is free.
    Look at the numbers: From 1992 through 1996, BIF-insured banks paid 
a total of $19.9 billion, while SAIF-insured institutions paid over 
$8.4 billion. In 5 years, the total paid was a staggering $28.3 
billion. During that period, a $100 million deposit SAIF-insured 
institution paid $1.8 million in premiums. A comparable BIF institution 
paid $810,000. Those payments would cover 36 years of premiums for a 
SAIF institution and 16 years for a BIF institution if they paid the 
average premium assessed between 1950 and 1990.
    The industry stepped up to the plate to recapitalize their funds. 
As a result, the FDIC got the money over a 5 year period, gaining the 
opportunity to earn substantial interest that built up the funds. That 
is just the way a single premium annuity works. An insurance company 
charges less in nominal dollars than it expects to pay out, making up 
the difference and earning a profit by investing.
Conclusion
    ACB appreciates this opportunity to present our views on the 
significant deposit insurance issues before you today. The deposit 
insurance system is still strong, but could be made even stronger. We 
urge you to move quickly to give the FDIC the flexibility that it needs 
to deal with the strains imposed by extraordinary growth in insured 
deposits at a few institutions. Prompt passage of legislation like the 
Ney/Tubbs Jones bill (H.R. 1293) will strengthen and stabilize the 
system.
    In addition, Congress may wish to seek an early consensus on 
additional issues that could be added to this legislation. Indexing 
coverage, providing for increased coverage of retirement accounts, 
capping the size of the fund and providing for the rebates could result 
in comprehensive reform that would substantially improve the system.
    Deposit insurance is an essential part of our banking system. While 
a variety of opinions exist within the industry regarding what reforms, 
if any, should be enacted, general consensus exists that any reform 
should leave the FDIC stronger. It should continue and strengthen the 
original mission of the FDIC to protect depositors. America's Community 
Bankers is committed to working with you and your Committee, and others 
in the industry to help forge a bill that can move expeditiously 
through Congress.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM ROBERT I. 
                            GULLEDGE

Q.1. Some of the past concern about raising the deposit 
insurance level above $100,000 was the moral hazard of putting 
the American taxpayer at risk if financial institutions fail. 
Give me your thoughts as to why we should raise the deposit 
insurance level above $100,000 and place the American taxpayer 
at risk.

A.1. The reasons for raising the insurance level above $100,000 
are covered in detail in my written statement submitted for the 
hearing record, but I will summarize them below. The ICBA does 
not agree that raising the deposit insurance level above 
$100,000 will materially increase the risk to the American 
taxpayer. This is more fully described in my written statement, 
and also summarized below.
    Higher deposit insurance coverage levels would benefit 
communities, consumers, and small businesses. It would help 
address the funding challenges and competitive inequities faced 
by community banks and ensure that they have lendable funds to 
support their communities.
    Inflation has severely eroded the real value of FDIC 
coverage, which has been a bulwark of consumer confidence in 
our financial system, in the two decades since it was last 
adjusted. The current limit is inadequate for today's savings 
needs, particularly growing retirement savings needs.
    Higher coverage would benefit consumers. A recent Gallup 
consumer survey conducted for the FDIC showed that: 57 percent 
of respondents cited Federal deposit insurance as ``very 
important'' in determining where to invest; one in eight 
households keep more than $100,000 in the bank; one-third of 
all households reported having more than $100,000 in the bank 
at one time or another; and nearly four out of five (77 
percent) respondents thought deposit insurance coverage should 
keep pace with inflation.
    Reports of the 816 uninsured depositors at the recently 
failed Superior Bank, FSB demonstrate well the need for 
increased coverage. Some of those who will lose substantial 
sums include an injured worker who deposited a $145,000 
disability settlement the day before the thrift failed; and a 
woman who deposited $120,000 in proceeds from the sale of her 
deceased mother's home days before the thrift failed. Many of 
the uninsured had their retirement savings at the thrift, 
including one person with $3 million in an IRA. The ICBA 
supports substantially higher coverage levels for retirement 
savings.
    These stories demonstrate that depositors with more than 
the coverage limit are not necessarily wealthy or capable of 
exercising ``depositor discipline'' by scrutinizing their 
banks. If Federal bank regulators can be surprised by the true 
financial condition of a bank (as in the case of both the 
Superior and Keystone National Bank failures), then how can we 
expect the ordinary depositor to exercise ``depositor 
discipline''?
    Higher coverage would benefit small businesses. A recent 
ABA survey of small business owners found that half think the 
current level of deposit insurance coverage is too low. If the 
coverage were doubled, 42 percent said they would consolidate 
accounts now held in more than one bank; 25 percent would move 
money to smaller banks; and 27 percent would move money from 
other investments into banks.
    Higher coverage would benefit our communities. Consumers 
and small businesses shouldn't be forced to spread their money 
around to many banks to get the coverage they deserve. 
Customers should be able to support their local banks, and 
local economies, with their deposits.
    Higher coverage levels are needed to enable community banks 
to maintain sufficient core deposits to meet community lending 
needs as they lose deposits to mutual funds, brokerage 
accounts, the equities markets and too-big-to-fail banks. Since 
1992, deposit growth has lagged the growth in bank loans by 
about half--hence small banks are finding it harder to meet 
loan demand that supports economic growth. And because of their 
small size, the community banks lack access to the capital 
markets for alternative sources of funding.
    Community bankers in agricultural and rural markets are 
particularly faced with these difficulties. As the Federal 
Reserve Board noted in the attached July 27 letter to 
Representative Spencer Bachus (R-AL), who Chairs the Financial 
Institutions Subcommittee (House Financial Services), asset and 
deposit growth at small banks in agricultural and rural areas 
(see lines 6 and 7 of accompanying chart) between 1995 and 2000 
has failed to keep pace with asset and deposit growth for small 
banks in metropolitan areas (see line 8).
    Also, growth of uninsured deposits at agricultural banks 
(far right column of line 6) greatly lags growth of uninsured 
deposits at all other banks for this period, averaging 3.9 
percent annually compared to double-digit percentage annual 
increases at all other institutions. And other Federal Reserve 
data shows deposit growth for all small banks is lagging loan 
growth. We believe this to be direct evidence of the 
difficulties many community bankers face in attracting and 
maintaining core deposits to meet loan demand.
    FDICIA reforms minimize taxpayer exposure. Higher coverage 
limits will not necessarily increase exposure to the FDIC or 
the taxpayers. A variety of factors serve to minimize any 
increase in exposure to the FDIC or the taxpayers from bank 
failure losses due to an increase in deposit insurance coverage 
levels.
    The reforms in bank failure resolutions instituted by the 
Federal Deposit Insurance Corporation Improvement Act of 1991 
FDICIA-- including prompt corrective action, least cost 
resolution, depositor preference, and a special assessment when 
a systemic risk determination is made--are all designed to 
reduce losses to the FDIC.
    It is ironic to talk about the moral hazard of increasing 
deposit insurance coverage to account for inflation when the 
trend of greater and greater deposit concentration in fewer and 
fewer banks that are likely too-big-to-fail continues. This 
deposit concentration, not an increase in coverage levels, 
presents the greatest systemic risk and ``moral hazard'' in our 
financial system and to the loss exposure of the FDIC and the 
taxpayer. And even if an emergency determination of systemic 
risk is made by the Secretary of the Treasury, and if all 
depositors--and creditors--at Large Complex Banking 
Organizations (LCBO's) are again made whole, a special 
assessment on all banks will be levied to recover all of these 
bailout costs.

Q.2.a. Mr. Plagge's testimony says ``there is general, although 
not unanimous, support with the banking industry for 
permanently indexing the level of deposit insurance coverage.'' 
What percentage of your membership supports indexing the level 
of deposit insurance coverage? What percentage of your 
membership supports covering municipal deposits? What 
percentage of your membership supports covering IRA's, and 
other retirement accounts? What percentage of your membership 
would be willing to pay a small, steady premium?

A.2.a. While we have not conducted a formal, membership-wide 
survey of community banker support for indexing coverage, 
covering municipal deposits, IRA's and other retirement 
accounts, and paying a small, steady premium, the ICBA strongly 
supports all of these proposals as part of a comprehensive 
approach to deposit insurance reform.
    On the procedural level, the ICBA formulates its public 
policy positions through a multifaceted input and review 
process involving the organization's banker-elected and banker-
composed Executive Committee, Board of Directors (composed of 
over 100 bank and thrift executives from 48 States), 13 
separate issue committees (e.g., Federal Legislation, Policy 
Development, Regulation Review), as well as consulting with 
individual community bankers and State community banking trade 
associations affiliated with the ICBA.
    In addition to being approved and ratified by the ICBA's 
Policy Development Committee, Executive Committee and Board of 
Directors, our current policy resolutions were ratified by 
unanimous voice vote of the 1,300 community banker delegates to 
the ICBA Annual Convention held in Las Vegas, Nevada in March 
2001. Our policy resolutions on ``Deposit Insurance'' and 
``Community Bank Funding and Liquidity'' are attached.
    Our stance in strong support for comprehensive deposit 
insurance reform, including provisions to both substantially 
increase current coverage levels and index this new base for 
future inflation, is the result of community-banker 
deliberations over the course of the last several years. This 
process was intensified in March 2000 following former FDIC 
Chairman Donna Tanoue's announcement at the ICBA Annual 
Convention in San Antonio, Texas that her agency would be 
undertaking a thorough review of and make recommendations on 
Federal deposit insurance reform. Chairman Tanoue's speech 
mentioning proposals to increase and index coverage levels for 
inflation since 1980 drew a standing ovation from the community 
banker delegates at the convention.
    Throughout this process, all of the above-noted issues (and 
other possible reforms) have been considered, and often 
reconsidered, by various ICBA committees and ultimately our 
Executive Committee and Board of Directors. This process has 
provided our banker membership with extensive and repeated 
opportunities to weigh in on the issues under consideration and 
formulate the trade association's positions and advocacy 
strategies.
    With regard to paying a small, steady premium, I would 
reiterate my testimony at the August 2 hearing that the ICBA 
believes ``that in a carefully constructed, integrated reform 
package which includes substantial increases in deposit 
insurance coverage levels, bankers would be willing to pay a 
small, steady premium in exchange for increased coverage levels 
and less volatility in premiums.'' This will enable bankers to 
better budget for premiums and will help avoid unexpectedly 
high premiums during economic downturns. In addition, we 
believe premium swings would be less volatile and more 
predictable, and it would also result in ``free riders,'' like 
Merrill Lynch and Salomon Smith Barney which have now pumped 
upward of $100 billion into insured deposits, paying some level 
of premiums and thereby reduce further dilution of the 
insurance fund(s) reserve ratio.

Q.2.b. Mr. Plagge's testimony also discusses a study which 
shows that ``doubling coverage could result in net new deposits 
to the banking industry of between 4 percent and 13 percent of 
current domestic deposits, with the lower end of the range more 
likely.'' Also doing this ``would lower the BIF-SAIF reserve 
ratio below the required 1.25 percent.'' Is this worth the 
potential cost? Is it worth the potential for premium increases 
that would accompany a significant increase of the insurance 
limit?

A.2.b. The premium costs of an increase in deposit insurance 
coverage must be considered in the context of comprehensive 
reform. The ICBA believes that community bankers are willing to 
pay a small, steady, fairly priced premium as part of a 
comprehensive package that includes a substantial coverage 
increase. In a comprehensive package, the hard target 1.25 
percent reserve ratio would likely be replaced by a flexible 
range in order to reduce premium volatility. Premiums would 
remain steady as long as the reserve ratio stayed within the 
range. Thus, a dip in the reserve ratio below 1.25 percent in 
such a scenario would not result in increased premiums.

Q.2.c. What do you think of Mr. Hage's proposed bill to merge 
the BIF and the SAIF, allow for flexible recapitalization of 
the deposit insurance fund and permit the FDIC to impose a fee 
on existing institutions for excessive growth?

A.2.c. We believe Mr. Hage's proposed bill is too narrow. 
Instead, the ICBA supports a comprehensive approach to deposit 
insurance reform as more fully described in our answer below to 
Question 3.

Q.3.a. Mr. Powell indicated that perhaps all the FDIC proposed 
reforms did not have to be in one package. What would be on 
your ``must have in the bill'' list if you were making one?

A.3.a. The ICBA's preference, as noted in Answer 2 above, would 
be comprehensive legislation that: (1) substantially raises 
coverage levels and indexes the new base for future inflation; 
(2) increases coverage for public deposits and retirement 
products; (3) removes the current hard 1.25 percent designated 
reserve ratio in favor of a flexible range, with rebates, based 
on past contributions, when the fund exceeds the upper end of 
the range; (4) repeals the current statutory requirement that 
banks pay a 23 cent premium when the fund(s) drop below the 
DRR; and (5) institutes a pricing structure that fairly 
evaluates the risks of individual banks without undue 
complexity or cost, including the payment of a small, steady 
premium. Also, in the context of a comprehensive bill, the ICBA 
would not oppose merger of the BIF and the SAIF into a single 
insurance fund.
    The ICBA's bottom line on deposit insurance reform remains 
that we cannot support any legislative proposals that do not 
substantially increase current coverage levels and index the 
new base for future inflation.

Q.3.b. Should these reforms be done now?

A.3.b. Yes. The ICBA fully shares the view stated in the FDIC's 
recent report ``Keeping the Promise: Recommendations for 
Deposit Insurance Reform'' that the time for comprehensive 
action is now in a noncrisis atmosphere. Indeed, the recent 
Superior Bank, FSB failure should serve as a catalyst for 
action. Delay in dealing with the S&L crisis of the late 1980's 
not only prolonged the problem, but also greatly increased the 
costs of the bailout.
    The ICBA is also concerned that a piecemeal approach to 
deposit insurance reform will not result in all the important 
issues being addressed adequately, or possibly at all. Should 
Congress move on a limited package this year, as some suggest, 
momentum for action on other critical topics could well be 
lost. That would be unfortunate, as the ICBA joins the Senate 
Banking Committee's Financial Institutions Subcommittee 
Chairman Tim Johnson (D-SD), Representative Bachus, and others 
who believe the best way to deal with this complex situation is 
to face all the issues directly in a proactive fashion. To do 
otherwise could be an invitation to larger obstacles down the 
road.






                      2001 ICBA POLICY RESOLUTIONS

                               [Excerpts]
                           DEPOSIT INSURANCE
    A strong and well-functioning Federal Deposit Insurance System is 
the foundation on which consumer confidence in our banking and 
financial system rests. That confidence in turn plays a pivotal role in 
maintaining stability during difficult economic times. The Federal 
Deposit Insurance System has worked well for more than 65 years, but 
following the ``financial modernization'' accomplished in the Gramm-
Leach-Bliley Act, it is now time to review and modernize our Federal 
Deposit Insurance System as well.
Increased Coverage Levels
    ICBA strongly supports increasing deposit insurance levels and 
regularly indexing them for inflation to adequately preserve the value 
of its protection going forward. Deposit insurance coverage levels have 
not been increased in 20 years--the longest period in FDIC history 
without an increase. Deposit protection has been eroded in half due to 
inflation since 1980 and is inadequate for today's savings needs, 
particularly growing retirement savings needs. The less deposit 
insurance coverage is really worth due to inflation erosion, the less 
confidence Americans will have in the protection of their money, and 
the soundness of the financial system will be diminished.
    Adequate deposit insurance levels are also critical to community 
banks' ability to attract core deposits to support community lending as 
they lose deposits to mutual funds, brokerage accounts, the equities 
markets, and ``too-big-to-fail'' banks. Increased coverage levels will 
help local communities by enabling depositors to keep more of their 
money in local banks, where it can be reinvested for community projects 
and local lending.
    The ICBA also supports full deposit insurance coverage for in-
market municipal (public) deposits--taxpayer funds that should not be 
put at risk. State deposit collateralization requirements make it 
harder for community banks to compete for these deposits with larger 
banks. Many loaned-up community banks do not have securities available 
to use for collateral. Those that do must tie up assets in lower-
yielding securities affecting their profitability and ability to 
compete. Full deposit insurance coverage of in-market municipal 
deposits would free up the investment securities used as collateral, 
enable community banks to offer a more competitive rate of interest to 
attract municipal deposits, and enable local governmental units to keep 
deposits in their local banks and communities.
Other Deposit Insurance Reform Issues
    The FDIC has undertaken a timely and a comprehensive review of the 
Federal Deposit Insurance System. In addition to the issue of coverage 
levels, the FDIC is reviewing two other key issues: Fairness in deposit 
insurance pricing and funding insurance losses over time. The ICBA 
supports this comprehensive review and--in conjunction with an increase 
in the coverage level--supports efforts to reform the system to:

 Adequately assess deposit growth at rapidly growing 
    institutions--which currently pay no insurance premiums to offset 
    the dilution in the reserve ratio caused by their deposit growth 
    (``free rider'' problem).
 Appropriately differentiate pricing for individual 
    institutions based on risk.
 Reduce premium volatility by smoothing out premium payments to 
    remedy the current procyclical nature of deposit insurance 
    premiums--with premiums lowest when the industry is healthiest and 
    highest when the industry is weakest and can least afford to pay--
    caused by the hard target reserve ratio.
 Provide appropriate options for rebate of excess fund reserves 
    to the industry.
 More equitably apportion the costs of systemic risk 
    protection, recognizing that the benefits of a stable financial 
    system goes beyond the banking system alone.
                  COMMUNITY BANK FUNDING AND LIQUIDITY
                               [Priority]
    Community banks are facing serious funding and liquidity challenges 
as they find it harder and harder to attract and maintain core deposits 
to match asset growth and support community lending. According to the 
FDIC, deposits increased by only 4.1 percent in 1999, the smallest 
annual increase since 1993, while bank lending increased 7.8 percent. 
Community banks continue to see disintermediation of deposits to mutual 
funds, brokerage accounts, the equities markets, tax-free credit unions 
and ``too-big-to-fail'' banks. Alternative sources of funds at 
competitive prices for community banks are scarce because community 
banks lack ready and efficient access to the capital markets. By 
contrast, large commercial banks can access the capital markets for 
funds and use securitization to supplement deposits. High tax rates on 
traditional saving instruments such as certificates of deposit further 
encourage investment in higher risk investments and drain community 
bank core deposits.
Deposit Insurance Coverage Levels
    To stem the deposit flight out of local communities and enable 
community banks to better compete with the emerging financial 
conglomerates, the ICBA urges that Federal deposit insurance coverage 
levels be increased, and indexed for inflation going forward.
    Deposit insurance coverage has been frozen at $100,000 since 1980. 
Inflation alone has cut the real value of deposit insurance protection 
in half. The ICBA strongly supports an increase in deposit insurance 
coverage levels in order to help community banks attract additional 
core deposits. Improved access to Federal Home Loan Bank advances will 
help (see below), but more is needed as advances are not a complete 
substitute for deposits. Increased coverage levels will allow 
depositors to keep more of their money in local banks, thus boosting 
the supply of lendable funds at community banks and providing funds to 
keep local economies prosperous.
    While community banks now have more alternative funding sources, 
these sources cannot be relied on as a complete replacement for 
deposits. Community bankers recognize this and their examiners caution 
against too great a reliance on nontraditional funding sources. 
Community banks need to offer higher levels of deposit insurance to 
avoid overdependence on Federal Home Loan Bank advances.
Federal Home Loan Bank Access
    Federal Home Loan Bank System modernization provisions included in 
the Gramm-Leach-Bliley Act of 1999 represented a significant step in 
addressing community bank funding problems by providing Community 
Financial Institutions (insured depository institutions with less than 
$500 million in assets) greatly enhanced access to the Federal Home 
Loan Banks for long-term fixed-rate funding.
    The ICBA will continue its work to expand eligibility for direct 
access to longer-term funding sources as these provisions are 
implemented. The ICBA strongly encourages the FHLB's to move forward to 
implement their expanded collateral options available for Community 
Financial Institutions (CFI's) as rapidly as possible without 
jeopardizing safety and soundness. We urge the FHLB's to develop the 
products and programs to support their CFI members lending to 
agriculture and small businesses as envisioned by the legislation.
Other Sources
    ICBA will continue to work to improve community bank access to 
other longer-term funding from sources including the Farm Credit 
System, Farmer Mac and the Federal Reserve banks in order to be better 
able to meet their local lending demand. We call upon the Federal 
Reserve to review the operations of its discount window as a potential 
new long-term funding window for community banks.
    ICBA will continue to interface with banking regulators on the 
growing importance of community bank use of nondeposit sources of 
liquidity. ICBA will work to educate its members about funding 
alternatives and the asset/liability management challenges that arise 
with their use.
 RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM JEFF L. 
                             PLAGGE

Q.1. Some of the past concern about raising the deposit 
insurance level above $100,000 was the moral hazard of putting 
the American taxpayer at risk if financial institutions fail. 
Give me your thoughts as to why we should raise the deposit 
insurance level above $100,000 and place the American taxpayer 
more at risk?

A.1. The severe effect of inflation over the last 21 years has 
cut the real value of the $100,000 insurance limit in half. 
Thus, the coverage that individuals and importantly, small 
businesses, have received has diminished significantly over 
time. The importance of deposit insurance to maintaining the 
confidence of our system requires very careful consideration of 
the real value of the protection provided.
    A very important part of your question is what risk this 
poses to taxpayers. A critical provision, enacted in the FDIC 
Improvement Act of 1991, makes banks entirely responsible for 
any losses or other expenses of the FDIC. In effect, this means 
that the entire capital of the banking industry stands behind 
the funds. Therefore, the taxpayer risk is extremely small 
under our current system and an increase of the insurance limit 
would have no appreciable effect on this.
    Some observers have commented that the increase of the 
insurance limit from $40,000 to $100,000 in 1980 contributed to 
the losses in the S&L crisis. While this increase may have made 
it easier for some high-flying S&L's to fund their risky 
activities, the failure on the part of the S&L's regulator to 
close insolvent institutions was the primary cause of the 
significant losses. This, of course, was exacerbated by poor 
accounting methods, insufficient capital and lack of prompt 
regulatory action to prevent abuses from taking place or 
becoming worse. With such lax regulatory oversight, those high-
flying S&L's could have raised any level of funding regardless 
of whether the limit were $40,000 or $100,000.

Q.2.a. Mr. Plagge, your testimony says ``there is general, 
although not unanimous, support with the banking industry for 
permanently indexing the level of deposit insurance coverage.'' 
What percentage of your membership supports indexing the level 
of deposit insurance coverage?

A.2.a. While it would be impossible to say with any precision 
what percentage of our membership supports indexing, it is fair 
to say that the vast majority believes that indexing the fund 
going forward--whether the fund is indexed from $100,000 or 
some higher base level--would be appropriate. As I said in my 
statement, support is not unanimous. There are some 
institutions that believe that no change-- either increasing 
the current base of $100,000 or indexing going forward--should 
be undertaken. We base our response on discussions within our 
Government Relations Council (about 130 bankers from every 
State and all bank sizes), but also discussions held in 
numerous forums and meetings throughout the country over the 
last 18 months.
    It is very important to remember that as the real value of 
the insurance limit has fallen with inflation, it becomes 
increasingly difficult, particularly for smaller institutions, 
to raise sufficient amounts of funds to meet loan demand in 
their communities. For many banks, a source of funding is the 
number one issue. Recent increases in loan-to-deposit ratios 
demonstrate that many community banks are searching for funds 
to support loan demand. Thus, there is an important public 
policy issue that underlies the need to keep the insurance 
coverage limit revised to reflect inflation.

Q.2.b. What percentage of your membership supports covering 
municipal deposits?

A.2.b. It would be difficult to estimate a percentage with any 
precision as there are varying opinions on increasing coverage 
for municipal deposits, and frankly, there is not a consensus 
within the industry. Some of our members support full coverage 
on municipal deposits. They believe that there is no economic 
difference to the municipality whether the deposits are fully 
secured or fully insured by the FDIC, yet there is a big 
difference in the management of the collateral, which is costly 
and time-consuming to administer and often absorbs resources 
that would have otherwise been used for lending. There are also 
other bankers who support a system that would allow them to 
purchase additional insurance from the FDIC to cover these 
deposits, perhaps at limits to $5 million or $10 million 
(reflecting the level of deposits that are often associated 
with these deposits). As the collateral rules are dependent on 
State law and regulation, the opinions on the importance of 
coverage vary from State-to-State. There are also bankers who 
want no change. ABA believes that the issue should be under 
consideration as legislation is developed. It is worth noting 
that there is precedent under current deposit insurance 
practices for a differentiation between municipal and other 
deposits.

Q.2.c. What percentage of your membership supports covering the 
IRA's, and other retirement accounts?

A.2.c. The vast majority of bankers support a differential 
coverage limit on IRA's, Keoghs, and other retirement accounts. 
Again, there are some institutions that are opposed to any 
increase of any sort in the level. As noted in ABA's testimony, 
there is precedent for differential coverage: Between 1978 and 
1980, the coverage for IRA's and Keoghs was two-and-a-half 
times ($100,000) the limit at that time ($40,000). The recent 
failure of Superior Bank has highlighted the fact that many 
people have retirement savings that exceed the insurance limit. 
This is not ``hot'' money and well-deserves special 
consideration. Moreover, the retirees are hardly the source of 
market-discipline that would constrain risk-taking at financial 
institutions.

Q.2.d. What percentage of your membership would be willing to 
pay a small, steady premium?

A.2.d. Increasingly bankers have become concerned about the 
potential costs that a revised risk-based assessment system 
would involve. Thus, there is very strong and near universal 
opposition to any reform that would entail additional costs to 
the industry. The ABA strongly opposes this concept when the 
fund is above 1.25 percent of insured deposits. The industry 
does recognize that there is potential for the fund to fall 
below the 1.25 percent level and that costs would arise at that 
time. Moreover, changes such as increasing the insurance limit 
above $100,000 might move the reserve ratio closer to the 1.25 
percent designated reserve level and increase the likelihood 
that new premium payments would have to be made. However, those 
potential costs are far different than the immediate increase 
in premiums for approximately 4,500 banks that has been 
suggested in examples presented by the FDIC. These banks, among 
the 92 percent of the industry currently in the 1A risk-
category, pay no premiums. The prospect of paying higher 
premiums when the fund has over $3 billion in excess capital is 
very disturbing for the industry. In this regard, I attach a 
letter, recently sent by ABA President Donald Mengedoth to the 
House Financial Services Committee, which addresses this issue 
in detail.

Q.2.e. Is it worth the potential for premium increases that 
would accompany a significant increase of the insurance limit?

A.2.e. There were many bankers, particularly community bankers, 
who had expressed a willingness to pay some small premium if 
the insurance limit was raised to $200,000. They believe they 
would benefit from new deposits flowing into their banks from 
such a change. They recognized that the current reserve ratio 
would decline and thus might run the risk of paying some small 
premium in the future. As political opposition to doubling the 
insurance limit has increased and as the realities of the 
potential costs of greater premiums due to the reduction of the 
reserve ratio, the acceptability of paying any new costs has 
fallen dramatically. The concern over paying greater costs has 
also risen as the suggestions about splitting up the top-rated 
category has made it clear that some institutions that pay no 
premiums today would be required to pay something if these 
changes were adopted.
    It is important to differentiate between the two types of 
additional costs. Under the current premium structure, any 
increase in the insurance level, even indexing, would raise the 
potential for additional premiums because the insurance funds 
would move closer to the 1.25 percent designated reserve ratio. 
That loss of cushion is acceptable to most, but not all, banks 
in this context. The second costs--asking banks not currently 
paying premiums to pay when the fund is above 1.25 percent--is 
completely unacceptable to the great majority of our members 
and to ABA.

Q.2.f. What do you think of Mr. Hage's proposed bill to merge 
the BIF and the SAIF; allow for flexible recapitalization of 
the deposit insurance fund and permit the FDIC to impose a fee 
on existing institutions for excessive deposit growth?

A.2.f. We believe it is too narrow. The provisions in Mr. 
Hage's bill provide a reasonable starting point for any reform. 
As ABA pointed out in our testimony, there are other very 
important considerations--including capping the funds, 
providing rebates and adjusting insurance levels for 
inflation--that should be considered as part of any 
comprehensive plan. We are pleased that the FDIC and the other 
banking regulators recognize the need for a comprehensive 
approach to reforming the deposit insurance system.

Q.3. Mr. Powell indicated that perhaps all the FDIC proposed 
reforms did not have to be in one package. (a) What would be on 
your ``must have in the bill'' list if you were making one? (b) 
Should these reforms be done now?

A.3. We have serious doubts about proceeding in stages, frankly 
because we doubt there would be a second stage. In our written 
statement we have laid out the many issues that should be 
considered as part of any comprehensive reform of the FDIC. We 
believe that any narrowing of the list or prioritizing would 
tend to limit the possibility that a complete review of the 
issues be undertaken.
    From our discussions at our large Summer Planning Meeting 
two messages were heard loud and clear: First, that industry 
would be opposed to any reform that would raise the cost of the 
system to the banking industry; and second, that any reform 
package should include a cap on the fund and a rebate or 
dividend system.






RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM CURTIS L. 
                              HAGE

Q.1. Some of the past concern about raising the deposit 
insurance levels above $100,000 was the moral hazard of putting 
the American taxpayer at risk if financial institutions fail. 
Give me your thoughts as to why we should raise the deposit 
insurance level above $100,000 and place the American taxpayer 
more at risk?

A.1. ACB supports a modest increase in general coverage levels 
indexed from the $40,000 level Congress set in 1974, since that 
was the last time coverage was adjusted solely to account for 
inflation. Depending on the index used, that would result in 
coverage of approximately $135,000. We also support indexing 
coverage to account for future inflation. We do not believe 
such an increase in coverage would pose additional risk to the 
taxpayers because the ``real,'' or inflation-adjusted level of 
coverage would be unchanged. Moreover, the deposit insurance 
funds remain strong and banking industry capital--the first 
line of defense against losses--remains at historically high 
levels.
    Nevertheless, ACB would not an advocate an increase in 
general coverage levels if it were accompanied by unacceptable 
increases in costs or if debate over the issue threatened to 
delay action on more urgent deposit insurance reform issues.
    ACB believes Congress should act quickly to deal with the 
rapid growth in deposits at a few ``free rider'' institutions. 
As I said in our testimony, ACB urges Congress to act this year 
on a bill to merge the Bank Insurance Fund (BIF) and the 
Savings Association Insurance Fund (SAIF), eliminate the 
mandatory 23-basis-point premium, and give the FDIC authority 
to impose premiums on excess deposit growth.
    ACB does not believe that a modest increase in coverage 
levels or indexing would greatly increase the total amount of 
insured deposits. Frankly, our members believe that there would 
be some shuffling of deposits among insured institutions, but 
no major infusion of deposits from outside the system. Since 
there would be only a modest increase in total insured 
deposits, a premium increase would not be justified.
    However, we agree with the FDIC that indexing coverage 
would be helpful to maintain the relative position of deposit 
insurance in the Nation's economy. Indexing would allow an 
individual to maintain the same relative level of coverage 
without opening multiple, additional accounts at different 
institutions.
    While ACB does not advocate a substantial increase in 
general coverage levels, we strongly support providing a 
substantial increase in retirement account coverage. As I said 
in our testimony to the Committee, Americans are increasingly 
responsible for managing their own retirement funds and need a 
safe haven for these important assets. In the recently passed 
tax legislation, Congress encouraged even greater growth in 
these accounts. Clearly, substantially increased deposit 
insurance coverage would help implement this public policy.

Q.2.a. Mr. Plagge's testimony says ``there is general, although 
not unanimous, support within the banking industry for 
permanently indexing the level of deposit insurance coverage.'' 
What percentage of your membership supports indexing the level 
of deposit insurance coverage?

A.2.a. ACB has not surveyed our membership on this question 
explicitly. However, in the fall of 2000, we formed a deposit 
insurance team of 32 members to comprehensively examine the 
FDIC's deposit insurance options paper, which raised the 
possibility of indexing. The team's consensus was that if it 
was not possible to obtain modest increases in coverage in the 
short run, the Congress should at least index coverage going 
forward. That would maintain the relative role of deposit 
insurance in the Nation's economy without adding significant 
new risk to the FDIC. This conclusion (as well as the Team's 
other recommendations) was later endorsed unanimously by the 70 
members of ACB's Government Affairs Steering Committee and 
Board of Directors.

Q.2.b. What percentage of your membership supports covering the 
municipal deposits?

A.2.b. ACB members hold differing views on increased coverage 
for municipal deposits. This generally reflects differences in 
State and local practices. For example, in Minnesota local 
governments have joined together to form mutual funds, 
effectively by-passing insured depository institutions. In 
other States, not all depository institutions are eligible to 
accept municipal deposits. On the other hand, some minority 
owned institutions believe they might benefit from increased 
coverage for these deposits. In sum, ACB believes that 
policymakers should avoid imposing an across-the-board premium 
for increased coverage that would not benefit all institutions.

Q.2.c. What percentage of your membership supports covering the 
IRA's and other retirement accounts?

A.2.c. As indicated in my reply to question 1, ACB strongly 
supports a substantial increase in coverage for retirement 
accounts. ACB's deposit insurance team believes that this has a 
solid basis in public policy and would be a major benefit to 
the Nation's retirees and those approaching retirement. In 
addition, these deposits would be a major boost to community 
lending by providing a stable base of long-term funding.

Q.2.d. What percentage of your membership would be willing to 
pay a small, steady premium?

A.2.d. ACB strongly supports maintaining the current statutory 
language preventing the FDIC from imposing premiums on well-
capitalized and well-run institutions when FDIC reserves are 
above the required levels. We reject the notion that by not 
paying premiums currently, these institutions are getting 
``free'' deposit insurance coverage. My bank and thousands of 
others have already paid for our coverage. From 1992 through 
1996, insured institutions paid a total of $28.3 billion into 
the insurance funds. That is a large majority of the 
approximately $42 billion now available in BIF and SAIF. Much 
of the additional amount is the interest earned on the money we 
paid in.

Q.2.e. Mr. Plagge's testimony also discusses a study which 
shows that ``doubling coverage could result in net new deposits 
to the banking industry of between 4 percent and 13 percent of 
current domestic deposits, with the lower end of the range more 
likely.'' Also doing this ``would lower the BIF-SAIF reserve 
ratio below the required 1.25 percent.'' Is this worth the 
potential cost?

A.2.e. ACB does not believe that doubling deposit insurance 
coverage--which could reduce the reserve ratio below the 
required 1.25 percent--would be worth the potential cost. As I 
indicated in response to question 1, we would expect only a 
very modest increase in deposits as a result of doubling 
coverage. ACB believes that prompt action on legislation to 
permit banks to pay interest on business checking accounts 
would do far more to improve banks' ability to attract 
deposits. We strongly urge the Senate to act on this proposal, 
which has already passed the House as H.R. 974.

Q.2.f. Is it worth the potential for premium increases that 
would accompany a significant increase of the insurance limit?

A.2.f. As indicated in my answers to other questions, ACB does 
not support a significant increase in general coverage limits 
in large part because they would likely be accompanied by 
unacceptable premiums.

Q.3.a. Mr. Powell has indicated that perhaps all of the FDIC-
proposed reforms did not have to be in one package. What would 
be on your ``must have in the bill'' list if you were making 
one?

A.3.a. ACB's ``must have in the bill'' proposals are contained 
in H.R. 1293, the Deposit Insurance Stabilization Act, 
introduced by Representatives Bob Ney (R-Ohio) and Stephanie 
Tubbs Jones (D-Ohio). That bill fully addresses the concern 
that one or both of the deposit insurance funds could fall 
below the 1.25 percent ratio, triggering a damaging 23 basis 
point premium. H.R. 1293 contains three elements:

 Permits the FDIC to impose a fee on existing 
    institutions for deposit growth that materially dilutes the 
    insurance funds, so that the required reserve ratio can be 
    maintained. Currently, the FDIC may impose an excessive 
    deposit growth fee on new institutions or new branches. By 
    allowing the FDIC to impose fees on existing institutions, 
    H.R. 1293 would address the current ``free-rider'' problem.

 Merges the BIF and the SAIF. According to the FDIC, 
    merging the BIF and the SAIF would create a more stable, 
    actuarially stronger deposit insurance fund. A single, 
    larger fund would be less affected by either rapid deposit 
    growth at a few institutions or losses from failures.

 Allows for flexible recapitalization of the deposit 
    insurance fund. If the reserve ratio of the merged fund 
    falls below the required level of 1.25 percent, the bill 
    would give the FDIC flexibility in recapitalizing the fund 
    over a reasonable period of time. By repealing the 
    automatic assessment of 23 basis points, H.R. 1293 would 
    give the FDIC authority to use a laser beam approach, 
    rather than a sledgehammer, to recapitalize the insurance 
    fund.

    ACB believes that Congress should act quickly on this 
legislation to help ensure the continued strength of the FDIC 
and prevent the potential diversion of billions of dollars away 
from community lending to homeowners, consumers, and small 
businesses.

Q.3.b. Should these reforms be done now?

A.3.b. ACB strongly urges the Congress to act this year on the 
proposals contained in H.R. 1293. We would welcome action on 
other issues--such as providing for rebates and substantially 
increasing coverage for retirement accounts. However, if the 
list of comprehensive reform proposals is too long for the 
Congress to pass this year, we ask that you set priorities, 
enact what you can this year, and return to the rest next year.
    Further large transfers from uninsured money market funds 
into insured deposits, accompanied by just a few costly 
failures, could easily trigger large premium assessments across 
the country. There is no way to predict those events with any 
accuracy. But unless Congress acts now, the matter will be 
outside your control. That is a risk we should not take and one 
we can avoid.

          RESPONSE TO ORAL QUESTION OF SENATOR JOHNSON

                      FROM CURTIS L. HAGE

    I would like to take this opportunity to supplement my 
response to Chairman Johnson's question on this topic.

Q.1. Senator Johnson asked for responses to a Treasury 
Department suggestion ``that Federal Home Loan Bank advances 
and other secured capital be considered in the deposit 
insurance assessment base. The FDIC's report said that a bank's 
reliance on noncore funding, which may include these advances, 
should be considered risky.''

A.1. My bank has relied for years on Federal Home Loan Bank 
advances; they are a core part of my funding. Advances are a 
stable and reliable supplement to my core deposit base. With 
these options, I do not have to rely on other funding sources, 
such as the higher-cost brokered deposits. The FHLBank advances 
are over-collateralized as required by regulation and they add 
strength to a properly run depository institution as an 
alternative source of funding. My use of advances makes my 
institution more stable, reducing the likelihood that the FDIC 
would suffer any loss associated with our insured deposits.
    It is true that a bank might use advances, or any other 
funding source, to finance risky operations. However, the risk-
based premium structure is in place precisely to impose 
appropriate costs on more risky activities. If the FDIC finds 
that certain types of lending or other activities increase the 
risk of failure, then it should impose a premium to reflect 
that risk. The additional risk would stem from the activity, 
not how that activity is funded, especially when the funding 
source is as stable as advances from the Federal Home Loan Bank 
System.
    While it is true that the collateral supporting advances 
stands ahead of the FDIC in the event of an institution failure 
and resolution, appropriately used advances provide necessary 
funding flexibility, helping ensure that depository 
institutions remain healthy. Adding advances as a risk factor 
would unnecessarily raise costs to the detriment of consumers 
and businesses that ultimately benefit from the responsible use 
of advances.
    Now that the System is more fully open to the commercial 
banks, advances are becoming more important to community 
lending throughout the country. Given the shortage of deposits 
in many communities, it would not make sense to artificially 
discourage depository institutions use of Federal Home Loan 
Bank advances for housing and community development.
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