[Senate Hearing 107-963]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 107-963


                  THE FEDERAL DEPOSIT INSURANCE SYSTEM
                     AND RECOMMENDATIONS FOR REFORM

=======================================================================

                                HEARING

                               before the

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

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                                   ON

 THE FEDERAL DEPOSIT INSURANCE SYSTEM AND RECOMMENDATIONS FOR REFORM, 
     FOCUSING ON MERGING THE BANK INSURANCE FUND WITH THE SAVINGS 
  ASSOCIATION INSURANCE FUND, STATUTORY RESTRICTIONS ON PREMIUMS, AND 
                       DESIGNATED RESERVE RATIOS

                               __________

                             APRIL 23, 2002

                               __________

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


88-088              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
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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

                       Aaron D. Klein, Economist

              Sarah Dumont, Republican Professional Staff

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                        TUESDAY, APRIL 23, 2002

                                                                   Page

Opening statement of Chairman Sarbanes...........................     1

Opening statements, comments, or prepared statements of:
    Senator Gramm................................................     2
    Senator Johnson..............................................     2
    Senator Shelby...............................................     4
    Senator Bayh.................................................     4
    Senator Enzi.................................................     4
        Prepared statement.......................................    35
    Senator Crapo................................................     5
    Senator Reed.................................................    15
        Prepared statement.......................................    35
    Senator Bennett..............................................    15
    Senator Stabenow.............................................    15
        Prepared statement.......................................    36
    Senator Bunning..............................................    25
        Prepared statement.......................................    36
    Senator Corzine..............................................    29
        Prepared statement.......................................    37
    Senator Akaka................................................    37
    Senator Hagel................................................    38

                               WITNESSES

Donald E. Powell, Chairman, Federal Deposit Insurance 
  Corporation,
  Washington, DC.................................................     5
    Prepared statement...........................................    38
    Response to written questions of:
        Senator Reed.............................................    61
        Senator Bunning..........................................    64
Alan Greenspan, Chairman, Board of Governors, Federal Reserve 
  System, Washington, DC.........................................     7
    Prepared statement...........................................    44
    Response to written questions of Senator Reed................    65
Peter R. Fisher, Under Secretary for Domestic Finance, U.S. 
  Department of the Treasury.....................................     9
    Prepared statement...........................................    49
    Response to written questions of Senator Reed................    67
John D. Hawke, Jr., Comptroller of the Currency, U.S. Department 
  of the Treasury................................................    12
    Prepared statement...........................................    53
    Response to written questions of Senator Reed................    68
James E. Gilleran, Director, Office of Thrift Supervision, U.S. 
  Department of the Treasury.....................................    14
    Prepared statement...........................................    58
    Response to written questions of Senator Reed................    84

                                 (iii)

 
                  THE FEDERAL DEPOSIT INSURANCE SYSTEM
                     AND RECOMMENDATIONS FOR REFORM

                              ----------                              


                        TUESDAY, APRIL 23, 2002

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

    The Committee met at 10:05 a.m. in room SD-538 of the 
Dirksen Senate Office Building, Senator Paul S. Sarbanes 
(Chairman of the Committee) presiding.

         OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

    Chairman Sarbanes. The hearing will come to order.
    We are very pleased this morning to welcome a distinguished 
panel of witnesses for our hearing on the Federal Deposit 
Insurance System: Don Powell, the Chairman of the FDIC; Alan 
Greenspan, the Chairman of the Federal Reserve Board; Peter 
Fisher, Under Secretary of the Treasury; Jerry Hawke, the 
Comptroller of the Currency; and James Gilleran, the Director 
of the Office of Thrift Supervision.
    Let me acknowledge the fine work that has been done by 
Senator Tim Johnson, who chairs the Subcommittee on Financial 
Institutions, and who has held a number of Subcommittee 
hearings on the issue of deposit insurance reform.
    The objective of this morning's hearing is to review the 
broad public purposes behind our system of Federal deposit 
insurance and to consider recommendations that have been made 
for changes to the system.
    The Federal deposit insurance system was created by 
Congress in 1934 for the generally acknowledged purpose of 
establishing greater stability and public confidence in our 
banking system, and providing small depositors a secure place 
to keep their savings.
    I think the system, by and large, has served this purpose 
well over the years. But proposals for changes merit careful 
examination and review.
    The current discussion was really started or precipitated 
by the release last April of a report by the FDIC which made a 
number of recommendations for deposit insurance reform.
    In addition, since the release of the report, a number of 
other proposals for changes in the system have gained 
attention, and we expect to review all of these issues here 
this morning.
    There is a vote, I should note, currently scheduled for 
11:30 a.m., which will of course intrude into the proceedings 
of the Committee. But I hope we can move ahead with dispatch 
and get as much of the hearing in as we can before the vote and 
then, presumably, we will return afterwards.
    I will defer the balance of my statement in an effort to 
accomplish that objective, and I yield to Senator Gramm.

                STATEMENT OF SENATOR PHIL GRAMM

    Senator Gramm. Mr. Chairman, thank you very much. I want to 
thank you for these hearings. I want to thank our distinguished 
panel today for coming.
    I am going to have to go very shortly to a Republican 
conference at 11:30 having to do with the energy bill. And so, 
I just want to make a short opening statement. Then I am going 
to come back and at least get an opportunity to ask some 
questions.
    I would like to say that I am opposed to raising deposit 
insurance limits. No one who sat on this Committee during the 
S&L crisis can be unconcerned about the solvency of insurance 
funds and about the impact of deposit insurance on behavior.
    I can remember brokered accounts flowing by the hundreds of 
millions into S&L's that were insolvent, that had no hope of 
ever achieving solvency. And yet, those brokered accounts moved 
by the hundreds of millions of dollars in $100,000 increments.
    I am increasingly concerned about debt of banks to the 
Federal Home Loan Bank system, and the prior claim that system 
has to assets over the FDIC.
    I am not really sure that we have properly taken into 
account the subordinated position that we are now in in our 
insurance fund as the level of borrowing from the Federal Home 
Loan Bank has expanded.
    Finally, let me say the House bill provision which gives a 
credit on FDIC insurance for providing subsidies to targeted 
constituencies is among the worst ideas that I have ever seen.
    If we ever get into the position where we are setting 
insurance premiums based on political correctness rather than 
risk, then we are in great danger. And I am adamantly opposed 
to that provision in the House bill.
    So this is a very important hearing. To this point, we have 
heard from many different groups, and I am not being critical. 
We have had as good hearings as any chairman could set with a 
diversity of opinion. But primarily, we have heard from the 
advocates of this change.
    Today, Mr. Chairman, we are hearing from those who have the 
responsibility for regulation, the public interest, and the 
protection of the depositor. So, I think this is critically 
important testimony.
    Thank you.
    Chairman Sarbanes. Thank you.
    Senator Johnson.

                STATEMENT OF SENATOR TIM JOHNSON

    Senator Johnson. Mr. Chairman, thank you for holding 
today's hearing on the Federal deposit insurance system and 
recommen-
dations for reform.
    I would like to welcome our distinguished panel of 
witnesses and thank them for the considerable time that they 
have put into preparing their testimony and for appearing with 
us today.
    I want to thank you, Mr. Chairman, for taking the issue up 
at the Full Committee level. The timing of this hearing is 
auspicious. The FDIC now projects the BIF ratio at 1.26 percent 
of insured deposits, perilously close to the level that would 
trigger mandatory premiums for BIF-insured institutions.
    I believe Congress should act swiftly to enact fundamental 
comprehensive deposit insurance reform to avoid the disruptions 
that could result from these mandatory premiums.
    I would note there is a significant interest among 
Committee Members in enacting reform. In February, Senators 
Hagel, Reed, Enzi, and I introduced S. 1945, the Safety Act, 
which implements the FDIC's thoughtful and comprehensive 
recommendations for reform. And since that time, Senators Bayh, 
Allard, and Stabenow on the Committee have joined us in 
cosponsoring that important legislation.
    I believe that the absolutely bipartisan support for the 
Safety Act shows the importance of this issue to our country. 
And I believe that working together across the aisle, we can 
accomplish something that will mean a great deal to hard-
working Americans who rely on local banks and thrifts for their 
banking needs.
    Just last week, the House Financial Services Committee 
passed a deposit insurance reform bill, substantially similar 
to the Safety Act, by a vote of 52 to 2, with the explicit 
support of both the Chairman and the Ranking Member. That bill 
won the support of Members from all ideological walks and is 
likely to win widespread support on the floor of the House of 
Representatives.
    In fact, as I read through the written testimony of today's 
witnesses, I was struck by the broad agreement on most key 
elements of deposit insurance reform. Setting aside the issues 
of coverage and indexing, I would note that the agreement 
appears to extend to all other elements of reform. In 
particular, it appears that the witnesses agree on two 
fundamental principles.
    First, that the FDIC has identified critical weaknesses in 
the current deposit insurance system that should be addressed 
immediately. And second, that the FDIC has set forth 
recommendations that indeed address those weaknesses.
    I have to stress this broad agreement because discussions 
about comprehensive deposit insurance reform tend to send a 
misleading signal of divisiveness. This is because the 
discussions often focus on the one area that lacks consensus; 
namely, whether coverage should be increased or, at the very 
least, indexed, to keep pace with inflation.
    In no way do I mean to minimize the importance of coverage 
or indexing to successful comprehensive reform. In fact, I do 
not 
believe a package is possible unless it includes elements of 
the coverage and indexing measures contained in the Safety Act. 
But, I do think a critical point tends to get lost in the 
shuffle and that is that the Federal Deposit Insurance System 
needs to be fixed and the time to fix it is now. Before I close 
here, I want to make one final point with respect to indexing.
    I believe it is critical to emphasize what it means when 
someone opposes indexing deposit insurance coverage to 
inflation. Setting all rhetoric aside, opposition to indexation 
is, in fact, support for 
reducing deposit insurance coverage to some other level. And I 
would like those witnesses who do not support indexing to 
explain to this Committee what alternative level of coverage 
they believe would indeed be appropriate.
    And with that, Mr. Chairman, I once again want to thank you 
for holding today's hearing and I thank the witnesses for being 
with us here today.
    Chairman Sarbanes. Thank you, Senator Johnson, for the 
effort that you have put in on this issue.
    Senator Shelby.

             COMMENTS OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    As this debate moves forward, I think we have to be mindful 
of two critical issues. The first is the role that deposit 
insurance plays in our banking system. By protecting savings, 
insurance promotes confidence in the banking system. This 
faith, in turn, ensures the financial stability necessary for 
economic growth. Therefore, I think our focus should be on 
those changes which boost stability and confidence and enhance 
the strength of the banking system.
    Second, the deposit insurance is the nexus that links the 
banking system directly to the pocketbook of the American 
taxpayer and we should keep that in mind.
    As someone who participated on this Committee in the 
cleanup of the thrift debacle, I know firsthand that the 
taxpayer--yes, the taxpayer--is ultimately on the hook for the 
losses of insured institutions, no matter what the rhetoric is. 
Therefore, I believe that we must proceed only after thorough 
consideration of the implications reform may have for new or 
additional taxpayer exposure.
    Yes, taxpayer exposure. Are we going to visit the taxpayer 
again? I hope not. We need to be careful in what we are 
crafting.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you, Senator Shelby.
    Senator Bayh.

                 COMMENTS OF SENATOR EVAN BAYH

    Senator Bayh. Mr. Chairman, I have no opening statement, 
other than to thank our witnesses and to compliment Senator 
Johnson for his leadership on this issue. He has done a very 
able job.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Good. Thank you.
    Senator Enzi.

              COMMENTS OF SENATOR MICHAEL B. ENZI

    Senator Enzi. Mr. Chairman, I would ask that my full 
statement be allowed to be a part of the record. I want to 
thank the Chairman for holding this hearing, the witnesses for 
being here.
    I want to thank Senator Johnson for allowing me to work 
with him on this legislation. I believe that what he and 
Senators Reed, Hagel, and myself put together provides the 
Committee with an excellent starting point to examine the 
changes to the current deposit insurance system.
    I am pleased because I think a number of issues can be 
agreed upon by nearly everyone, and I would hope that the few 
remaining issues do not prevent us from making needed changes 
as soon as possible.
    This legislation is too important for banks not only in 
Wyoming, but across the country, to get stalled.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you, Senator Enzi.
    Senator Crapo.

                 COMMENTS OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman. I agree that it is 
very critical that we move from the common ground we have on 
these issues to resolve the remaining issues, and to see this 
important legislation move forward.
    I thank Chairman Sarbanes for the attention he is bringing 
to this important issue.
    Chairman Sarbanes. Good. Thank you.
    Well, gentlemen, we are ready to hear from the panel. 
Chairman Powell, since you are the point person for the Federal 
Deposit Insurance Corporation, we will hear from you first.

                 STATEMENT OF DONALD E. POWELL

        CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION

    Chairman Powell. Thank you, Chairman Sarbanes, and Members 
of the Committee. I am delighted to be here. And I appreciate 
your willingness to hold this hearing.
    As a former banker, I came to Washington not knowing a 
great deal about the Federal Deposit Insurance Corporation, 
other than they had three lines of business--supervision, 
resolutions, and 
insurance. And I perhaps knew more about the supervision area 
and the resolution area than I did about the insurance.
    So after I came to Washington, I sat down with the staff at 
the FDIC and became informed and briefed as it relates to the 
reform proposal that was introduced by my predecessor last 
year.
    It became apparent to me after sitting down with these 
people, while I may have had some question about the outcome of 
the recommendation, that the process was one that was very 
thorough. They reached out not only to industry, to trade 
associations, to Members of Congress, to the American public, 
but also to insurance consultants, and I came to the conclusion 
that the process was very sound.
    When I look at our fiduciary role as it relates to 
insurance, two areas come to my mind foremost. One, as Senator 
Shelby indicated, is my hope and desire that the taxpayer will 
never, never pay for any failed institutions.
    Second, industry premiums should be fair and based upon 
risk.
    The point of reform is neither to increase assessment 
revenue from the industry, nor to relieve the industry of its 
obligation to fund the deposit insurance system. Rather, it is 
to distribute the assessment burden more evenly over time and 
more fairly across the insured institutions. It should not be a 
burden for the taxpayer.
    My remarks will be in three areas. One is merging the 
funds. Two is managing the funds. And three, maintaining the 
value of insurance.
    I think there is general agreement about merging the funds. 
The funds merged would be more diverse, would be stronger. 
Today, 40 percent of the SAIF funds are held by banks. There is 
the potential for premium disparity. Finally, there would be 
administrative efficiency in a merged fund. I think there is 
common ground and not much debate as it relates to merging the 
two funds.
    Managing the funds is something I feel strongly about. As 
we look at the results of the past legislation as it relates to 
specific areas within managing the funds, it becomes apparent 
to me and important to me that the FDIC Board should have some 
discretion and judgment in managing the funds, with some 
parameters and with accountability to the Congress, to the 
American people, and to the industry. I hope that in some way 
we would eliminate the procyclical bias in the system and 
charge steady premiums over time.
    It is my view that all institutions represent some risk to 
the system. Therefore, all should pay. I recognize this 
because, as a former banker, there were years that I paid--1 
year that I paid more in premiums than I earned. So, I 
understand the burden of paying 
deposit insurance premiums.
    I also understand that every institution provides some 
risk. And today, those institutions that are defined as well-
managed and well-capitalized, in excess of 90 percent of the 
institutions, do not pay any insurance premium at all.
    I do not know of a product, an insurance product, where you 
do not have to pay. I think that needs to be reformed also, and 
I would hope that this reform legislation would allow the FDIC 
Board to develop a risk model with today's environment, looking 
at the risk of every institution and those that possess more 
risk to the fund would have to pay higher premiums.
    Being well-managed and well-capitalized are two components 
of risk. Risk is a change in environment that should be looked 
at from time to time. I would hope that we would look at 
earnings, growth, funding sources, including the funding 
sources of secured liabilities. Senator Gramm mentioned this a 
moment ago. I think it is of some concern to insured 
institutions.
    The risk is dynamic. It is fluid and it changes. The risks 
of yesterday are not the risks of today. So it is important 
that we at the FDIC be allowed to design a risk profile that 
would charge higher premiums to those that pose more risk to 
the fund. It is very 
important.
    Also, it is important that we understand the overall risk 
of the industry. Senator Johnson mentioned a moment ago that 
the Bank Insurance Fund is now standing at approximately 1.26 
percent.
    It is my view that the health of our industry, the overall 
banking industry, is solid. We are coming off of record 
earnings, strong capital, and lots of diversification.
    Under the present law, we do not have a choice. If the BIF 
drops below 1.25 percent, we will assess the industry and, in 
my view, that is a burden to the industry that is not 
necessary.
    So, I think it is important that the FDIC Board be allowed, 
again, with accountability, with parameters, to manage the Fund 
as it relates to the overall risk within the industry and 
specifically with risk within each individual institution.
    Also, there is a current flaw that we would hope to 
correct--the imbalance of those institutions that are not 
paying premiums now.
    I chartered a bank 4 years ago. We did not pay any premiums 
for FDIC insurance. That is wrong. We did not break the law and 
I do not want to penalize innovators. Innovators are people 
that do not break the law, but I think that imbalance is wrong 
and that all should pay.
    As it relates to that, those institutions that paid into 
the Fund prior to 1996, our proposal calls for assessment 
credits. I think that too is very important as we go forward, 
to recognize those that have paid into the Fund. And we have 
allowed for credit toward those assessments that those 
institutions would pay, again, based upon the risk profile. If 
the risk profile of the institutions changes, their ability to 
earn and use assessment credits also changes.
    It would not bother me if, in fact, assessment credits 
offset premiums 3, 4, 5, 6, 7, 8 years, again, depending upon 
the risk profile of the industry and that individual 
institution. I would be especially sympathetic in the years 
ahead to those institutions that have paid into the fund in the 
past.
    So, basically, eliminating the procyclical bias, steady 
premiums over time, reserve for overall industry risk, the 
risk-based premiums, and correct the imbalance of free 
insurance that is now within the system.
    The third issue is maintaining the value of the coverage.
    The FDIC is not proposing to increase coverage in real 
terms. But doing nothing, coverage will erode. I do not believe 
that the value of deposit insurance should be allowed to erode 
over time. And I also think that there should be special 
consideration to those 
savers who place their money in retirement accounts.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you very much, Chairman Powell. 
You came in well under the time, and we appreciate that.
    We are allocating 10 minutes. We said 5 to 10 minutes and 
we will go with the 10. But if you can come in under that, we 
would appreciate that.
    Chairman Greenspan, we would be happy to hear from you.

                  STATEMENT OF ALAN GREENSPAN

              CHAIRMAN, BOARD OF GOVERNORS OF THE

                     FEDERAL RESERVE SYSTEM

    Chairman Greenspan. Thank you, Mr. Chairman.
    Deposit insurance, as you just pointed out, was adopted in 
this country as part of the legislative framework of the Great 
Depression. My reading of the debate surrounding the issue in 
1933 has led me to conclude that deposit insurance in this 
country was designed mainly to protect the unsophisticated 
depositor with limited financial assets from the loss of their 
modest savings.
    As discussed more fully in my statement, which, 
incidentally, I ask be included in the record----
    Chairman Sarbanes. It will be included in full.
    Chairman Greenspan. --there was only one time Congress used 
an increase in deposit insurance ceilings for a purpose other 
than to protect unsophisticated depositors. That was the 
increase in 1980 to the current $100,000 level, so that thrifts 
could issue an insured deposit not subject to then prevailing 
Regulation Q deposit rate ceilings which apply to deposits, as 
you remember, below $100,000.
    The very large issuance of insured, market-rate, $100,000 
deposits significantly exacerbated the losses to the taxpayers 
from a bankrupt thrift insurance fund that was caused at bottom 
by the flawed structure of the thrift industry.
    As recognized from the beginning, deposit insurance has 
involved a tradeoff. On the one hand, there are benefits from 
the protection of small depositors and the contribution of 
deposit insurance to overall, short-term, financial stability 
by eliminating deposit runs. On the other hand, deposit 
insurance imposes costs from the 
inducement to higher risk-taking by depository institutions 
whose depositors become indifferent to the risk taken by the 
institution whose liability the Government has guaranteed. The 
resultant long-term financial imbalances increase the need for 
Government supervision to protect the taxpayers' interest. The 
crafting of reforms of the deposit insurance system must 
struggle to balance these tradeoffs.
    The Federal Reserve Board believes that deposit insurance 
reforms should be designed to preserve the benefits of 
heightened financial stability and the protection of small 
depositors without at the same time a further reduction in the 
market discipline and the inducement it creates for additional 
risktaking by the depository institutions.
    The Board also believes that there are several steps that 
the Congress should take to improve the strength and efficiency 
of the existing deposit insurance structure and limit the risk 
of future disruptions to the insurance funds, the banking 
system, and the economy. These are spelled out in some detail 
in my statement, but let me summarize them here.
    The Board supports the merger of the BIF and SAIF and the 
elimination of statutory provisions that require the Government 
to give away to banks the valuable subsidy of deposit insurance 
whenever the deposit insurance fund reaches a predetermined 
ratio to insure deposits.
    We also support more flexibility for the FDIC to impose 
risk-based premiums. The Board also believes it is desirable to 
permit a wider range of fund/reserve ratios so that the 
insurance fund can be built up in good times and be drawn down 
as needed without necessarily imposing sharp changes in the 
deposit insurance premiums that could be destabilizing to the 
banking system and the economy.
    Finally, we support the use of rebates when the fund ratios 
are strong, targeted to the strongest banks that have paid in 
premiums for an extended period of time as a reasonable way to 
reduce, if not eliminate, the free rider problem.
    The Board does not support an increase in, or an indexing 
of the current $100,000 deposit insurance ceiling. We 
understand that this posture would result in the erosion of the 
real purchasing power of the current ceiling. But in the 
Board's judgment, it is 
unlikely that increased coverage today would add measurably to 
the stability of the banking system. Macroeconomic policy and 
other elements of the safety net, combined with the current, 
still significant level of deposit insurance, continue to be an 
important bulwark against bank runs. Thus, the problem that 
increased coverage is designed to solve must be related to 
either the individual depositor, the party originally intended 
to be protected by deposit insurance, or to the individual bank 
or thrift.
    As our surveys of consumer finances indicate, most 
depositors have balances well below the current insurance limit 
of $100,000, and those that do have larger balances have 
apparently been adept at achieving a level of deposit insurance 
coverage they desire by opening multiple insured accounts. Such 
spreading of asset holdings is perfectly consistent with the 
counsel always given to investors to diversify their assets--
whether stocks, bonds, or mutual funds--across different 
issuers.
    If the problem that raising the ceilings is seeking to 
address is at depository institutions, it would seem 
disproportionately a small bank issue, since insured deposits 
are a much larger proportion of total funding than at large 
banks. But smaller banks appear to be doing well. Since the 
mid-1990's, adjusted for the effects of mergers, the smaller 
banks' assets and uninsured deposits have expanded at twice the 
pace of the largest banks. Clearly, small banks have a 
demonstrated skill and ability to compete for uninsured 
deposits. To be sure, uninsured deposits are more expensive 
than insured deposits and bank costs would decline and profits 
rise if their currently uninsured liabilities received a 
Government guarantee. But that is the issue of whether 
subsidizing bank profits through deposit insurance serves a 
national purpose. And I might add that throughout the 1990's, 
small banks' return on equity was well maintained.
    In our judgment, neither financial stability, nor 
depositors, nor depositories have been disadvantaged by the 
erosion of the real value of the current ceiling, other than by 
the reduction in profits that accrue to banks from the deposit 
insurance subsidy. Raising the ceiling now would extend the 
safety net, increase the Government subsidy to banking, expand 
moral hazard, and reduce the incentive for market discipline 
without providing any real evident public benefits.
    With no clear public benefit to increasing deposit 
insurance, the Federal Reserve Board sees no reason to increase 
the scope of the safety net. Indeed, the Board believes that as 
our financial system has become ever more complex and 
exceptionally responsive to the vagaries of economic change, 
structural distortions induced by Government guarantees have 
risen. We have no way of ascertaining at exactly what point 
subsidies provoke systemic risk. Nonetheless, prudence suggests 
that we be exceptionally deliberate when expanding Government 
financial guarantees.
    Thank you very much, Mr. Chairman.
    Chairman Sarbanes. Thank you, Chairman Greenspan.
    Now, we will hear from Treasury Under Secretary Peter 
Fisher.

                  STATEMENT OF PETER R. FISHER

              UNDER SECRETARY FOR DOMESTIC FINANCE

                U.S. DEPARTMENT OF THE TREASURY

    Mr. Fisher. Thank you, Mr. Chairman, and Members of the 
Committee. I am grateful to you for this opportunity to present 
the Administration's views on reform of the deposit insurance 
system. I want to thank Chairman Powell and the FDIC staff for 
keeping this important topic before us. And I would like to add 
that I am honored to be sitting in the middle of this panel of 
four men with so many years of experience in both Government 
and in banking.
    Our current deposit insurance system is intended to balance 
the interests of savers and taxpayers by aiming to protect them 
both from exposure to bank losses and, thereby, to promote 
public confidence in the U.S. banking system. Consistent with 
this objective, the Administration believes that some 
improvements could be made in the system's operation and 
fairness. Specifically, the Administration favors reforms that 
would: Reduce the system's procyclical bias by allowing the 
insurance fund reserve ratio to vary within a range and 
eliminating triggers that could cause sharp changes in 
premiums; Improve the system's risk diversification by merging 
the bank and thrift insurance funds and; Ensure that 
institutions appropriately compensate the FDIC for insured 
deposit growth while also taking into account the past 
contributions of many institutions to build the fund reserves.
    We share the concern mentioned by Senator Gramm and FDIC 
Chairman Powell that some banks' growing use of secured 
liabilities increases risk to the insurance funds. We are also 
increasingly sympathetic to the FDIC's request for more 
flexibility to vary premiums according to the risks that 
individual institutions pose. However, the Administration 
cannot support an increase in deposit insurance coverage 
limits, whether directly or by indexation. While my written 
testimony, which I hope can be included in the record, 
elaborates on our support for the reforms we think worth 
pursuing, my remarks this morning will focus on the reasons the 
Administration is opposed to an increase in coverage limits.
    There is financial benefit to savers to be derived from 
increased coverage limits because individuals can today hold 
insured deposits up to the limit at any number of banks, and 
even through multiple accounts at a single bank under different 
legal capacities. The only credible benefit to savers is that 
of greater convenience. But this is of potential use to only 
that small fraction of the population that has sufficient 
savings, and which they choose to hold in the form of deposits, 
to have any possible need for coverage in excess of $100,000.
    The best available data indicate that only about 3 percent 
of households with deposit accounts hold any uninsured 
deposits, and the median income of these households was 
approximately double the median income of households with 
deposits under $100,000.
    Ample opportunities already exist for those fortunate few 
with substantial deposits, including retirees and those saving 
for retirement, to obtain FDIC coverage equal to several times 
the $100,000 limit. So unlike all other Government programs 
where benefits have been indexed, our deposit insurance system 
gives individual savers the ability to choose to receive the 
benefit of deposit insurance in excess of the fixed nominal 
limit if they wish. An increase in coverage limits would 
reduce, not enhance, competition among banks in general, but 
would not predictably benefit any particular class or category 
of banks.
    Proponents of higher coverage limits have claimed that they 
are necessary for community banks to remain competitive in 
attracting funds. However, as Chairman Greenspan has just 
alluded to, the Federal Reserve has data that shows there is no 
evidence that community banks have trouble attracting deposits 
under the existing coverage limits.
    Furthermore, because higher coverage limits would apply to 
all depository institutions, including those that are part of 
large, multibank holding companies, it is hard to see how 
higher limits could improve community banks' ability to compete 
with larger banks for deposits.
    Indeed, I believe that one reason the issue of coverage 
limits has surfaced is precisely because the decline in the 
real value of the coverage limit over the last two decades has 
served to promote a healthy competitive dynamic among banks in 
vying for the attention of customers. Continuing the current 
fixed ceiling on deposit insurance coverage, while permitting 
individuals to hold insured accounts at more than one 
institution, provides consumers with the potential benefits of 
greater total insured deposits if they need them and fosters a 
competitive discipline on bankers to provide quality services 
to their customers. Indexation of deposit insurance coverage 
limits would remove this discipline and only serve to reduce 
competition from what it otherwise would be.
    Increased coverage limits would not provide any benefit to 
the overwhelming majority of Americans, but as taxpayers, it 
would expose them to additional risk. Given the lack of 
potential financial benefits for consumers or of any potential 
improvement in banking system competition, we cannot justify 
the increase in the Government's off balance sheet contingent 
liabilities that would result from higher deposit coverage 
limits. Thus, weighing the ephemeral benefits of increased 
coverage against the significant costs of added risk and the 
erosion of market discipline, the Administration cannot support 
an increase in coverage limits.
    Finally, we think it is important for Congress to address 
the 
uneven distribution of supervision costs which we think is a 
real problem. All the Federal and State bank supervisory 
agencies should continue to have resources necessary to promote 
safety and soundness. I know that Comptroller Hawke will 
discuss this issue in a moment. We look forward to working with 
Congress and the FDIC Board to devise a solution to this 
problem.
    Let me conclude by reaffirming the Administration's support 
for the FDIC's proposed reforms that would reduce the system's 
procyclical bias, merge the funds, take account of deposit 
growth and past contribution, and enhance the FDIC's 
flexibility to vary premiums according to risk.
    Thank you for the opportunity to appear before the 
Committee.
    Chairman Sarbanes. Thank you very much, Secretary Fisher.
    Next we'll hear from Jerry Hawke, Comptroller of the 
Currency.
    Mr. Hawke.

                STATEMENT OF JOHN D. HAWKE, JR.

                  COMPTROLLER OF THE CURRENCY

                U.S. DEPARTMENT OF THE TREASURY

    Mr. Hawke. Thank you, Mr. Chairman, and Members of the 
Committee. I appreciate the opportunity to be here today.

    Our position on the major issues in deposit insurance 
reform is essentially the same as those expressed by Chairman 
Greenspan and Secretary Fisher, and I will not burden the 
Committee with repetition on those points. My written statement 
elaborates on those issues, and I would ask that it be included 
in the record.

    Chairman Sarbanes. It will be included in the record.

    Mr. Hawke. I would like to use my time to focus on an issue 
that is of major consequence to the OCC--the need to reform the 
way that bank supervision is funded. This issue is of direct 
relevance to deposit insurance reform, we believe, for a number 
of reasons.

    First, it relates to the way that deposit insurance funds 
are now being used to absorb the costs of supervising insured 
State banks that are not members of the Federal Reserve System. 
The question of deposit insurance reform necessarily involves 
consideration of how large the funds should be, and that 
question compels consideration of how the funds are being used 
and might be used in the future.

    Second, some of the proposals for deposit insurance reform 
have held out the prospect that there might be rebates made 
from the fund when it exceeds a certain size, or credits 
against future premium liabilities given under some 
circumstances for banks that have paid into the funds in times 
past. We believe that any consideration of rebates or credits 
must take into account the long-standing inequity that national 
banks have suffered by reason of the present use of the funds 
to finance the costs of State bank supervision by the FDIC.

    Third, we believe that a good solution to the problem of 
disparate funding involves the insurance funds, and I will come 
to that in a few moments.

    While all insured banks, both State and national, have in 
years past paid premiums into the funds and are obligated to 
pay premiums in the future sufficient to maintain the insurance 
funds at the designated reserve ratio, State banks receive a 
special benefit from the funds that is not afforded to national 
banks. Each year, the funds, which are now about $42 billion, 
are tapped to pay the FDIC's costs of supervising State banks 
that are not members of the Federal Reserve System. I should 
add that State banks that are Fed members receive supervision 
from the Federal Reserve, and the Fed's costs of providing such 
supervision are charged against the System's earnings, which 
just last year were approximately $32 billion.

    In 2001, the FDIC and the Fed together spent nearly $1 
billion, by our estimate, on State bank supervision. Yet, none 
of these costs were passed on to the banks that they supervise. 
To be sure, State banks do pay modest direct assessments to 
their State supervisors, but the supervision provided by the 
States is a relatively small component of the overall 
supervision of State banks. Thus, in 2001, we estimate that 
State banks in the aggregate paid only $237 million in State 
assessments, or about 22 percent of the total cost of their 
supervision, both Federal and State.
    In stark contrast, national banks pay 100 percent of the 
cost of their supervision in direct assessments that must be 
levied by the OCC. In 2001, those payments totaled more than 
$400 million.
    As a result of the fact that the Fed and the FDIC absorb 
their costs of supervising State banks, there is a continuing 
incentive for national banks to convert to State charters to 
realize the lower costs that are thus made available. Indeed, 
State supervisors aggressively proselytize for such 
conversions, heavily exploiting fee disparity as a major part 
of their sales pitch to national banks.
    The unfairness of this disparity is underscored by two 
facts. First, the supervisory functions performed by the Fed 
and the FDIC for State banks are exactly the same as those 
performed by the OCC for national banks. There is virtually no 
function we perform for national banks that is not replicated 
for State banks at our sister agencies. Second, because 
national banks account for about 55 percent of the amount 
presently in the Bank Insurance Fund, they are in practical 
effect picking up more than half of the FDIC's costs of 
supervising State banks.
    Ending this anomaly is not just a matter of fairness to 
national banks. It is a very necessary component of allocating 
the costs and benefits of deposit insurance in an equitable and 
efficient manner among insured banks. We respectfully submit 
that this issue should be considered in the context of any 
legislation that would bear on the determination of how large 
the fund should be and how rebates and credits are calculated.
    One approach to the resolution of this problem that we have 
formulated is to use the earnings on the FDIC's insurance funds 
to cover the costs of both State and national bank supervision. 
Today, with combined reserves of the BIF and SAIF at about $42 
billion, the interest income earned by the funds of about $2\1/
2\ billion per year exceeds by a large margin the combined 
supervisory costs of the FDIC, OCC, OTS, and all 50 State 
supervisory agencies. And the $525 million that the FDIC spends 
on State bank supervision is already a charge against the 
funds.
    Under our proposal, which is spelled out in more detail in 
an OCC white paper, a nondiscretionary formula would be devised 
that would operate automatically to provide the various 
supervisory agencies, both Federal and State, with a baseline 
amount 
reflecting their current levels of expenditures on supervision. 
The allocations would be adjusted each year under the formula 
to reflect changes in the composition and risk profile of the 
banks. In the event the earnings on the funds were insufficient 
to cover the allocations called for by the formula, the various 
agencies would have to resort to their assessment authority to 
make up any shortfall. But, we calculate it would take a very 
significant reduction in the size of the funds to reach this 
point.
    Such an arrangement would not only remedy the inequity to 
national banks that exists today, but also it would add new 
vitality to the dual banking system by creating a regulatory 
environment in which banks choose their charters on the basis 
of the quality of supervision and the suitability of the 
charter for their business objectives, rather than on the basis 
of a disparity in supervisory assessments attributable solely 
to the fact that the preponderance of the costs of supervising 
State banks are absorbed by the Federal agencies responsible 
for the major portion of that supervision.
    Thank you very much, Mr. Chairman.
    Chairman Sarbanes. Thank you, Comptroller Hawke.
    Our final panelist this morning is James Gilleran, the 
Director of the Office of Thrift Supervision.
    Mr. Gilleran, we are happy to have you here.

                 STATEMENT OF JAMES E. GILLERAN

             DIRECTOR, OFFICE OF THRIFT SUPERVISION

                U.S. DEPARTMENT OF THE TREASURY

    Mr. Gilleran. Thank you, Mr. Chairman. I am very pleased to 
be here.
    I support the Committee focusing on a core bill. And a core 
bill would contain a merger of the funds, because I believe 
that the funds are probably at their prime time to merge. Both 
BIF and SAIF group institutions are about equally sound. So 
this would be an ideal time to do it.
    I support giving the FDIC Board greater flexibility in 
setting premiums. And I support the elimination of the free 
rider problem.
    If you recall, Senator Sarbanes, during my confirmation 
hearing, you asked a question about where I was in connection 
with increasing deposit insurance coverage. At that time, I 
said that I had not concluded on the issue because I had not 
seen enough studies or talked to enough people to get views on 
it, but that I looked forward to participating in the 
discussion that you are having today.
    I ask that my comments be admitted into the record, also.
    Chairman Sarbanes. It will be included in the record.
    Mr. Gilleran. Since that time, I have talked to an awful 
lot of people, read whatever is available on the subject and, 
even though coming out of the community banking system I had a 
natural interest in supporting the increase of deposit 
insurance or indexation, over the last at least 4 or 5 months, 
I have concluded that it is not of a net benefit to the system, 
not of a net benefit to most banks, and will result in higher 
costs, which will reduce earnings and 
reduce ability to be able to lend. So, therefore, I do not 
support 
either increasing the amount of coverage or indexation.
    In answer to Senator Johnson's question about addressing 
specifically the indexation piece of it, that, initially, that 
sounded to me like a very logical thing to do, a mild thing to 
do, something that the system and the industry could adapt to, 
and the fund could adapt to over time.
    However, interestingly enough, in talking to enough 
community bankers, and I had 50 thrifts in my office a couple 
of weeks ago and they were medium-size, and some large and 
small and I asked them, who supported increasing deposit 
insurance coverage, or indexation? And not one of them did, 
which really surprised me.
    The reasons given as to why they did not support it was 
because: One, they did not see that they would be getting any 
large inflow of deposits because of it. Two, they could not see 
how it could possibly be done without increasing the cost of 
the assessment from the FDIC, which I think is absolutely 
correct. And three, on indexation, they felt that any periodic 
increases of coverage would only mean that they would have to 
have more communication with their customers on their subject, 
changing signage and other problems in connection with it.
    So that the net effect of all of those cost increases, plus 
the FDIC increased assessment, would put them into a position 
where they do not see any benefit.
    I think that, just looking at the deposit insurance on an 
aggregate basis, if you say to yourself that the $100,000 is 
reduced in value, in fact, by moving the money around to many 
banks, you can insure any amount of money in the system. So the 
inflationary 
effects are not depreciating the ability of an individual to 
protect his money by the system.
    In addition, initially, I felt that the coverage of 
retirement 
accounts appeared to be a reasonable thing to do, to provide a 
retiree with a greater ability to feel comfortable about his 
retirement nest egg.
    But, then, again, I have concluded that, by singling out 
one group in our society to protect in a greater way, surfaces 
questions about whether or not other groups in our society 
should be singled out to be protected in other ways by the 
fund. And I have concluded that that is not a good idea.
    So, I am in a position where I am no longer supporting any 
of those ideas, even though they looked attractive to me at the 
start.
    Senator Sarbanes, I go back to the fact that I completely 
support a basic bill that would include the merger of the fund, 
greater flexibility to the FDIC Board, and elimination of the 
free rider problem.
    Thank you, sir.
    Chairman Sarbanes. Thank you very much. It has been a very 
interesting panel.
    We have been joined by three of our colleagues and I will 
defer to them just briefly before we turn to questions, if they 
have any opening statement.
    Senator Reed.

                  COMMENT OF SENATOR JACK REED

    Senator Reed. I ask that my statement be placed in the 
record, Mr. Chairman.
    Chairman Sarbanes. Senator Bennett.

              COMMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. I have no opening statement, Mr. Chairman.
    Chairman Sarbanes. Senator Stabenow.

               COMMENT OF SENATOR DEBBIE STABENOW

    Senator Stabenow. Mr. Chairman, I would just ask to be able 
to put my statement in the record.
    Chairman Sarbanes. Good.
    Senator Stabenow. Thank you.
    Chairman Sarbanes. Thank you very much.
    First, I want to follow up on Comptroller Hawke's testimony 
and ask Chairman Powell and Chairman Greenspan their reaction 
to the notion that the charges for auditing the national banks 
should be paid out of the proceeds on the deposit insurance 
premiums.
    Chairman Powell. Chairman Sarbanes, as I mentioned earlier 
in my testimony, I chartered a bank 4 years ago, and had been 
in the banking business more than 30 years prior to that. I 
converted from a State bank charter to a national charter, 
understanding and knowing that I would be assessed fees for the 
examination.
    Chairman Sarbanes. I think Jerry Hawke was the Comptroller 
at the time. Did that influence your decision?
    [Laughter.]
    Chairman Powell. Somewhat. But what did influence my 
decision was the value of a national charter.
    I believe that the value of a national charter, in my 
particular market area, had more value than a State charter. I 
fully recognized that I would have to pay fees to the 
Comptroller of the Currency for examination and that, had I 
remained a State charter, I would have some benefit of not 
paying those fees.
    So there is value in the national charter, as Comptroller 
Hawke has said many times. I made the conscious decision, 
knowing full well that I would have to do that.
    Furthermore, I am convinced that the Comptroller and the 
good people at the OCC are very resourceful and will be able to 
manage this within their own budget without dipping into the 
FDIC.
    Chairman Sarbanes. Chairman Greenspan.
    Chairman Greenspan. I think the issue that Comptroller 
Hawke raises is obviously an issue which has to be addressed 
for many of the reasons that he stipulates.
    Nonetheless, I also agree with Chairman Powell that the 
value of a national charter is quite significantly superior to 
that of a State charter and that the differential fees paid by 
banks with the differing charters, in my judgment, probably 
grossly reflects the relative value expectations because we do 
not see a great deal of drift between different charters. The 
shift of an institution from State to a national charter 
occurs, but it is not very prevalent.
    The problem, however, that I see with the issue is that 
when you get involved with the insurance funds and the issue of 
the Federal Government supporting the State banks' 
examinations, you run into issues of the dual banking system. 
And I think that if you were to have a State bank supervisor 
representative here, they would have serious questions with it.
    My own judgment is that the solution to the OCC's problem, 
and there is a problem here, is appropriated funds, in the 
sense of eliminating the tie between the cost of supervision 
and the solvency of the supervisor. It is a national purpose 
that is involved here and appropriated funds, in my judgment, 
would be the ideal solution to his problem.
    Chairman Sarbanes. Well, that is a good theoretical 
solution, but I do not know in practice whether it always works 
on the appropriated funds side. But that is our problem, 
primarily, and I recognize that.
    The national banks pay the deposit insurance premiums. Is 
that correct?
    Mr. Hawke. That is correct, Mr. Chairman.
    Chairman Sarbanes. The State banks pay them. Right?
    Mr. Hawke. That is correct.
    Chairman Sarbanes. Now out of those premiums that the State 
banks pay, the examination by the FDIC is funded. Is that 
correct?
    Mr. Hawke. State banks get the benefit of FDIC supervision 
and the cost of that supervision is charged against the fund, 
whereas the national banks have to pay the full cost of their 
supervision themselves.
    Chairman Sarbanes. Pay themselves. So, in a sense, there is 
not a level playing field on the cost of the examination. Is 
that essentially your argument?
    Mr. Hawke. Not only is there not a level playing field, but 
since national banks account for more than half of the funds 
that have been paid into the insurance fund, essentially, 
national banks are bearing 55 cents of the cost of every dollar 
that the FDIC spends on State bank supervision.
    Chairman Sarbanes. What are the factors that would 
determine what the level of deposit insurance should be?
    Now, presumably, if it runs along unchanged, you continue 
to have inflation. You continue to erode the real coverage that 
is provided to a depositor. You all agree that there should be 
deposit insurance, as I understand it. I do not think there is 
anyone at the table who suggests to the contrary.
    So what are the factors that would determine what the level 
should be because, obviously, if the system played itself out, 
you could reach a point where if you just stayed where you 
were, the real coverage would be pretty small. I do not know 
that we are there yet, or how close we are to it. But, in your 
mind, what are the factors that go into setting what the 
deposit insurance coverage should be?
    Who wants to take that on?
    [No response.]
    Well, just to be fair, why don't we start with Chairman 
Powell and go across the panel?
    [Laughter.]
    And then I see my time has run out and I will yield to my 
colleagues for questions.
    Chairman Powell. Perhaps there are several factors, 
Chairman Sarbanes. From the consumer standpoint, I think I 
would refer to a recent Gallup poll that was conducted year 
that reflects that, almost 50 percent of the consumers believe 
that deposit insurance should be increased from the current 
level. And 77 percent of the consumers believe that deposit 
insurance should be indexed.
    Chairman Sarbanes. Should be what?
    Chairman Powell. Indexed. That is a Gallup poll.
    We recently received a letter from the AARP strongly 
supporting the increase in coverage. And again, I would remind 
you that the FDIC's position is that it be indexed.
    So from the consumer standpoint, I think the consumers have 
spoken as it relates to the Gallup poll and for sure, an 
important segment of our society, the senior citizens, have 
spoken.
    For the bankers, I think it would be debatable concerning 
what level the insurance coverage should be, and primarily from 
the funding source. But I think bankers will all agree that 
coverage is extremely important. At what level depends upon 
which cycle we may be in. Normally, we do not talk about the 
importance of FDIC insurance when times are good. As I 
mentioned, I have been a banker for over 35 years. And I will 
confess to you that deposit insurance was not foremost in my 
mind 27 of those years. Three of those years, it was a matter 
of life and death. It was critically important to the liquidity 
and to the solvency of our institution.
    Again, depending upon the cycle, what the level should be I 
think is debatable among bankers. So if the consumer clearly 
sees value, understands that there is value there, the bankers 
in general will support.
    My concern as it relates to coverage is that coverage is 
debated during down times and we react perhaps with unintended 
consequences by increasing coverage. Thus, again, our position 
is that it should be indexed.
    When we talk about coverage, I am concerned about those 
that oppose indexing. Essentially, they are saying that they 
support a reduction in the real level of deposit insurance 
coverage. The scary part to me is that they do not say how low 
they want to reduce the real value of the coverage. How low 
does it have to go before it no longer serves the purposes that 
it was created for?
    Chairman Sarbanes. Chairman Greenspan.
    Chairman Greenspan. Well, I am somewhat surprised by the 
Gallup poll, which I read as 50 percent are not in favor of 
increasing the coverage and 23 percent are not in favor of 
indexing.
    Usually, the responses to such polls when there is no cost 
on the other side is 100 percent in favor. And so, I find the 
poll surprising in a different sense from the way one would 
ordinarily look at it. I think the question really gets down to 
the notion of what problem is deposit insurance supposed to 
solve?
    We do, through our survey on consumer finances, have fairly 
extensive data on what deposits are held at what levels, by 
income groups, by education groups, and so on. And the data I 
think fairly conclusively indicate that there is very little 
stringency at these levels and, if anything, the levels are 
significantly above where the basic purpose of protecting the 
individual savers from the type of problems that the 
originators of the FDIC in the 1930's contemplated.
    We do not know where that number is, but it is 
significantly below where it is today. And you are quite 
right--we do support a reduction in the real value of the 
coverage, basically because we think that it is too high to do 
what it is supposed to do, so that there is an excess in there 
which we think can be used for better purposes for public 
policy.
    I do suggest that there will come a point, if indeed the 
$100,000 is not changed, is not indexed, and prices continue to 
rise, when you will get a significant set of questions as to 
whether, indeed, the coverage level in real terms is adequate. 
I do not think we are close to that in any respect and would, 
therefore, not find a particular useful purpose in indexing.
    Chairman Sarbanes. Mr. Fisher.
    Mr. Fisher. First, I would provide both a historical 
perspective and then an analytic framework.
    Chairman Greenspan's written testimony suggests that taking 
inflation index from the 1930's, the initial $5,000 amount 
today, that in current dollar terms would be about $60,000.
    Chairman Sarbanes. I am not sure which index that would be.
    Chairman Greenspan. That is the personal consumption 
expenditures index.
    Chairman Sarbanes. Which, as I understand it, is the most 
conservative of the indices.
    Chairman Greenspan. It is not a question of conservative. 
It is a question of being, in our judgment, the most accurate.
    Chairman Sarbanes. Fine.
    Chairman Greenspan. Therefore, we tend to use that rather 
than the CPI for reasons I have discussed previously.
    Chairman Sarbanes. Excuse me for interrupting, but if we 
were to use the CPI, what would the figure be?
    Chairman Greenspan. The number is higher. I do not know 
specifically what it is.
    I will be glad to submit that for the record, Mr. Chairman.

    The amount that $5,000 in 1934--the deposit insurance 
ceiling at that time--is worth today depends upon the index 
used to measure inflation. If the chain-type personal 
consumption expenditure (PCE) deflator is used, then $5,000 in 
1934 is worth $58,206 in 2001. But, if indexation to the 
consumer price index (CPI) had been in place since 1934 for 
deposit insurance coverage, then such coverage would be at 
$66,082 in 2001.

    Chairman Sarbanes. Thank you. Sorry, go ahead.
    Mr. Fisher. That is all right. But given the recent 
performance, using the PCE inflator, it would be another 20 
years just on a back-of-an-envelope basis, before we would be 
up in the $100,000 range indexing from here.
    As an analytic framework, I would suggest looking at median 
household income, which, if memory serves, is in the $32,000 to 
$35,000 range today, and seeing what level of transaction 
balances, not the totality of their savings, but the median-
income family, what do they need in terms of deposit insurance 
to serve their needs in providing deposit insurance on 
transaction balances.
    Then perhaps looking at the bottom 10 or 20 percent of the 
income distribution and trying to find a coverage level that 
would provide them with coverage for their savings.
    The data underlying, if memory serves, is that today there 
are roughly 90 million deposit-taking households in America. 
Only 5 million of those have deposits in excess of $100,000. 
And of that 5 million, roughly half choose to be fully insured, 
to go through the process of dividing up their accounts, and 
the other half choose to have some uninsured deposits.
    That seems to me to be a statement of a nonproblem, that it 
is a relatively small section of the population, a small 
fraction, and it is one where they divide about in half, 
whether they choose to go through the inconvenience of getting 
multiple accounts, whether they choose to have some uninsured.
    Mr. Hawke. Mr. Chairman, I think the answer to your 
question lies in the original purposes of deposit insurance. It 
was originally conceived of as a way to provide households with 
a safe repository for their short-term liquidity, and to do so 
without imposing on households and on unsophisticated people 
the need to make investment decisions.
    Deposit insurance has become much more than that. It has 
become an investment vehicle. And, I think we should resist 
efforts to make deposit insurance more of an investment vehicle 
than a repository for household liquidity.
    Today, anybody can get virtually unlimited deposit 
insurance coverage, which means that even under today's system, 
it has become something vastly more extensive than the original 
concept of deposit insurance.
    Chairman Sarbanes. Mr. Gilleran.
    Mr. Gilleran. I think it is at an amount that covers the 
vast majority of savers. So if it covers 95 percent, that 
sounds pretty good to me. In addition, because you can get 
unlimited coverage by moving your money into other 
institutions, it would seem it would completely cover those who 
want a larger coverage.
    So, I think that the $100,000 limit is okay as it is.
    Chairman Sarbanes. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Greenspan, to pick up on some of your statements, 
what does insurance solve? In other words, what is the problem 
that it solves? If the thrust of it is to protect the most 
vulnerable of our depositors in the population. As Secretary 
Fisher said, and correct me if I am wrong, was it fewer than 2 
percent, less than 2 percent of the population of the United 
States, about 5 million people, that have accounts of about 
$100,000?
    Mr. Fisher. I think it is 5 million households.
    Senator Shelby. Households.
    Mr. Fisher. Have deposits in excess of $100,000.
    Senator Shelby. So about 5 percent of the people. What is 
the average bank deposit in a CD or whatever, in the United 
States, roughly, today? It is not $100,000. I know that.
    Mr. Fisher. Much smaller.
    Senator Shelby. What is the average savings account in the 
banks of the United States?
    Chairman Powell. I think it is approximately $10,000 to 
$12,000.
    Senator Shelby. Okay, $10,000 to $12,000. Not $100,000. 
Let's go back to risk. Risk has to be an important component 
here. Let's talk about that just for a minute, what is the size 
of the BIF fund today, roughly?
    Mr. Powell.
    Chairman Powell. The combined funds are approximately $42 
billion.
    Senator Shelby. How much?
    Chairman Powell. About $42 billion.
    Senator Shelby. That's $42 billion?
    Chairman Powell. Yes, combined.
    Senator Shelby. And what about the SAIF? What is that?
    Chairman Powell. That is the combined funds.
    Senator Shelby. Well, break them down.
    Chairman Powell. The BIF is $30 billion and the SAIF is the 
difference.
    Senator Shelby. What is the real risk in the country before 
you would have to have a financial crisis to eat the fund up, 
which it has before, before it visits the taxpayers. Right?
    Chairman Powell. Right.
    Senator Shelby. Do you believe that $42 billion is enough 
money in the fund, considering all the exposure that our banks 
have in America?
    Chairman Powell. I believe it is today, Senator.
    Senator Shelby. You do?
    Chairman Powell. Yes, sir.
    Senator Shelby. Today.
    Chairman Powell. Yes, sir.
    Senator Shelby. But you do not know about tomorrow.
    Chairman Powell. Yes, sir. Right.
    Senator Shelby. So, as you said, it is a fluid situation.
    Chairman Powell. That is right.
    Senator Shelby. It is a moving target.
    Chairman Powell. Right.
    Senator Shelby. Who pays and who doesn't pay the insurance, 
FDIC insurance, in America? Just go over it. Who pays and who 
doesn't pay?
    Chairman Powell. Currently, under the current law?
    Senator Shelby. It is the law of the land passed by 
Congress.
    Chairman Powell. That is right. Institutions that are well-
managed and well-capitalized do not pay any premium.
    Senator Shelby. They get the benefit of the insurance, 
don't they?
    Chairman Powell. Yes, sir.
    Senator Shelby. So, they are getting a free ride, 
basically. Right?
    Chairman Powell. Well----
    Senator Shelby. They are or they are not.
    Chairman Powell. Those institutions would say that they 
paid into the fund----
    Senator Shelby. I understand that.
    Chairman Powell. That is true. They are not paying current 
assessments.
    Senator Shelby. And how many of the banks in the United 
States, or what percentage of banks, are not paying into the 
fund?
    Chairman Powell. That number is 92 percent.
    Senator Shelby. Was that 92 percent?
    Chairman Powell. Yes, sir.
    Senator Shelby. Say that again. So, 92 percent of the banks 
in the United States do not pay into FDIC fund. Only 8 percent 
are paying in. Yet, the fund insures them all. Is that correct?
    Chairman Powell. Yes, sir.
    Senator Shelby. Up to $100,000.
    Chairman Powell. Yes, sir.
    Senator Shelby. Does that make sense?
    Chairman Powell. No, sir. That is the reason our reform is 
before this Committee.
    Senator Shelby. And that brings to light that if there is a 
crisis and we eat the funds up fast, or you did, by bail-outs 
and so forth, the Comptroller and everybody else would be right 
here before this Committee for more money from the taxpayer, 
just like the thrift debacle. Is that correct? That is true, is 
not it?
    Chairman Powell. That is true.
    Senator Shelby. Who pays and who doesn't? I think that is 
very important.
    What is the average, Chairman Greenspan, if you recall, and 
I am sure you would, in Europe, what kind of insurance fund do 
they have with their banks in Europe? Does it vary from country 
to country, or is it more uniform?
    Chairman Greenspan. It varies from country to country. And, 
for example, in Japan, they for a while had insured all 
deposits.
    Senator Shelby. Blanket insurance.
    Chairman Greenspan. Blanket insurance. Then, as of March 
31, they came back down to a more moderate level.
    It varies from country to country. The principle, however, 
is generally the same throughout the world.
    Senator Shelby. Mr. Fisher.
    Mr. Fisher. No.
    Senator Shelby. Thank you.
    Risk, I think is what it is all about.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. First, I would say to my colleagues, I 
understand the vote that was scheduled for 11:30 a.m. has now 
been scheduled for after lunch. So, we will be able to continue 
uninterrupted.
    Before I yield to Senator Johnson, Chairman Powell, I just 
want to clarify one thing. You said 92 percent of the banks 
were not now paying into the insurance fund. Correct?
    Chairman Powell. Yes, sir.
    Chairman Sarbanes. But a very significant percentage of 
those banks had previously paid into the insurance fund in 
order to build their levels up to a point where no assessments 
would be required. Is that not correct?
    Chairman Powell. That is correct.
    Chairman Sarbanes. Because I wanted to make clear that we 
focus on this free rider problem, because there are financial 
institutions that are getting the benefit of the deposit 
insurance who previously had paid into the fund to build it up 
to the level where the assessments would stop. But there are 
other financial institutions, as I understand it, who have 
never paid into the deposit insurance fund and are receiving 
the coverage.
    So when we talk about the so-called free rider problem, as 
I always understood it, it refers to that latter group and not 
the former group. Is that correct?
    Chairman Powell. Yes, sir.
    Chairman Sarbanes. Do you know, roughly, of the 92 percent, 
how it breaks down between those who have previously paid in 
and helped to build up the fund and those who have never paid 
into it?
    Chairman Powell. Say that one more time. Do I know those of 
the 92 percent that do not pay?
    Chairman Sarbanes. Yes. Some of those have previously paid 
in and helped to build up the fund. Some have never paid.
    Chairman Powell. About 10 percent have never paid into it.
    Chairman Sarbanes. Have never paid into the fund.
    Chairman Powell. Right.
    Chairman Sarbanes. Okay. Thank you.
    Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman.
    Chairman Powell, I would like to touch base a little bit on 
the urgency of FDIC reform this year.
    You indicated in your testimony that the current BIF 
reserve ratio has fallen to 1.26 percent. Given the requirement 
that the FDIC begin charging premiums and the ratio falls below 
1.25, do you think that BIF-insured institutions will be paying 
premiums within the year if nothing is done? And also, do you 
see competitive implications for the prospect of BIF 
institutions paying assessments while SAIF institutions pay 
none?
    Chairman Powell. Senator, under the current economic 
environment and the current condition of the industry, I do not 
believe that we should assess the industry, as you mentioned. 
However, if, in fact, the fund drops below the 1.25, we have no 
choice. One or four institutions, together with deposit growth, 
could cause the fund to go below the 1.25.
    Senator Johnson. So, we are not talking failures here. We 
are just talking deposit growth.
    Chairman Powell. We are talking both. We could be talking 
about failures, one or two large institutions, and perhaps 
deposit growth could both contribute to the fund dropping below 
the 1.25.
    Again, emphasizing, we would hope that the law would 
change, allowing the FDIC Board to manage the fund.
    Senator Johnson. What risks do you see for the industry and 
the economy if you had no choice but to impose assessments now?
    Chairman Powell. Well, I think it would be unfair, number 
one.
    Also, it would take monies out of financial institutions 
that they could be using to serve their communities with credit 
extensions.
    Senator Johnson. For Chairman Greenspan and Mr. Fisher, you 
both indicated support for the FDIC's recommendation that it 
have the authority to manage the reserve ratio within a range. 
And you have noted that it is logical to provide for reserve 
growth above 1.25 when conditions are good, and for reserves to 
decline below that level when conditions are unfavorable.
    And Mr. Greenspan, you observed that FDIC's suggested 
target reserve range be widened in order to reduce the need to 
change premiums abruptly. I wonder if you would elaborate a bit 
on what you believe an appropriate range would be, and how you 
might go about determining that range?
    Chairman Greenspan. Our view, Senator, is that the FDIC 
should have as much discretion as the Congress feels 
comfortable giving them in this regard.
    [Laughter.]
    Senator Johnson. I think it is back in our lap, Mr. 
Chairman.
    [Laughter.]
    Chairman Greenspan. The reason I say that is the greater 
the range in discretion they have, the more flexible the system 
will be.
    Having rigid trigger points is not helpful. I agree with 
the Chairman about the issue of fairness, certainly. But it 
also has problems of disrupting the economy or particular 
industries such as banking, which is not very helpful. That is, 
it creates an unnecessary instability, and if you allow the 
insurance premium rates to move in a manner which are 
continuous and not abrupt, I believe you can manage the risk 
system far more efficiently.
    Senator Johnson. Mr. Fisher, do you concur, basically? Or 
do you have any elaboration?
    Mr. Fisher. I concur.
    Senator Johnson. Several of you have endorsed a concept of 
awarding assessment credits to institutions based on 
contributions to the funds prior to 1997.
    Chairman Greenspan notes that the current system in which 
both the entrants and the fast growers are awarded insurance 
coverage virtually cost-free is both inequitable and 
contributes to moral hazard.
    I would be interested to hear from those of you who would 
care to comment, and particularly Chairman Greenspan, on 
whether an assessment credit of the type contained in S. 1945, 
the Safety Act, successfully addresses the weaknesses that the 
FDIC has identified in this regard?
    Mr. Greenspan, and then Mr. Powell, perhaps.
    Chairman Greenspan. Well, I think that the FDIC's 
evaluation of this is something that makes a good deal of sense 
to us.
    Senator Johnson. Mr. Powell.
    Chairman Powell. I concur.
    [Laughter.]
    Senator Johnson. That is what we like to hear.
    To Mr. Gilleran, we are covering a little bit of past area 
here, but, in light of your change of view or at least 
modification or correction of view, that you now oppose both an 
increase in coverage and indexation.
    We have had the current level of $100,000 for over 20 
years. Is there a point, and if so, at what point is that, that 
adjusting for this eroding loss of coverage makes sense?
    Mr. Gilleran. Senator, I do not think I changed my opinion.
    Senator Johnson. A clarification, for our purposes.
    Mr. Gilleran. And I solidified a view.
    I think there is always probably a de minimis coverage 
level that makes sense. I think that where the $100,000 is 
right now should not be reduced. And even though over time 
inflation reduces the value of that in real dollars, that 
through utilizing more than one account, the customers are 
still protected--they can get 100 percent protection of all of 
their funds by spreading it around--it would certainly come 
down to a point as to whether or not $100,000 was equal to a 
peppercorn, as they say, in the law, and therefore, of no real 
value to any individual institution.
    But certainly, in my view, the coverage is not there at 
this point.
    Senator Johnson. I see my time has expired here. I will ask 
one very quick question again for Mr. Gilleran.
    You observed that your objections to a special level of 
coverage for retirement accounts was based on the notion that 
we should not be singling out one particular type of savings 
for public policy reasons. But the very reason we have 401(k)'s 
and IRA's in the first place is because we have made public 
policy choices that we want to encourage savings for retirement 
and that there is a larger public reason for doing that. 
Doesn't it follow, then, that it is not illogical that we have 
an extra concern for retirement savings and the coverage that 
would go for that?
    Mr. Gilleran. I completely support 401(k) plans and 
retirement funds. However, my view as a regulator and as a 
member of the FDIC Board is on the safety, the soundness, and 
the protection of the fund. And I believe that by extending the 
coverage to specific parts of our society is, in a way, 
defusing the safety and soundness of the fund. Therefore, I 
would not want to see it going to other areas and I am very 
cautious on supporting this at this time.
    Senator Johnson. Thank you.
    Chairman Sarbanes. Thank you, Senator Johnson.
    Senator Bunning.

                COMMENTS OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman.
    First of all, I want to apologize to the panel for being 
late. And second, I would like to include my opening statement 
into the record, if that is okay with the Chairman.
    Chairman Sarbanes. Certainly. It will be included in the 
record.
    Senator Bunning. I have a question for Mr. Powell.
    Many of my bankers in Kentucky are very concerned about the 
cost of some of these proposals. Can you tell me what you think 
the cost of indexing, raising coverage to $130,000, doubling 
retirement account coverage, including municipal deposits would 
be to a first- or second-tier bank that has assets under $100 
million?
    I realize you probably do not have that off the top of your 
head, or maybe you do. And maybe you have to get back to me on 
it, but do you have any kind of a ballpark figure?
    Chairman Powell. It was just handed to me, Senator.
    Senator Bunning. That is great.
    Chairman Powell. One hundred thirty thousand dollars 
general coverage, just increasing to $130,000, is about 8 basis 
points.
    Senator Bunning. Eight basis points.
    Chairman Powell. Right. One hundred thirty thousand 
dollars, general, in our IRA coverage at $250,000, is 9.5 basis 
points. Just the IRA increase to $250,000 is 2 basis points.
    Now the cost to the institution would depend upon that 
institution's risk profile and the risk to the industry.
    Just because, in fact, if this does happen, and again, 
reminding everyone that we are not supporting increasing the 
limit. We are supporting indexing--is that allowing the FDIC 
Board to manage the fund does not necessarily mean that we 
would pass that increased cost to the institutions.
    Senator Bunning. Who would you pass them to?
    Chairman Powell. The fund itself may be okay.
    Senator Bunning. Yes. But what happens if you had some kind 
of a crisis?
    Chairman Powell. Well, if that would happen, then we would 
assess the industry regardless of what happened here.
    Senator Bunning. I will follow up with the same question 
because it has something to do with the first one. This is for 
you and for Chairman Greenspan and for any others who want to 
answer.
    You have offered certain testimony, and all the others have 
offered contradicting testimony, more or less. And I want to 
congratulate Chairman Greenspan because I think it is one of 
the very few times that you and I agree on this, and I am very 
happy to agree with you.
    [Laughter.]
    On raising coverage, I am particularly interested in 
hearing both of you expand on the S&L crisis and why raising 
coverage would not have an effect in a similar situation.
    For Chairman Greenspan, why it would have an effect. In 
other words, you are saying it is not going to have an effect. 
And in testimony that the Chairman and all others gave, it 
would not have an effect.
    Chairman Powell. On the cost to the institutions?
    Senator Bunning. Yes.
    Chairman Powell. First, I think it is important that we 
focus, to some extent, on what we all agree on. We agree, I 
would say, on every element of deposit insurance reform except 
the coverage issue.
    Senator Bunning. Which is a big one. What do we have it 
for?
    Chairman Powell. Well, let me just say that managing the 
fund is very important to me and risk-based premiums is 
extremely important to me.
    Senator Bunning. But to the average citizen and banker out 
there, the amount of coverage and the safety of their money is 
more important. Granted, your assessment is correct. But to the 
average person depositing $50,000 in the bank and having an 
FDIC-insured deposit, it is the most important thing.
    Chairman Powell. Well, to the average banker, also, costs 
associated with that and being able to pay assessments based 
upon risk profile I think is important. In addition, allowing 
the FDIC Board to manage the Fund.
    I am not sure you were in the room when I mentioned a 
moment ago about the Gallup poll and the average consumer.
    Senator Bunning. I was not.
    Chairman Powell. That the average consumer, in the results 
of a recent Gallup poll, indicated that approximately 50 
percent of those believed that coverage should be increased.
    Senator Bunning. The average Gallup poll also said that 75 
percent of the people believed that we should drill in ANWAR. 
So much for the Gallup polls.
    Chairman Powell. Seventy-seven percent of those people in 
the Gallup poll believed that it should be indexed. We also 
received a letter from the AARP supporting increased coverage. 
Again, we do not support that. We support indexing. So the 
consumer in various ways has spoken also.
    Senator Bunning. Mr. Chairman, would you like to comment on 
the difference between the S&L crisis that we went through and 
this current thing that we are considering?
    Chairman Greenspan. Yes. Senator. The S&L crisis was 
fundamentally caused by the fact that we constructed a thrift 
industry which essentially had long-term assets funded by 
short-term liabilities, which is an intermediary which can 
exist only in a noninflationary environment where short-term 
rates are generally low and stay low so that you do not get an 
interest rate mismatch.
    When that industry ran into the huge inflationary 
pressures, the interest receipts from their asset side, the 
long-term mortgages, went up far less than the rollover costs 
that were funded with rapidly rising short-term interest rates, 
and they began to lose money very dramatically and they came 
close to default pretty much across the board with respect to 
their capital.
    While raising the deposit insurance ceiling was not the 
cause of the S&L crisis, it exacerbated it because, as was 
pointed out previously, the availability of $100,000 chunks at 
market interest rates that were Federally insured, induced a 
very significant degree of distorted investments which, at the 
end of the day, cost the American taxpayer very substantial 
amounts of money. It did not have to happen that way and, 
clearly, we would have had a problem without the rise in 
coverage.
    But I think we have to be very careful about increasing 
coverage because first of all, it reduces the oversight which 
all forms of noninsured depositors tend to have on banks. And I 
have heard lots of arguments that they are all very 
unsophisticated and they cannot tell, but the people who hold 
uninsured deposits, from the surveys that we have had, are 
well-educated, knowledgeable, and they do have, and indeed, 
have had, a restraint on inappropriate lending practices on the 
part of institutions.
    So our judgment is that deposit insurance should be there 
for the purpose of the $50,000 depositor or, on average much 
less, being sure that their deposits are secured. Those are 
truly unsophisticated people who are depositing funds at those 
amounts. And we conclude that it is necessary to have a degree 
of coverage to make certain that that is the case.
    The current level, we perceive, as I indicated earlier, 
Senator does far more than is remotely necessary to maintain 
the basic purposes of deposit insurance. We have argued that 
while the holding of the $100,000 rate ceiling will eventually 
erode in real terms, we think that is good, not bad, for a 
while.
    At some point, it will create problems and we think at that 
point, we would address the issue. But as Secretary Fisher 
said, that by any relevant measure is a long way away.
    Senator Bunning. Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you.
    Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    Chairman Greenspan, to follow on Senator Bunning's 
question, you point out the structural mismatch of the 1980's 
between long-term interest rates on assets and short-term 
interest rates in borrowing which was exacerbated, in your 
words, by increasing deposit insurance. Is there anything of 
that character today structurally in the banking industry which 
would argue against increasing the rates?
    Chairman Greenspan. No, Senator. I think that the lessons 
of the 1980's hopefully were substantially absorbed. That does 
not mean that we have a full maturity match on the asset side 
and on the liability side of both thrifts and banks. We do not. 
We still have something of a problem there.
    And indeed, a good deal of people believe banking should be 
lend long where interest rates tend to be higher, fund short 
and hope. That is not an effectively useful strategy as far as 
I can judge. There is some of that, but it is nowhere near the 
order of magnitude that existed amongst the thrifts in the 
1970's.
    Senator Reed. I do not know if there is any coincidence, 
but the motto of my State is ``Hope.''
    [Laughter.]
    Let me just try to probe one other aspect of this issue, 
and that is the one of risk.
    There seems to be implicit in your comments, Chairman 
Greenspan and Mr. Fisher, this notion about raising deposit 
coverage will somehow exacerbate risk. And I know it will 
increase the amount of coverage outstanding. But it seems to me 
that the principal way we try to manage risk in the banking 
industry is by very vigorous oversight and regulation. I do not 
assume that you would say that we would minimize that or 
somehow that would be put aside if we increased the coverage.
    You are not inferring that, are you, Mr. Fisher?
    Mr. Fisher. I am certainly saying that if we increase 
coverage, we reduce the amount of discipline that comes out of 
depositors for uninsured deposits. That is certainly an element 
of what we look to. We do not rely exclusively on the 
regulators to provide a discipline on management.
    Senator Reed. Well, my perception is most of the major 
problems are caused not by wild-eyed depositors, but by 
imprudent managers who are not actively supervised. And so, I 
think the presumption that raising coverage is going to create 
this undiscipline in the banking system I think is a little bit 
too much.
    Mr. Fisher. I guess we may differ, then, Senator.
    Senator Reed. I guess we do.
    Chairman Greenspan. Senator, may I respond to that?
    Senator Reed. Mr. Chairman.
    Chairman Greenspan. The issue is not the depositors. It is 
the issue of subsidized funds available to banks which would 
induce the type of investments we are concerned will tend to be 
more risky. Indeed, that is exactly what did happen in the 
1980's. So the principle is still there. It is just that the 
order of magnitude is quite different.
    Senator Reed. But the principle still argues for very 
vigorous supervision by regulators, by risk assessments. And I 
do not see anyone at this table suggesting that you are going 
to stop doing that, or perhaps I am missing something.
    Chairman Greenspan. No, Senator, we will not. And if I had 
full confidence that we regulators were capable of doing 
anything close to what discipline in the marketplace can do, I 
would agree with you. I have been around too long to make that 
statement.
    Senator Reed. Let me ask a question of Mr. Powell and Mr. 
Gilleran because you, in fact, through your agencies, do clean 
up after the failure of banking institutions. There is a 
presumption also in the testimony that most people consciously 
make these choices to have uninsured accounts. They do it 
deliberately. It is a convenience matter. Is that your sense 
from the experience at FDIC and OTS, Mr. Powell?
    You know, they are very sophisticated. They go ahead and 
they say, I want to put $100,000 insured, but I do not want to 
go across the street to the other banks. So, I will put $50 
uninsured. Is that the case?
    Chairman Powell. I am not sure I can make that assumption, 
Senator. Since coming to the FDIC, I have experienced several 
bank closures and I have looked at the uninsured depositors. 
There were a lot of retirees, a lot of unsophisticated people 
who lost money in the Superior failure, Keystone failure, and 
the most recent smaller institutions that failed. I have 
received lots of letters.
    Senator Reed. Mr. Gilleran.
    Mr. Gilleran. I was the Superintendent of Banks in 
California from 1989 to 1994, and I had the unfortunate job of 
closing 25 banks. In general, I would say that those who lost 
money on an uninsured basis were businesses where, on the books 
of the business, they had a zero balance in the bank account, 
but they had a lot of outstanding checks that were out there 
that had not cleared yet. So, in fact, the balance on the 
bank's books was in excess of $100,000. And therefore, when the 
checks all cleared, some of them were not covered because the 
$100,000 level was exceeded.
    There are always those individuals who do forget and that 
they do have amounts in a bank because they have a long-
standing relationship with a bank and therefore, feel like they 
are very comfortable. I would say that those are very small in 
number and that anybody who has a fiduciary responsibility in 
connection with funds, which is a big source of deposits to 
banks, that those individuals are very much on top of the 
$100,000 limit situation. So, therefore, I think it is well 
monitored.
    Senator Reed. Thank you.
    Chairman Powell. I also remember the Bank of New England. I 
think also we must remember that sometimes those sophisticated 
depositors, in fact, do take their money out prior to the 
failure. But there are still others that suffer uninsured 
losses.
    Senator Reed. Well, I think in this whole discussion, that 
certainly, we have to concentrate on the overall effects of the 
banking system. But we also have to think about when these 
banks fail, real people lose their money. If we are providing 
some protection, we might consider providing more protection.
    Chairman Powell. It has been something like 27,000 people 
over the past 10 years that have lost money as a result of 
uninsured deposits, totalling roughly $700 million.
    Senator Reed. Thank you, Mr. Powell.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Senator Corzine.

              STATEMENT OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Mr. Chairman. And I apologize 
to the panel for being late. I was at the Federal Reserve 
dealing with a financial literacy issue which I know is near 
and dear to people on this panel.
    I also think it is appropriate in the context of the 
discussion that we are having here since the testing of high 
school students has been on a deterioration with respect to 
financial literacy capacity of our students.
    One wonders whether the general public has the 
sophistication to allow them to provide all that discipline 
that the marketplace would say they have. I think that is the 
essence of why there is a debate about some of these limits. I 
congratulate Senator Johnson and the others for their work in 
this area.
    I have not heard, and maybe you spoke about it before I 
joined the other Senators, about retirement accounts and 
municipal deposit accounts. And it is kissing cousins to 
debates that have gone on in the House with regard to rebates, 
bad actors, or lifeline banking accounts.
    I wonder if one wants to comment on the idea that certain 
kinds of activities may legitimately draw different kind of 
coverage than just general deposits, IRA's for one. Promoting 
retirement is something that we may think is a public good. 
Municipal deposits where reinvesting monies in the communities 
where the banks or financial institutions are located, may be a 
positive ingredient and justify a different kind of limit than 
you might have otherwise.
    I guess this bad actor issue is a matter of rebates to 
people who do not fulfill other obligations that we might say 
of public goods by flying banking accounts as to promote 
savings by people who are low and moderate income.
    Is there a basis for having these carve-outs that are 
different than general insurance that we talked about with 
regard to deposits? And how do you all feel about it and how do 
you feel about the specific elements in the bill that is being 
proposed?
    Let's start with Mr. Powell.
    Chairman Powell. I am always first.
    [Laughter.]
    Senator, first of all, as to your opening comments, the 
FDIC supports this whole notion of education and financial 
literacy among all people. In fact, we have a program known as 
Money Smart that we believe is a great product that we are 
attempting to get into the marketplace.
    Also, I think that it is important that you understand one 
of our charges. And that is that the FDIC is to make sure that 
we educate the public in relation to the FDIC insurance. We 
take that, too, very seriously. We have a website and pamphlets 
to make sure that the public-at-large understands what FDIC 
insurance is and, in fact, how they are covered.
    We do not support additional coverage for municipal 
deposits. And we are committed to studying ways in which there 
may be a vehicle through additional premiums that municipal 
deposits may be, in fact, increased. But today, we do not 
support increasing coverage for municipal deposits.
    Chairman Greenspan. I agree with Chairman Powell's view.
    Senator Corzine. I would like, though, to know whether you 
all just believe that there should be only general deposit 
insurance and there should be no carve-outs for retirement 
accounts or municipal or any kind of fundamental usage of 
insurance as the basis of public policy.
    Mr. Fisher. Yes, Senator. While, obviously, improving 
America's savings rate is an overriding and important 
objective, particularly to try to promote investment in the 
future and pay for our collective retirements, we think that 
the deposit insurance program has a particular purpose. It is 
about confidence in the banking system. That is its overarching 
purpose.
    It serves the purpose for small depositors at the bottom 
end of the income spectrum, to provide a complete safety net 
for them. But it cannot be all things to all people. And we are 
not in favor, we do not support any of the carve-outs that you 
just described.
    Senator Corzine. We are going to hear the same thing, I 
suspect.
    Mr. Hawke. I would concur. Senator Johnson made a point a 
minute ago about 401(k)'s and IRA's, which are, of course, 
creatures of the tax code. I am not sure we want to see deposit 
insurance become a vehicle for the realization of a variety of 
different social policies the way we use the tax code today. 
Keeping deposit insurance faithful to its original concept 
seems to me to make a lot of sense. And, when you start 
departing from the original purposes of deposit insurance and 
start using it for other purposes, it is hard to see where you 
stop.
    Mr. Gilleran. I feel open to the subject of securing better 
retirement funds. However, I am really dissuaded from 
supporting it because of the fact that it opens up so many 
other discussions of what else should be included. It is almost 
like, once you start down that road, there is no stopping it.
    But I completely agree that the primary purpose of the 
deposit insurance program is the safety and soundness of the 
banking industry. And carving out various segments of our 
society for greater protection I think would put in jeopardy 
the safety and soundness factor.
    Senator Corzine. Thank you.
    Chairman Sarbanes. I want to ask another basic question. I 
asked before what should be the level of deposit insurance just 
to try to find out what the factors are. I want to ask the 
question, why is 1.25 percent the figure that should govern the 
ratio and what is in the fund?
    I ask that question because, as I understand it, and this 
goes to the argument that some banks are too big to fail. At 
the moment, if you assume a loss of assets of 25 percent, which 
is a fairly high figure because the FDIC tells us that, 
traditionally, the loss of assets has been somewhere between 5 
and 10 percent on a failed bank, once they do all their 
recoveries and everything. But in recent times, the five 
largest failures since 1999, losses have ranged between 10 and 
15 percent of total assets.
    So just for the sake of illustration, there are eight BIF-
insured institutions now that are so large that if they had 25 
percent of assets lost, they would more than use up the fund. 
Just the failure of one of those eight institutions would 
exhaust the fund. Then, if you change the ratio, the figures 
change. But that raises the question, it seems to me, whether 
1.25 is adequate.
    Now all the talk is in terms of a range of discretion 
around 1.25. But why is the 1.25 the right figure, particularly 
in light of this observation about large banks and what their 
failure would do and how the fund could cover them?
    We could not even take the hit of one of the largest 
financial institutions failing. At least there is a big 
question mark as I now see the situation. So that leads one to 
say, well, what is the rationale that determines what the ratio 
should be?
    Chairman Greenspan.
    Chairman Greenspan. I am in the unusually useful position 
to answer that question.
    [Laughter.]
    Chairman Sarbanes. Actually, you usually are in that 
position on any question.
    [Laughter.]
    Chairman Greenspan. Well, no, because somebody at a meeting 
on deposit insurance a number of years ago was trying to decide 
what would be the appropriate ratio, and I unhelpfully just 
threw out, just looking at this chart, the average looks like 
1.25. I was just making a historical statement. I am not 
absolutely certain that that is where it came from, but I 
wouldn't want to bet against it.
    [Laughter.]
    The reason is, as you point out, Mr. Chairman, this is not 
an insurance fund in the typical sense of the word. An 
insurance fund is one which sets premiums and creates a level 
of assets which effectively will insure against the realistic 
probabilities of the types of defaults and losses which you 
point out.
    We do not have private insurers and the reason we do not is 
that, unlike insurance on life or auto/casualty, where you have 
a reasonably good distribution of what the losses are and you 
can set premiums fairly closely to achieve an optimum insurance 
system, we do not know what the probabilities are of these very 
large losses and the potential contagion that exists within the 
banking industry which creates that.
    There is no contagion generally in true insurance. Most 
losses are independent of each other. That is not true of 
banking. The result of that is that you need a very large 
premium if you are going to act in a manner which will protect 
an insurance fund from going below zero.
    The only way you can get deposit insurance is through the 
lender of last resort, who does not have to create very large 
premiums to insure the tail-end of the probability distribution 
which creates these very huge losses.
    As a result, private insurance insurers, which you may 
remember 15, 20 years ago, including in Maryland, had great 
difficulty when they were pressed. They had inadequate 
reserves. As a consequence of that, we have, of necessity, a 
subsidized insurance system because you could not charge the 
premiums which would truly act as insurance against the types 
of real risks that are out there.
    What we have done instead is to create the current system, 
which for most purposes, is working. It means that commercial 
banks and thrifts are paying for the losses. But the broad 
contagion, low-probability, large-cost event can only be 
insured by a lender of last resort.
    So that is the way the system evolved. The 1.25, I can 
assure you, is merely a notion of what numbers, in fact, looked 
like over the history. They are not a scientifically 
constructed number.
    Chairman Sarbanes. Yes. Well, I appreciate that answer. It 
does leave still open the question whether the growth of these 
large institutions, the failure of only one of them--in other 
words, not a systemic failure in the banking system, but a 
breakdown in the one institution--whether they should require 
us to reexamine whether the levels are adequate. If you did not 
have the large institutions in the picture, you would have a 
different question.
    In other words, you would say, well, the fund is large 
enough that it could handle the failure of any financial 
institution if there were a breakdown of its management. The 
growth of the large institutions now precludes us from making 
that statement. At least there are reasonable probabilities 
that that is the case. And I do not know. Should that require 
us to reexamine the levels at which the fund is maintained?
    Chairman Powell. Senator, I think you bring up something 
that we have discussed at the FDIC. How would we deal with a 
large institution that would fail, not only from the fund, but 
also the complexity of disposing of assets and selling assets 
into the marketplace and paying off depositors.
    Hopefully, as supervisors, we would be able to determine 
and make the necessary regulatory decisions to prohibit a large 
institution from failing.
    I think the marketplace would recognize very quickly that a 
large institution was in trouble. And I think that depositors, 
uninsured depositors, also, sophisticated uninsured depositors, 
would recognize that that, in fact, is the case. I am not sure 
what would happen. Probably, in larger institutions, there are 
more sophisticated depositors than in smaller institutions.
    But it is an issue. And I do not have a good solution for 
it, other than, as regulators, we should be on top of that. As 
you know, we now have certain powers, including prompt 
corrective action, including some other powers that we can put 
in play that hopefully would prohibit a large institution from 
failing.
    Chairman Sarbanes. Clearly, if it did and the fund was 
inadequate, you would come to the Congress. The Congress would 
then have to vote the money, just as we did in the S&L times, 
in order to deliver on the guarantee.
    Chairman Powell. Right.
    Chairman Sarbanes. Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman.
    Just let me direct this to Mr. Greenspan, in particular. I 
want to clarify a little bit in my mind. We talked about the 
resistance to higher levels of coverage or indexation.
    Chairman Greenspan. We are talking about premiums at this 
stage. No, the issue that is involved here is a premium 
question, as to whether, in fact, premiums are being set 
appropriately.
    It is a very tricky question because we support risk-based 
premiums because it moves in the right direction, but we do not 
claim that it creates a system which is a true insurance 
system.
    Senator Johnson. Right.
    Yes, Mr. Powell.
    Chairman Powell. I think it is important that, before we go 
to the taxpayers, Senator, we would go back to the industry to 
replenish the fund. Again, that would depend upon how large the 
hole would be.
    Chairman Sarbanes. Well, all right. Then we have the 
countercyclical arguments that we get into.
    Chairman Powell. Right. Exactly.
    Chairman Sarbanes. Or the procyclical arguments.
    Chairman Powell. Right.
    Chairman Sarbanes. The impact that that has on the industry 
in what may be a time of difficulty or even distress.
    Senator Johnson. There may be a disconnect. I am moving on 
to a separate issue, and that is back again to the whole 
question of whether there should be indexation or any increase 
of any kind in terms of FDIC coverage. The objection has been 
that it creates additional moral hazard.
    And so that I understand this a little better, it would 
seem to me that the point of risk-based pricing is to mitigate 
the additional coverage risks, that along with more recent 
reforms such as prompt corrective action, PCA, and that those 
are designed to minimize any additional hazard that might come 
from higher levels of coverage or indexation. Is that not 
reading this correctly, or are these not adequate tools to 
cover that additional risk?
    Chairman Greenspan. No, on the contrary, I think you 
correctly identify it, Senator.
    The issue is that at any given level of coverage, the 
existence of these various other elements which mitigate the 
moral hazard are valuable. But the problem is, we do not have 
the capacity to increase the degree of oversight supervision, 
the prompt corrective action, that offsets the rise in the 
ceilings.
    But you are certainly correct that the purpose of risk-
based premiums, amongst other things, is to make whatever the 
level of coverage is less subject to moral hazard.
    Senator Johnson. It is certainly true that those who 
support some indexation are not suggesting that there be some 
free benefit out there, that, in fact, additional coverage be 
offset by the additional premium, which is based on any 
additional risk incurred.
    Chairman Greenspan. The issue of the amount of premiums 
involved would be determined independently of that. The problem 
that you have is that, if, for example, you raise coverage and 
you are at a level where the increased requirements of the fund 
necessitate an increase in premiums, then, clearly, to be sure, 
coverage goes up, but so do premiums.
    Senator Johnson. Okay. Mr. Chairman, I will pass. My time 
has expired.
    Chairman Sarbanes. Thank you.
    Senator Corzine.
    Senator Corzine. I am fine.
    Chairman Sarbanes. No questions?
    Senator Corzine. No questions.
    Chairman Sarbanes. Well, this has been an extremely 
interesting panel, and we very much appreciate both your 
testimony and your responses here today and the obvious care 
that went into the preparation of the full statements that have 
been included in the record. We very much thank you for your 
contributions.
    The hearing is adjourned.
    [Whereupon, at 12:05 p.m., the hearing was adjourned.]
    [Prepared statements and response to written questions 
supplied for the record follow:]
             PREPARED STATEMENT OF SENATOR MICHAEL B. ENZI
    Thank you, Mr. Chairman. First, I want to thank you for holding 
this hearing. I believe it is important that we continually evaluate 
the status of the deposit insurance system. It is crucial to the 
stability of our banking system to not watch over it as closely as 
possible.
    I also want to thank our distinguished witnesses who are with us 
today. Your knowledge and background in dealing with these issues will 
help us immensely as we continue to work on this issue.
    As everyone knows, the House Financial Services Committee passed 
its version of deposit insurance reform last week, and I think it is 
important that this Committee keep pace on this critical issue. I want 
to thank Senator Johnson for allowing me to work with him on his 
legislation. I believe that what he, Senators Reed, Hagel, and myself 
have crafted provides the Committee with an excellent starting point to 
examining changes to the current deposit insurance system.
    I am extremely pleased because I think a number of issues can be 
agreed upon by nearly everyone, and I would hope that the few remaining 
issues do not prevent us from making needed changes as soon as 
possible. This legislation is too important for banks, not only in 
Wyoming, but also across the country to let it get stalled.
    S. 1945 addresses a number of problems with the current system. It 
merges the BIF and SAIF account, which I believe is widely supported. 
The legislation also 
requires mandatory risk-based premiums, because all institutions, no 
matter how well managed, offer some risk to the funds, they should all 
pay some amount into it. The legislation also allows the FDIC to have 
more flexibility when assessing premiums. The bill eliminates the hard 
target of 1.25 percent, in favor of letting the FDIC manage the funds 
within a range of 1 to 1.5 percent. This clarifies that in good 
economic times, it would be appropriate for the FDIC to increase 
reserves, so that in recessionary times, FDIC could relieve pressure on 
banks by allowing the ratio to float down until it is more comfortable 
for banks to replenish the fund. The bill also specifies that wide 
swings in assessment rates should be avoided.
    Again, I believe this issues is of critical importance. I thank 
you, Mr. Chairman, for holding this hearing, and I look forward to 
working with you and other Members of the Committee as we continue 
working on this issue.
                               ----------
                PREPARED STATEMENT OF SENATOR JACK REED
    Thank you, Mr. Chairman, and I appreciate your convening this very 
timely hearing, especially in light of last week's passage of deposit 
insurance reform legislation by the House Financial Services Committee.
    As an original cosponsor of the Safe and Fair Deposit Insurance Act 
of 2002 (the ``Safety Act''), I strongly support the efforts prompted 
by the FDIC's Options Paper of April 2001 to look closely at the system 
we have in place now, and begin the work we need to do to improve and 
strengthen it for years to come. I want to commend Senator Johnson for 
his work on the ``Safety Act,'' and for moving the Committee into a 
position where we can begin to consider these important issues.
    Our banking system has been the envy of the world because of its 
safety, strength, and transparency. Our work on deposit insurance 
reform through the ``Safety Act'' will only build on that record.
    In recent years, we have seen some troubling bank failures, the 
largest of which occurred last summer at Superior Bank of Illinois, 
costing the Savings Association Insurance Fund almost $500 million. 
Others have followed since then, dropping the funds to a precipitous 
level. By instituting some of the reforms outlined in the FDIC's 
Options Paper, as well as in the ``Safety Act,'' such as merging the 
two insurance funds, and removing the ``hard target'' of those funds, 
we can ensure a much more stable and viable system for the future.
    Obviously, there are several other issues suggested by the FDIC and 
the legislation where there are serious disagreements, such as on 
raising the coverage limits of deposit insurance for individual 
accounts, as well as for retirement accounts, and indexing that 
coverage going forward. However, I am confident that through the 
upcoming Committee and floor process, we will able to reach a good 
compromise on the issues that will benefit the industry and all 
Americans who continue to depend upon it.
    Thank you, Mr. Chairman.

             PREPARED STATEMENT OF SENATOR DEBBIE STABENOW

    Thank you, Mr. Chairman. I am glad that we are focusing our 
attention today on the issue of deposit insurance reform.
    Let me begin my remarks by commending the leadership of Senators 
Johnson and Hagel. They have done excellent work, putting together a 
reform proposal. Their bill, the Safe and Fair Deposit Insurance Act, 
is a solid and reasoned approach.
    I am proud to be a cosponsor of this bill. In all, there are 
already 7 Members of this Committee on the bill. I know of few other 
proposals before our Committee that have garnered such strong 
bipartisan cosponsorship. That, I believe, is a true testament to the 
strength of the Johnson-Hagel initiative and a reflection of their 
collaborative efforts.
    It was just about a year ago that then-FDIC Chairwoman Donna Tanoue 
argued to Congress that the time to address flaws in the system is 
now--while the industry is strong and the overwhelming majority of 
institutions remain healthy. I agree with her and I hope that we can 
move a bill forward.
    While there are several issues about which there is disagreement, 
the need for reform, as outlined in the FDIC's April 2001 report, is 
clear. I hope we will work together to resolve the outstanding 
differences people have regarding reform. Questions about the $100,000 
coverage level, indexation, municipal coverage, accounting for loan 
loss reserves, and so-called free riders are just a few of the issues 
to which the answers are not simple. And, indeed, we, as policymakers, 
may disagree about what is the best solution to some of the questions 
reform of the deposit insurance system raises. At the end of the 
process, however, I believe that we can pass a solid bill that is an 
improvement over the status quo.
    We all know that last week the House Financial Services Committee 
overwhelmingly reported out a bill very similar to the Johnson-Hagel 
bill. Indeed, the vote was 52 to 2. With such broad support in 
Committees of jurisdiction in both Houses, I believe momentum is 
growing.
    I thank the Chairman for calling today's hearing. I welcome our 
witnesses before us. And I look forward to working closely with my 
colleagues to move a reform bill.
    Thank you.

                               ----------
               PREPARED STATEMENT OF SENATOR JIM BUNNING

    I would like to thank you, Mr. Chairman, for holding this very 
important hearing and I would like to thank all of our witnesses for 
testifying today.
    We have been struggling with this issue for a number of years. My 
own experience with FDIC reform started when I was a Member of the 
House Banking Committee during the S&L bailout. That was not a fun time 
for anyone involved and I know most of you were involved in one way or 
another.
    Because of that wonderful experience, I enter into any discussion 
of deposit reform with a certain amount of trepidation. Obviously, none 
of us want to live through that mess again. However, that does not mean 
that the current system cannot and should not be improved. There are a 
lot of good things in both the Senate bill offered by my colleague, Tim 
Johnson, and the House bill. A lot of which I agree with. The FDIC 
should have flexibility. We should merge the funds. We should eliminate 
the cliff. All of these are ideas that should have become law a long 
time ago and I am glad they are before this Committee now.
    But I am a little nervous about one thing, how much is this going 
to cost the small- to mid-sized banks in my State. My bankers want a 
lot of the things in these bills. They like the items I previously 
mentioned, and they like increased coverage, in the abstract. They are, 
however, very much afraid of how much this is going to cost their 
banks.
    I think, when you add up all of these proposals, that is a very 
legitimate fear. It is also my biggest fear. I do not want us to forget 
when we are trying to do all of these wonderful things, how much it is 
going to affect our small banks, who are so important to our economy. I 
do not want to force them to buy steak when what they really want is a 
hamburger. I can only speak for the bankers in my State, but they are 
telling me that although they like steak, they want a hamburger. They 
are afraid these proposals are getting a little too expensive.
    I look forward to hearing from all of you about the cost issue, 
especially on how it affects smaller banks. I also look forward to 
hearing your other testimony as well.
    I thank all of you for testifying today, I look forward to hearing 
from you.
    Thank you, Mr. Chairman.

              PREPARED STATEMENT OF SENATOR JON S. CORZINE

    Mr. Chairman, thank you for holding this important and timely 
hearing.
    Deposit insurance reform has been the center of a great deal of 
Congressional consideration and discussion as of late. Among the many 
key issues in this debate are whether general deposit coverage limits 
should be increased--and if so, by how much--or whether they should 
simply be indexed.
    The questions surround the adequacy of the current coverage limit 
and whether the value of that coverage has eroded since 1980, the last 
time it was raised. In my mind the most important element of this 
debate will be whether increasing the coverage will provide a net 
benefit that provides an incentive for people to save more. My guess is 
few, if any, consumers are aware that this debate is ongoing, and 
unless pressed for an answer, fewer would have an actual opinion on the 
matter. Little information exists that can provide us with an accurate 
portrayal of consumer sentiment on this subject.
    There are other items of importance to this debate aside from the 
question of 
increasing the coverage limits. Whether we should increase coverage for 
individual retirement accounts and municipal deposits; whether we 
should merge the BIF and the SAIF; how much flexibility the FDIC should 
have in setting the merged fund's designated reserve ratio; and whether 
the FDIC should be allowed to assess premiums on all institutions are 
all important considerations for us to undertake. There seems to be a 
growing consensus to act on most of these points.
    For those of us still undecided on the merits of various facets of 
this debate, this hearing will give us a unique opportunity to have an 
open, frank discussion of these important issues. Mr. Chairman, you 
have afforded us that opportunity by convening a hearing with a most 
distinguished panel.
    I welcome all of our witnesses and look forward to their testimony 
and to an engaging discussion.
    Thank you, Mr. Chairman.

                               ----------
             PREPARED STATEMENT OF SENATOR DANIEL K. AKAKA

    Thank you, Mr. Chairman. Last April, the Federal Deposit Insurance 
Corporation issued recommendations for deposit insurance reform. These 
recommendations 
included merging the two deposit insurance funds, the elimination of 
sharp premium swings, and indexing coverage levels to account for 
inflation. These recommendations initiated a national dialogue on how 
the Federal Deposit Insurance Corporation can operate more efficiently, 
provide greater economic stabilization, and protect savings. I thank 
Senator Johnson, Chairman of the Subcommittee on Financial 
Institutions, and his Subcommittee staff for all of their work in 
continuing the national dialogue.
    One area worthy of discussion is the merger of the two insurance 
funds. The 
current administration of two deposit insurance funds, the Bank 
Insurance Fund and the Savings Association Insurance Fund, has created 
a system where identical coverage is provided but assessments are 
determined separately. Banks and thrifts with similar risk levels could 
potentially be paying different amounts for coverage. This occurred in 
1995 and 1996, when the highest rated Savings Association Insurance 
Fund institutions were paying premiums while the highest rated 
institutions of the other fund were not. In addition, many financial 
institutions have both types of insured deposits. Merging the fund 
would simplify reporting and accounting 
requirements for financial institutions and the FDIC.
    Another area to examine is the elimination of sharp premium swings. 
Significant increases in deposit insurance premiums can occur when the 
designated reserve ratio falls below 1.25 percent of insured deposits. 
I am concerned because this would most likely happen during difficult 
financial times when banks would have difficulty paying sudden 
increases in their premiums. Access to credit could be restricted and 
an economic downturn could be prolonged. There is a need to provide the 
FDIC with greater flexibility in determining the appropriate reserve 
ratio in an attempt to level out the economic cycles.
    Finally, the issue of indexing or increasing coverage limits needs 
to be thoroughly evaluated to determine the possible impact such action 
would have on the Nation's banking system.
    I thank you for appearing today, and I look forward to your 
recommendations as we explore the issue of Federal deposit insurance 
reform.
    Again, Mr. Chairman, thank you for conducting this hearing.

               PREPARED STATEMENT OF SENATOR CHUCK HAGEL

    Thank you, Mr. Chairman, for holding this hearing today. It is an 
important and timely issue that deserves our full attention. I 
appreciate Senator Johnson's leadership on this issue and the work of 
Senators Enzi and Reed in crafting the Safe and Fair Deposit Insurance 
Act of 2002.
    Deposit insurance has been the bedrock for our banking system. It 
is especially significant to our Nation's community banks as the 
guarantee on deposits gives people confidence that their money will be 
safe. Last year, the Federal Deposit Insurance Corporation (FDIC) 
proposed several reforms to the deposit insurance system to address 
critical weaknesses such as the procyclical nature of the current 
system, the advent of ``free-riders,'' and the pricing mechanisms. 
These are reforms on which we can all generally agree.
    We must also support our community banks and the liquidity 
deficiencies they face today. We can do this by increasing coverage 
levels for general accounts, for retirement accounts, and for municipal 
deposit accounts. Increasing coverage will 
increase lending capacity for community banks, and is a necessary 
component to compete with the ``too big to fail'' advantage big banks 
enjoy.
    Raising coverage levels to $130,000 will help community banks raise 
core deposits and allow them to lend more back into farms, small 
businesses, and into their communities. This rotation of each dollar 
invested back into the community insures the stability of their way of 
life. The viability of community banks is dependent on 
deposit insurance and in order to continue to serve their customers, we 
must consider raising the coverage levels.
    These bankers know, better than any of us here in Washington, the 
needs of their customers and the needs of their banks. Studies have 
reinforced this viewpoint as well. A Gallup survey conducted on behalf 
of the FDIC found that deposit insurance is a factor in investment 
decisions and is especially important to more risk-averse consumers and 
those in older and less affluent households.
    I have heard from our witnesses here before us today of their 
opposition to 
increasing coverage levels. One reason stated is that you haven't heard 
from anyone on how this would benefit banks. Let me share one example 
with you:
    A $27 million bank located in Dalton, Nebraska, is the only bank in 
town. They have 1,500 customers and 3 percent of them hold 48 percent 
of the bank's deposits. These customers are well aware of the $100,000 
limit and will not hold accounts above that level and have often left 
the bank for competitor banks. This may be a viable option in 
Washington or Baltimore, where banks are present at grocery stores and 
on every other corner. But in Nebraska's small towns, there is not the 
option of going to a Fleet or a CitiBank. Customers are not only 
disserviced by having to drive to the next town, but that bank is also 
losing deposits. Raising the coverage level even a small amount, will 
allow them to keep more deposits in their banks and expand their 
lending capacity.
    Finally, I disagree with the theory that banks will become more 
reckless with 
increased coverage levels. I find it hard to believe that a community 
bank that has been in operation for decades will suddenly become 
irresponsible with its lending practices. This ``moral hazard'' 
argument is purely theoretical. Bad lending decisions and bank failures 
will be made regardless of a slight increase in coverage levels, not 
because of it.
    The proposals we will discuss today for deposit insurance reform 
are addressed in the Safe and Fair Deposit Insurance Act. I welcome the 
thoughts from our witnesses and hope we can act on this legislation 
soon.
    Thank you.

                               ----------
                 PREPARED STATEMENT OF DONALD E. POWELL
            Chairman, Federal Deposit Insurance Corporation
                             April 23, 2002

    Chairman Sarbanes, Senator Gramm, and Members of the Committee, it 
is a great pleasure to appear before you this morning to discuss 
deposit insurance reform. This is one of the key priorities of the 
Federal Deposit Insurance Corporation and I appreciate this Committee's 
interest in promoting the discussion.
    Deposit insurance has been a significant element of financial 
stability in this country for nearly 70 years and helped us through two 
major banking crises. During the crisis of the 1980's and early 1990's, 
the FDIC and the Resolution Trust Corporation resolved 2,362 failures 
of insured institutions involving more than $700 
billion in assets. The last time we saw a banking crisis of that 
magnitude was during the early 1930's. Yet, the outcomes were very 
different. I believe this is due in large part to the presence of the 
FDIC and its stabilizing presence in the marketplace. Deposit insurance 
played a significant role in ending the banking crisis of the Great 
Depression by reestablishing financial stability. During the more 
recent crisis, there were no bank panics, no disruptions to financial 
markets, and no debilitating effect on overall economic activity.
    We sometimes fail to appreciate the truly remarkable value and 
accomplishments of Federal deposit insurance, and we tend to undervalue 
or disregard its importance when times are good. The FDIC has played a 
key role in maintaining public 
confidence in our financial sector through good times and bad, and we 
are proud of this record.
    The deposit insurance system protects depositors and helps the 
economy by preventing bank panics and stabilizing the financial system. 
It should accomplish this without causing other problems. Specifically, 
it should not increase banks' incentive to engage in riskier behavior 
than would be possible in the absence of insurance--the moral hazard 
problem. And, most of all, deposit insurance should never again cost 
the taxpayers a dime.
    Many of the rules put in place by Congress in the Federal Deposit 
Insurance Corporation Improvement Act of 1991 (FDICIA) are designed to 
ensure that the deposit insurance funds are adequate, that the deposit 
insurance program is operated in a manner that is fiscally and 
economically responsible, and that banks and thrifts--rather than the 
taxpayers--fund the system. We understand that many features of the 
current system exist for good reason, and we have not lost sight of 
this in developing our proposals.
    I have been at the FDIC about 8 months now. I arrived with a 
banker's natural skepticism about the need for deposit insurance 
reform, but I quickly became 
convinced. While the current system is not in need of a radical 
overhaul, flaws in the system could actually prolong an economic 
downturn, rather than promote the conditions necessary for recovery. 
The current system also distorts incentives in ways that exacerbate the 
moral hazard problem. These flaws can be corrected only by legislation, 
and I appreciate this Committee's attention to this issue.
    The work that the FDIC staff did in coming up with its 
recommendations for 
reform a year ago is a model for how Government agencies should create 
public policy proposals. The staff did its homework and kept all of the 
players--Congress, the banking industry, scholars and experts, and the 
public--involved every step of the way. They prepared an excellent 
report on deposit insurance reform with very important recommendations 
and I have full confidence in that product.
    Since I came to the FDIC, I have had a chance to add my own 
thoughts to the FDIC's recommendations and together we have had a 
chance to refine the proposals. This morning, I would like to give you 
our view on the best course for reform.
    Specifically, I will address several areas: merging the funds, 
deposit insurance fund management and pricing of deposit insurance 
premiums, a one-time assessment credit, and deposit insurance coverage.
    While I understand that much of the debate has centered on 
coverage, I want to first emphasize what we regard as even more 
critical--merging the funds, and 
improving the FDIC's ability to manage the fund and price premiums 
properly to reflect risk. These changes are needed to provide the right 
incentives to insured institutions and to improve upon the insurance 
system's role as a stabilizing economic factor, while also preserving 
the obligation of banks and thrifts to fund the system. I will discuss 
each of the issues in turn.
Merging the BIF and the SAIF
    We should merge the Bank Insurance Fund (BIF) and the Savings 
Association Insurance Fund (SAIF). There is a strong consensus on this 
point within the industry, among regulators, and within the Congress.
    Originally, the two funds were intended to insure bank and savings 
association deposits separately. From the point of view of the insured 
depositor, there is 
virtually no difference between banks and thrifts. Moreover, many 
institutions currently hold both the BIF- and SAIF-insured deposits. 
More than 40 percent of SAIF-insured deposits now are held by 
commercial banks.
    A merged fund would be stronger and better diversified than either 
fund standing alone. In addition, a merged fund would eliminate the 
possibility of a premium disparity between the BIF and the SAIF. As 
long as there are two deposit insurance funds, with independently 
determined assessment rates, the prospect of a premium differential 
exists. When such a price disparity exists, banks and thrifts naturally 
gravitate to the lower price, wasting time and money trying to 
circumvent restrictions that prohibit them from purchasing deposit 
insurance at the lowest price--an undesirable result. A merged fund 
would have a single assessment rate schedule and the prospect of 
different prices for identical deposit insurance coverage would be 
eliminated.
    The potential for differing rates is not merely theoretical. The 
BIF reserve ratio at the end of 2001 stood at 1.26 percent ($1.26 in 
reserves for every $100 of insured deposits), barely above the 
Designated Reserve Ratio (DRR) of 1.25 percent, while the SAIF reserve 
ratio stood at 1.37 percent. The FDIC Board will decide within the next 
few weeks whether BIF rates must be raised for the second half of 2002 
to maintain the reserve ratio at the DRR.
    For all of these reasons, the FDIC has advocated merging the BIF 
and the SAIF for a number of years, and I wholeheartedly agree. Any 
reform plan must include merging the funds.
Fund Management and Premium Pricing
    Two statutory mandates currently govern the FDIC's management of 
the deposit insurance funds. One of these mandates can put undue 
pressure on the industry during an economic downturn. The other 
prevents the FDIC from charging appropriately for risk during good 
economic times. Together, they lead to volatile 
premiums.
    When a deposit insurance fund's reserve ratio falls below the 1.25 
percent DRR, the FDIC is required by law to raise premiums by an amount 
sufficient to bring the reserve ratio back to the DRR within 1 year, or 
charge at least 23 basis points until the reserve ratio meets the DRR. 
Thus, if a fund's reserve ratio falls slightly below the DRR, premiums 
need not necessarily increase much. On the other hand, if a fund's 
reserve ratio falls sufficiently below the DRR, average premiums will 
increase to 23 basis points, at a minimum.
    The potential for 23 basis point rates is problematic because, 
during a period of heightened insurance losses, both the economy in 
general and depository institutions in particular are more likely to be 
distressed. A 23 basis point premium at such a point in the business 
cycle would be procyclical and result in a significant drain on the net 
income of depository institutions, thereby impeding credit availability 
and economic recovery.
    When a fund's reserve ratio is at or above the 1.25 percent DRR 
(and is expected to remain above 1.25 percent), current law prohibits 
the FDIC from charging premiums to institutions that are both well-
capitalized, as defined by regulation, and well-managed (generally 
defined as those with the two best CAMELS examination ratings).\1\ 
Right now, 92 percent of banks and thrifts are well-capitalized and 
well-managed and pay the same rate for deposit insurance--zero. 
Significant and identifiable differences in risk exposure exist among 
these 92 percent of insured institutions. To take just one example, 
since the mid-1980's, institutions rated CAMELS 2 have failed at more 
than 2\1/2\ times the rate of those rated CAMELS 1.
---------------------------------------------------------------------------
    \1\ CAMELS is an acronym for component ratings assigned in a bank 
examination: Capital, Asset quality, Management, Earnings, Liquidity, 
and Sensitivity to market risk. The best rating is 1; the lowest is 5. 
A composite CAMELS rating combines these component ratings, again with 
1 being the best rating.
---------------------------------------------------------------------------
    This provision of law produces results that are contrary to the 
principle of risk-based premiums, a principle that applies to all 
insurance. Because the current 
system does not charge appropriately for risk, this increases the 
potential for moral hazard. This also means that safer banks 
unnecessarily subsidize riskier banks. Both as an actuarial matter and 
as a matter of fairness, riskier banks should shoulder more of the 
industry's deposit insurance assessment burden.
    In addition, the current statute also permits banks and thrifts to 
bring new deposits into the system without paying any premiums. 
Essentially, the banks that were in existence before 1997 endowed the 
funds, and newcomers are not required to contribute to the ongoing 
costs of the deposit insurance system. Since 1996, more than 900 new 
banks and thrifts have joined the system and never paid for the 
insurance. I know this firsthand because I chartered a bank in Texas in 
the late 1990's and we never paid a dime in deposit insurance premiums. 
Other institutions have grown significantly without paying additional 
premiums.
    These problems can be solved by eliminating the existing inflexible 
statutory 
requirements and by giving the FDIC Board of Directors the discretion 
and flexibility to set appropriate targets for the fund ratio, 
determine the speed of adjustment toward the target using surcharges or 
assessment credits as necessary, and charge premiums based on risk at 
all times, regardless of the reserve ratio.
Fund Management
    The FDIC recognizes that accumulating money in the insurance fund 
to protect depositors and taxpayers means less money in the banking 
system for providing credit. The current system strikes a balance by 
establishing a reserve ratio target of 1.25 percent. The existing 
target appears to be a reasonable starting point for the new system--
with a modification to allow the reserve ratio to move within a range 
to ensure that banks are charged steadier premiums. The point of the 
reforms is neither to increase assessment revenue from the industry nor 
to relieve the industry of its obligation to fund the deposit insurance 
system; but rather, it is to distribute the assessment burden more 
evenly over time and more fairly across insured institutions.
    In my view, the reserve ratio target should remain relatively 
steady over the longer run and move only in response to fundamental 
changes that are expected to alter the risk exposure of the fund for 
the foreseeable future. The target should not be viewed as a short-run 
instrument that should rise and fall continuously with the business 
cycle. The key to fund management would be to bring the fund ratio back 
toward the target in an appropriate timeframe when it moves away in 
either direction. Presumably, the farther the movement away from the 
target, the larger would be the expected credits, rebates, or 
surcharges, other things equal, in order to slow the momentum and pull 
the ratio back toward the target. However, the greater the range over 
which the FDIC has discretion to manage the fund, the more flexibility 
we will have to eliminate the system's current procyclical bias.
    The FDIC would prefer to steer clear of hard triggers, caps, and 
mandatory credits or rebates. Automatic triggers that ``hard-wire'' or 
mandate specific Board actions are likely to produce unintended adverse 
effects, not unlike the triggers in the current law. They would add 
unnecessary rigidity to the system and could prevent the FDIC from 
responding effectively to unforeseen circumstances. For a new deposit 
insurance fund management plan to work effectively, the Board must have 
the flexibility to respond appropriately to differing economic and 
industry conditions. For 
example, a given reserve ratio may warrant a credit rather than a 
rebate, and a smaller rather than a larger credit, depending upon 
economic conditions, industry performance, possible failures, and other 
circumstances. The legislation could contain an expectation of a rebate 
in certain circumstances with a requirement that the Board justify any 
alternative decision.
    While I believe that the FDIC Board needs greater discretion to 
manage the fund, I am not suggesting that we need unfettered discretion 
and I recognize the need for accountability. The FDIC will work with 
the Congress to develop guidelines on an appropriate range for the fund 
ratio around the target--as well as some direction for the FDIC Board's 
management of the fund ratio levels--and to develop reporting 
requirements for the FDIC's actions to manage the funds. For example, 
the Board could be expected to adopt rules that operate to pull the 
reserve ratio back, at an appropriate speed, whenever it moves away 
from the target in either direction and to publish a schedule for 
recapitalizing the fund whenever the ratio falls significantly below 
the target, as current law requires.
Charging Premiums Based Upon Risk
    How would premiums work if the FDIC could set them according to the 
risks in the institutions we insure? First, and foremost, the FDIC 
would attempt to make them fair and understandable. We would strive to 
make the pricing mechanism 
simple and straightforward. I believe that we can accomplish our goals 
on risk-based premiums with relatively minor adjustments to the FDIC's 
current assessment system.
    I am aware of the concern about using subjective indicators to 
determine bank premiums. We will be sensitive to that issue and work to 
ensure that we use objective indicators to the extent possible to 
measure risk in institutions. Any system we adopt will be transparent 
and open. The industry and the public at large will have the 
opportunity to weigh in on any changes we propose through the notice-
and-comment rulemaking process.
    Using the current system as a starting point, the FDIC should 
consider additional objective financial indicators, based upon the 
kinds of information that banks and thrifts already report, to 
distinguish and price for risk more accurately within the existing 
least-risky (1A) category. The sample ``scorecard'' included in the 
FDIC's April 2001 report represents one approach. In this example, 
banks currently in the best-rated category were divided into three 
groups using six financial ratios in addition to capital and CAMELS 
ratings (net income, nonperforming loans, other real estate owned, 
noncore funding, liquid assets, and growth). Actuarial analysis showed 
that different premiums would be warranted for these three groups, 
based on the FDIC's loss experience since 1984.
    We have since had many discussions with bankers and trade-group 
representatives regarding this sample scorecard, and we are making 
adjustments. We are 
willing to listen to the industry and Congress regarding alternative 
pricing schedules that also may be analytically sound.
    The FDIC's report also indicated that for the largest banks and 
thrifts, it might be possible to augment such financial ratios with 
other information, including market-based data, so long as the final 
result is fair and does not discriminate in favor of or against banks 
merely because they happen to be large or small.
    In short, I believe the right approach is to use the FDIC's 
historical experience with bank failures and with the losses caused by 
banks that have differing characteristics to create sound and 
defensible distinctions. However, we will not follow the results of our 
statistical analysis blindly--we recognize the need for sound judgment 
in designing the premium system.
Assessment Credits for Past Contributions
    One result of the FDIC's current inability to price risk 
appropriately is that the deposit insurance system today is almost 
entirely financed by institutions that paid premiums prior to 1997. 
More than 900 newly chartered institutions, with more than $70 billion 
in insured deposits, have never paid premiums for the deposit 
insurance they receive. Many institutions have greatly increased their 
deposits since 1996, yet paid nothing more in deposit insurance 
premiums.
    Since they are not paying premiums, new institutions and fast-
growing institutions have benefited at the expense of their older and 
slower-growing competitors. Under the present system, rapid deposit 
growth lowers a fund's reserve ratio and increases the probability that 
additional failures will push a fund's reserve ratio below the DRR, 
resulting in an immediate increase in premiums for all institutions.
    An assessment credit could be used as a mechanism to address the 
fairness issue that has arisen. I am reluctant to mandate a cash 
payment out of the fund at this time, given the recent fall in reserve 
ratios. But we can achieve the desired result by giving the banks and 
thrifts that built up the funds a credit toward their future 
assessments.
    A reasonable way to allocate the initial assessment credit would be 
according to a snapshot of institutions' relative assessment bases at 
the end of 1996, the first year that both funds were fully capitalized. 
Each institution would get a share of the total amount to be credited 
to the industry based on its share of the combined assessment base at 
yearend 1996. For example, an institution that held 1 percent of the 
industry assessment base in 1996 would get 1 percent of the industry's 
total assessment credit. Relative shares of the 1996 assessment base 
represent a reasonable proxy for relative contributions to fund 
capitalization, while avoiding the 
considerable complications that can be introduced by attempting to 
reconstruct the individual payment histories of all institutions.
    Institutions that had low levels of deposits on December 31, 1996, 
but subsequently experienced significant deposit growth would receive 
relatively small assessment credits to be applied against future 
premiums. Institutions that never paid premiums would receive no 
assessment credit. Institutions that made significant contributions 
into the deposit insurance funds would pay a lower net premium than 
institutions that paid little or nothing into the fund. Such an 
assessment credit would provide a transition period whereby banks that 
contributed in the past could defer any payment of net premiums.
    The combination of risk-based premiums and assessment credits tied 
to past contributions to the fund would help us fix the remaining 
problems related to rapid growers and new entrants. Regular risk-based 
premiums for all institutions would mean that fast-growing institutions 
would pay increasingly larger premiums as they gather deposits. Fast 
growth, if it posed greater risk, also could result in additional 
premiums through the operation of the FDIC's expanded discretion to 
price risk.
Deposit Insurance Coverage
    As a life-long banker, I can tell you that deposit insurance is 
important not only to individuals and families, but also to many small 
businesses, community banks, charities, and some local governments. In 
fact, as an agent of financial stability, 
deposit insurance is important to the entire economy. If you believe as 
I do that 
deposit insurance is important, the declining value of coverage should 
be a subject of concern.
    Our recommendation is simple: the coverage limit should be indexed 
from the present level of $100,000 to ensure that the value of deposit 
insurance in the economy does not wither away over time. In real terms, 
this does not expand coverage. It simply holds it steady over time. I 
challenge those who oppose indexation to 
either provide a number better than $100,000 or defend the principle of 
eroding deposit insurance. Over the 22 years since Congress last 
increased the coverage limit, the real value of the $100,000 coverage 
limit has declined to $47,000 in 1980 dollars. I also believe that 
indexing the limit on a set basis will prevent any unintended 
consequences that may result from making large adjustments on an 
irregular basis, which would seem to address the argument that sudden 
sharp increases resulted in economic disruptions in the past.
    My suggestion would be to index the $100,000 limit to a widely 
accepted index, such as the Consumer Price Index or the Personal 
Consumption Expenditures Chain-Type Index, and adjust it every 5 years. 
The first adjustment would take place on January 1, 2005. We should 
make adjustments in round numbers--say, increments of $10,000--and the 
coverage limit should not decline if the price level falls. These seem 
like the right elements of an indexing system, but I am willing to 
support any reasonable method of indexing that ensures the public 
understands that the FDIC's deposit insurance protection will retain 
its value. I look forward to working with the Congress to find a method 
of indexing that works.
    There has been some opposition to the FDIC's indexing proposal on 
the grounds that it would increase the Federal safety net. Frankly, I 
am puzzled by this. I am not recommending the safety net be increased. 
I am just recommending the safety net not be scaled back inadvertently 
because of inflation.
    Some argue against indexing by contending that the current limit 
already is too high, and they point to the problems of the 1980's in 
support of their concern. With respect to the problems of the 1980's, 
Congress undertook a comprehensive review of the deposit insurance 
system with FDICIA. Significant changes were made to many features of 
the system. Congress adopted prompt corrective action, the least-cost 
test and risk-based premiums as means to address moral hazard, but did 
not lower coverage. Moreover, as noted earlier, the real value of 
coverage today is far lower than it was even when the limit was 
increased to $40,000 in 1974, roughly a decade before the problems 
appeared.
    I do believe, however, there is one class of deposits for which 
Congress should consider raising the insurance limit, and that is 
retirement accounts. These accounts are uniquely important and 
protecting them is consistent with existing Government policies that 
encourage long-term saving. When we think about saving for retirement 
in this day and age, $100,000 is not a lot of money. Middle-income 
families routinely save well in excess of this amount. The shift from 
defined benefit plans to defined contribution plans has resulted in 
significant wealth being accumulated outside traditional pension funds.
    Protecting retirement accounts is consistent with Government 
policies encouraging savings and responsible retirement planning. 
Congress recently raised the annual maximum IRA contributions to $3,000 
this year and larger amounts in future years and allowed those over 50 
to make catch-up contributions. Some precedent 
exists for providing retirement accounts with special insurance 
treatment. In 1978, Congress raised coverage for IRA and Keogh deposit 
accounts to $100,000, while leaving basic coverage for other deposits 
at $40,000.
    The $220 billion of IRA and Keogh deposits currently at banks and 
thrifts is not large compared to the volume of overall deposits. Thus, 
if the coverage limit were raised for IRA and Keogh deposits, the 
initial effect on the fund reserve ratio would not be dramatic. 
However, the total volume of IRA's and Keoghs in the economy is more 
than $2.5 trillion and estimating the influx of retirement account 
deposits as a result of higher coverage is subject to uncertainty. We 
would also note that a phasing-in of higher coverage limits for 
retirement account deposits could allow for some measure of control 
over the effect on the fund reserve ratio. I urge Congress to give 
serious consideration to raising the insurance limit on retirement 
accounts.
Conclusion
    Deposit insurance has been a bulwark of the Nation's economy since 
its creation. It is no less important today. We must ensure that it can 
continue to stabilize the economy and protect depositors in the future.
    Deposit insurance reform is not about increasing assessment revenue 
from the 
industry or relieving the industry of its obligation to fund the 
deposit insurance system. Rather, it is to distribute the assessment 
burden more evenly over time and more fairly across insured 
institutions. This is good for the industry, good for depositors, and 
good for the overall economy.
    I take very seriously the responsibility of prudently managing the 
fund and maintaining adequate reserves--it is extremely important to 
the industry and to the 
financial stability of our country. We have only to look back at the 
bank and thrift crises of the 1980's and 1990's to understand this. The 
existing deposit insurance system has served us well, and we must be 
mindful of this in contemplating changes.
    The recommendations we have made would retain the essential 
characteristics of the present system and improve upon them. While I am 
Chairman, I will do all I can to ensure that the FDIC manages the 
insurance fund responsibly and is properly accountable to the Congress, 
the public, and the industry. Our recommendations will ensure that 
future Chairmen can do so as well.
    The Congress has an excellent opportunity to remedy flaws in the 
deposit insurance system before those flaws cause actual damage either 
to the banking industry or our economy as a whole. The banking industry 
remains strong despite the recent downturn. The FDIC has put forward 
some important recommendations for improving our deposit insurance 
system. While I believe we should remain flexible with regard to 
implementation, as a former banker and, as the FDIC's new Chairman, I 
believe that we should work together to make these reform proposals a 
reality, and I commend this Committee for providing us the opportunity 
to discuss this important issue.

                               ----------
                  PREPARED STATEMENT OF ALAN GREENSPAN
       Chairman, Board of Governors of the Federal Reserve System
                             April 23, 2002

    Chairman Sarbanes, Senator Gramm, it is a pleasure to appear before 
this Committee to present the views of the Board of Governors of the 
Federal Reserve System on deposit insurance reform. I will be 
addressing general reform issues, as 
proposed by the Federal Deposit Insurance Corporation (FDIC) in the 
spring of 2001, rather than any specific bill. Consequently, I will be 
expressing the broad views of the Federal Reserve Board on the issues 
associated with modifications of deposit insurance.
    At the outset, I should note that last year's FDIC report 
highlighted the significant issues and developed an integrated 
framework for addressing them. In broad terms, while the Board opposes 
any increase in coverage, we support the framework for other reform 
issues that the FDIC report constructed.
Benefits and Costs of Deposit Insurance
    Deposit insurance was adopted in this country as part of the 
legislative framework for limiting the impact of the Great Depression 
on the public. In the environment of the record number of bank failures 
of the time, deposit insurance in this country was designed mainly to 
protect the unsophisticated depositor with limited financial assets 
from the loss of their modest savings. References were made to the 
``rent money'' and the initial 1934 limit placed on deposit insurance 
was $2,500, promptly doubled to $5,000, a level maintained for the next 
16 years. I should note that the $5,000 of insurance coverage in 1934, 
consistent with the original intent of Congress, is equal to less than 
$60,000 today, based on the Personal Consumption Deflator in the GDP 
accounts.
    Despite its initial quite limited intent, the Congress over the 
intervening decades has raised the maximum amount of coverage five 
times to its current $100,000 level. The latest increase, in 1980, was 
a more than doubling of the cap level and was clearly designed to let 
depository institutions, particularly thrifts, offer an insured deposit 
free of the then prevailing interest rate ceilings on such instruments, 
which applied only to deposits below $100,000. Insured deposits of 
exactly $100,000 thus became fully insured instruments in 1980, but 
were not subject to an interest rate ceiling. The efforts of thrifts to 
use $100,000 CD's to stem their liquidity outflows resulting from 
public withdrawals of smaller below-market-rate insured deposits led 
first to an earnings squeeze and an associated loss of capital and then 
to a high-risk investment strategy that led to failure after failure. 
Depositors acquiring the new larger denomination insured deposits were 
aware of the plight of the thrifts but unconcerned about the risk 
because the principal amount of their $100,000 deposits was fully 
insured by the United States Government. In this way, the 1980 increase 
in the deposit insurance cap to $100,000 exacerbated the fundamental 
thrift problem associated with concentration on long-term assets in a 
high and rising interest rate environment. Indeed, it significantly 
increased the taxpayer cost of the bail out of the bankrupt thrift 
deposit insurance fund.
    Not withstanding this problematic episode, it is clear that deposit 
insurance has played a key--at times even critical--role in achieving 
the stability in banking and financial markets that has characterized 
the past almost 70 years. Deposit insurance, combined with other 
components of our banking safety net (the Federal Reserve's discount 
window and payment system guarantees) has meant that periods of 
financial stress are no longer characterized by depositor runs on banks 
and thrifts. Quite the opposite: Asset holders now seek out deposits--
insured and uninsured--as safe havens when they have strong doubts 
about other financial assets.
    Looking beyond the contribution of deposit insurance to overall 
financial stability, we should not minimize the security it has brought 
to millions of households and small businesses. Deposit insurance has 
provided a safe and secure place for those households and small 
businesses with relatively modest amounts of financial assets to hold 
their transaction and other balances.
    These benefits of deposit insurance, as significant as they are, 
have not come without cost. The very same process that has ended 
deposit runs has made insured depositors--as in the 1980's with 
insolvent, risky thrifts--largely indifferent to the risks taken by 
their depository institutions because their funds are not at risk if 
their institution is unable to meet its obligations. As a result, the 
market discipline to control risks that insured depositors would 
otherwise have imposed on banks and thrifts has been weakened. Relieved 
of that discipline, banks and thrifts naturally feel less inhibited 
from taking on more risk than they would otherwise assume. No other 
type of private financial institution is able to attract funds from the 
public without regard to the risk it takes with its creditors' 
resources. This incentive to take excessive risks is the so-called 
moral hazard problem of deposit insurance, the inducement to take risk 
at the expense of the insurer.
    Thus, two offsetting implications of deposit insurance must be kept 
in mind. On the one hand, it appears fairly unambiguous that deposit 
insurance has contributed to the prevention of bank runs that could 
have destabilized the financial structure in the short-run. On the 
other, there are growing concerns that even the current levels of 
deposit insurance have created such underwriting imbalances at insured 
depository institutions that future large systemic risks have arguably 
risen.
    Indeed, the reduced market discipline and increased moral hazard, 
have intensified the need for Government supervision to protect the 
interests of taxpayers and, in essence, substitute for the reduced 
market discipline. Deposit insurance and other components of the safety 
net also enable banks and thrifts to attract more resources, at lower 
costs, than would otherwise be the case. In short, insured banks and 
thrifts receive a subsidy in the form of a Government guarantee that 
allows them both to attract deposits at lower interest rates than would 
be necessary without deposit insurance, and to take more risk without 
the fear of losing their deposit funding. Put another way, deposit 
insurance misallocates resources by breaking the link between risks and 
rewards for a select set of market competitors.
    From the very beginning, deposit insurance has involved a tradeoff. 
On the one hand, deposit insurance contributes to overall short-term 
financial stability and the protection of small depositors. On the 
other hand, deposit insurance induces higher risk-taking, resulting in 
a misallocation of resources and larger long-term financial imbalances 
that increase the need for Government supervision to protect the 
taxpayers' interests. Deposit insurance reforms must balance these 
tradeoffs. Moreover, any reforms should be aimed primarily at 
protecting the interest of the economy overall, and not just the 
profits or market shares of particular businesses.
    The Federal Reserve Board believes that deposit insurance reforms 
should be 
designed to preserve the benefits of heightened financial stability and 
the protection of small depositors without at the same time further 
increasing moral hazard or reducing market discipline. In addition, we 
urge that the implementing details be kept as straightforward as 
possible to minimize the risk of unintended consequences that comes 
with complexity.
Recommendations for Reform
    The FDIC has made five broad recommendations.

    1. Merging BIF and SAIF. The Board supports the FDIC's proposal to 
merge the BIF and SAIFs. Because the charters and operations of banks 
and thrifts have become so similar, it makes no sense to continue the 
separate funds. Separate funds reflect the past, but neither the 
present nor the future. Merging the funds would diversify their risks, 
reduce administrative expenses, and widen the fund base behind an 
increasingly concentrated banking system. Most importantly, the 
Federally guaranteed insurance coverage provided to the two sets of 
institutions are identical, and thus the premiums need to be identical 
as well. Under current arrangements, the premiums could differ 
significantly if one of the funds fell below the designated reserve 
ratio of 1.25 percent of insured deposits and the other fund did not. 
Should that occur, depository institutions would be induced to switch 
charter to obtain insurance from the fund with the lower premium. This 
could distort our depository structure. The Federal Government should 
not sell an identical service, like deposit insurance, at different 
prices.

    2. Statutory Restrictions on Premiums. Current law requires the 
FDIC to impose higher premiums on riskier banks and thrifts but 
prevents it from imposing any premium on well-capitalized and highly-
rated institutions whenever the correspond-
ing fund's reserves exceed 1.25 percent of insured deposits. The Board 
endorses the FDIC recommendations that would eliminate the statutory 
restrictions on risk-based pricing and allow a premium to be imposed on 
every insured depository institution, no matter how well-capitalized 
and well-rated it may be or how high the fund's reserves.
    The current statutory requirement that free deposit insurance be 
provided to well-capitalized and well-rated banks when FDIC reserves 
exceed a predetermined ratio maximizes the subsidy provided to these 
institutions and is inconsistent with efforts to avoid inducing moral 
hazard. Put differently, the current rule requires the Government to 
give away its valuable guarantee when fund reserves meet some ceiling 
level. This free guarantee is of value to banks and thrifts even when 
they themselves are in sound financial condition and when macroeconomic 
times are good. At the end of last year, 92 percent of banks and 
thrifts were paying no premium. Included in this group were banks that 
have never paid any premium for their, in some cases substantial, 
coverage and fast-growing entities whose past premiums were 
extraordinarily small relative to their current coverage. We believe 
that these anomalies were never intended by the framers of the Deposit 
Insurance Fund Act of 1996 and should be addressed by the Congress.
    The Congress did intend that the FDIC impose risk-based premiums, 
but the 1996 Act limits the ability of the FDIC to impose risk-based 
premiums on well-capitalized and well-rated banks. And these two 
variables--capital strength and examiner overall rating--do not capture 
all the risk that banks and thrifts could create for the insurer. The 
Board believes the FDIC should be free to establish risk categories 
based on any well-researched economic variables and to impose premiums 
commensurate with these risk classifications. Although a robust risk-
based premium system would be technically difficult to design, a closer 
link between insurance premiums and individual bank or thrift risk 
would reduce moral hazard and the distortions in resource allocation 
that accompany deposit insurance.
    We note, however, that significant benefits in this regard are 
likely to require a substantial range of premiums but that the FDIC has 
concluded in its report that premiums for the riskiest banks would 
probably need to be capped in order to avoid inducing failure at these 
weaker institutions. We believe that capping premiums may end up 
costing the insurance fund more in the long run should these weak 
institutions fail anyway, with the delay increasing the ultimate cost 
of resolution. The Board has concluded, therefore, that if a cap is 
required, it should be set quite high so that risk-based premiums can 
be as effective as possible in deterring excessive risk-taking. In that 
way we could begin to simulate the deposit insurance pricing the market 
would apply and reduce the associated subsidy in deposit insurance.
    Nonetheless, we should not delude ourselves that even a wider range 
in the risk-based premium structure would eliminate the need for a 
Government backup to the deposit insurance fund, that is, eliminate the 
Government subsidy in deposit insurance. To eliminate the subsidy in 
deposit insurance--to make deposit insurance a real insurance system--
the FDIC average insurance premium would have to be set high enough to 
cover fully the very small probabilities of very large losses, such as 
during the Great Depression, and thus the perceived costs of systemic 
risk. In contrast to life or automobile casualty insurance, each 
individual insured loss in banking is not independent of other losses. 
Banking is subject to deposit run contagion, creating a far larger 
extreme loss tail on the probability distributions from which real 
insurance premiums would have to be calculated. Indeed, pricing deposit 
insurance risks to fully fund potential losses--pricing to eliminate 
subsidies--would require premiums that would discourage most depository 
institutions from offering broad coverage. Since the Congress has 
determined that there should be broad coverage, the subsidy in deposit 
insurance cannot be fully eliminated, although we can and should 
eliminate as much of the subsidy as we can.
    Parenthetically, the difficulties of raising risk-based premiums 
explain why there is no private insurer substitute for deposit 
insurance from the Government. No private insurer would ever be able to 
match the actual FDIC premium and cover its risks. A private insurer 
confronted with the possibility, remote as it may be, of losses that 
could bankrupt the insuring entity would need to set especially high 
premiums to protect itself, premiums that few, if any, depository 
institutions would find attractive. And, if premiums were fully priced 
by the Government or the private sector, the issuing entities would 
likely lower their offering rates, reducing the amount of insured 
deposits demanded, and consequently the amount outstanding would 
decline.

    3. Designated Reserve Ratios and Premiums. The current law 
establishes a designated reserve ratio for BIF and SAIF of 1.25 
percent. If that ratio is exceeded, the statute requires that premiums 
on well-capitalized and well-rated institutions must be discontinued. 
If the ratio declines below 1.25 percent, the FDIC must develop a set 
of premiums to restore the reserve ratio to 1.25 percent; if it appears 
that the fund ratio cannot be restored to its statutorily designated 
level within 12 months, the law requires that a premium of at least 23 
basis points be imposed on all insured entities.
    These requirements are clearly procyclical, lowering or eliminating 
fees in good times when bank credit is readily available and deposit 
insurance fund reserves should be built up, and abruptly increasing 
fees sharply in times of weakness when bank credit availability is 
under pressure and deposit fund resources are drawn down to cover the 
resolution of failed banks. The FDIC recommends that surcharges or 
rebates should be used to bring the fund back to the target reserve 
ratio gradually. The FDIC also recommends the possibility of a target 
range for the designated reserve ratio, over which the premiums may 
remain constant, rather than a fixed target reserve ratio and abruptly 
changing premiums.
    We support such increased flexibility and smoothing of premiums. 
Indeed, we recommend that the FDIC's suggested target reserve range be 
widened in order to reduce the need to change premiums abruptly. Any 
floor or ceiling, regardless of its level, could require that premiums 
be increased at exactly the time when banks and thrifts could be under 
stress and, similarly, that premiums be reduced at the time that 
depositories are in the best position to fund an increase in reserves. 
Building a larger fund in good times and permitting it to decline when 
necessary are prerequisites to less variability in the premium. This 
approach stands in favorable 
contrast to the present system that is designed to stabilize the 
designated reserve ratios of the funds at the cost of, perhaps wide, 
premium instability.
    In addition to widening the range for the designated reserve ratio, 
the Board would recommend that the FDIC be given the latitude 
temporarily to relax floor or ceiling ratios on the basis of current 
and anticipated banking conditions and expected needs for resources to 
resolve failing institutions. In short, on stability grounds we prefer 
less hardwiring of the rules under which the FDIC operates and more 
management flexibility for the Board of the FDIC, operating under broad 
guidelines from the Congress.

    4. Rebates. Since its early days, the FDIC has rebated ``excess'' 
premiums whenever it felt its reserves were adequate. This procedure 
was replaced in the 1996 law by the requirement that no premium be 
imposed on well-capitalized and highly rated banks and thrifts when the 
fund reaches its designated reserve ratio. The FDIC proposals would 
reimpose a minimum premium on all banks and thrifts and a more risk-
sensitive premium structure. These provisions would be coupled with 
rebates for the stronger entities when the fund approaches what we 
recommend be a higher upper end of a target range than the FDIC has 
suggested, and surcharges when the fund trends below what we suggest be 
a lower end of a target range.
    The FDIC also recommends that the rebates not be uniform for the 
stronger entities. Rather, the FDIC argues that rebates should be 
smaller for those banks that have paid premiums for only short periods 
or that have in the past paid premiums that are not commensurate with 
their present size and hence FDIC exposure. The devil, of course, is in 
the details. But this latter proposal makes considerable sense, and the 
Board endorses it. More than 900 banks--some now quite large--have 
never paid a premium, and without this modification they would continue 
to pay virtually nothing, net of rebates, as long as their strong 
capital and high supervisory ratings were maintained. Such an approach 
is both competitively inequitable and contributes to moral hazard. It 
should be addressed.

    5. Indexing Insured-Deposit Coverage Ceilings. The FDIC recommends 
that the current $100,000 ceiling on insured deposits be indexed. The 
Board does not support this recommendation and believes that the 
current ceiling should be maintained.
    In the Board's judgment, it is unlikely that increased coverage, 
even by indexing, would add measurably to the stability of the banking 
system today. Macroeconomic policy and other elements of the safety 
net, combined with the current, still-significant level of deposit 
insurance, continue to be an important bulwark against bank runs. Thus, 
the problem that increased coverage is designed to solve must be 
related to either the individual depositor, the party originally 
intended to be protected, or to the individual bank or thrift. Clearly, 
both groups would prefer higher coverage if it cost them nothing. But 
Congress needs to be clear about the nature of a specific problem for 
which increased coverage would be the solution.

Depositors
    Our surveys of consumer finances suggest that most depositors have 
balances well below the current insurance limit of $100,000 and those 
that do have larger balances have apparently been adept at achieving 
the level of deposit insurance coverage they desire by opening multiple 
insured accounts. Such spreading of asset holdings is perfectly 
consistent with the counsel always given to investors to diversify 
their assets--whether stocks, bonds, or mutual funds--across different 
issuers. The cost of diversifying for insured deposits is surely no 
greater than doing so for other assets. An individual bank would 
clearly prefer that the depositor maintain all of his or her funds at 
that bank, and would prefer to eliminate the need for depositor 
diversification by being able to offer higher deposit insurance 
coverage. Nonetheless, the depositor appears to have no great 
difficulty--should he or she want insured deposits--in finding multiple 
sources of fully insured accounts.
    In addition, the singular characteristic of postwar household 
financial asset holdings has been the increasing diversity of portfolio 
choices. The share of household financial assets in bank deposits has 
been declining steadily since World War II as households have taken 
advantage of innovative attractive financial instruments with market 
rates of return. There has been no break in that trend that seems 
related to past increases in insurance ceilings. Indeed, the most 
dramatic substitution out of deposits in recent years has been from 
both insured and uninsured deposits to equities and mutual funds 
holding equities, bonds, and money market assets. It is difficult to 
believe that a change in ceilings during the 1990's would have made any 
measurable difference in that shift. Indeed, the data indicate that the 
weakness in stock prices in recent quarters has been marked by 
increased flows into bank and thrift deposits.

Depository Institutions
    Does the problem to be solved by increased deposit insurance 
coverage concern the individual depository institution? If so, the 
problem would seem disproportionately a small bank issue since insured 
deposits are a much larger proportion of total funding at small banks 
than at large banks. But smaller banks appear to be doing well. Since 
the mid-1990's, adjusted for the effects of mergers, assets of the 
smaller banks, those below the largest 1,000, have grown at an average 
annual rate of 13.9 percent, almost twice the pace of the largest 1,000 
U.S. banks. Uninsured deposits at these smaller institutions have also 
grown more rapidly than at larger banks--at average annual rates of 22 
percent at the small banks versus 11 percent at the large banks, both 
on the same merger-adjusted basis. Clearly, small banks have a 
demonstrated skill and ability to compete for uninsured deposits. To be 
sure, uninsured deposits are more expensive than insured deposits, and 
bank costs would decline and profits rise if their currently uninsured 
liabilities received a Government guarantee. But that is the issue of 
whether subsidizing bank profits through deposit insurance serves a 
national purpose. I might add that throughout the 1990's, small banks' 
return on equity was well maintained. Indeed, the attractiveness of 
banking is evidenced by the fact that more than 1,350 banks were 
chartered during the past decade.
    Some small banks argue that they need enhanced deposit insurance 
coverage to equalize their competition with large banks because 
depositors prefer to put their uninsured funds in an institution 
considered too big to fail. As I have noted, however, small banks have 
more than held their own in the market for uninsured deposits. In 
addition, the Board rejects the notion that any bank is too big to 
fail. In 1991, Congress made it clear that the systemic-risk exception 
to the FDIC's least-cost resolution of a failing bank should be invoked 
only under the most unusual circumstances. Moreover, the resolution 
rules under the systemic-risk exception do not require that uninsured 
depositors and other creditors, much less stockholders, be made whole. 
Consistent with this view, the market clearly believes that large 
institutions are not too big for uninsured creditors to take at least 
some loss. Spreads on large bank subordinated debt are wider than 
spreads on similar debt of large and highly rated nonbank financial 
institutions. Indeed, there are no AAA-rated U.S. banking 
organizations.
    To be sure, failure to index deposit insurance ceilings has eroded 
the real purchasing power value of those ceilings. But there is no 
evidence of any detrimental effect on depositors or depositary 
institutions, with the possible exception of a small reduction in those 
profits that accrue from deposit guarantee subsidies that lower the 
cost of insured deposits. The current deposit insurance ceiling appears 
more than adequate to achieve the positive benefits of deposit 
insurance that I mentioned earlier in my statement, even if its real 
value were to erode further.
    Another argument often raised by smaller banks regarding the need 
for increased deposit insurance coverage is their inability to match 
the competition from those large securities firms and bank holding 
companies with multiple bank affiliates, offering multiple insured 
accounts through one organization. The Board agrees that such offerings 
are a misuse of deposit insurance. But, raising the coverage limit for 
each account is not a remedy since it would also increase the aggregate 
amount of insurance coverage that large multibank organizations would 
be able to offer. The disparity would remain.

Conclusion
    Several aspects of the deposit insurance system need reform. The 
Board supports, with some modifications, all of the recommendations the 
FDIC made in the spring of 2001 except indexing the current $100,000 
ceiling. The thrust of our proposed modifications would call for a 
wider permissible range for the size of the fund relative to insured 
liabilities, reduced variation of the insurance premium as the relative 
size of the fund changes with banking and economic conditions, and a 
positive premium net of rebates.
    There may come a time when the Board finds that households and 
businesses with modest resources are having difficulty in placing their 
funds in safe vehicles and/or that there is reason to be concerned that 
the level of deposit coverage could endanger financial stability. 
Should either of those events occur, the Board would call our concerns 
to the attention of the Congress and support adjustments to the ceiling 
by indexing or other methods. But today, in our judgment, neither 
financial stability, nor depositors, nor depositories are being 
disadvantaged by the current ceiling. Raising the ceiling now would 
extend the safety net, increase the Government subsidy to banking, 
expand moral hazard, and reduce the incentive for market discipline, 
without providing any real evident public benefits. With no clear 
public benefit to increasing deposit insurance, the Board sees no 
reason to increase the scope of the safety net. Indeed, the Board 
believes that as our financial system has become ever more complex and 
exceptionally responsive to the vagaries of economic change, structural 
distortions induced by Government guarantees have risen. We have no way 
of ascertaining at exactly what point subsidies provoke systemic risk. 
Nonetheless, prudence suggests that we be exceptionally deliberate when 
expanding Government financial guarantees.

                               ----------
                 PREPARED STATEMENT OF PETER R. FISHER
 Under Secretary for Domestic Finance, U.S. Department of the Treasury
                             April 23, 2002

    Mr. Chairman, Senator Gramm, and Members of the Committee, I 
appreciate the opportunity to provide the Administration's views on 
reform of the deposit insurance system. Chairman Powell and the FDIC 
staff are to be commended for their valuable contributions to the 
policy discussion of deposit insurance reform. I am also grateful for 
the Committee's interest in holding a hearing on this important issue.
    Our current deposit insurance system is intended to balance the 
interests of savers and taxpayers by aiming to protect them both from 
exposure to bank losses and, thereby, to promote public confidence in 
the U.S. banking system. Consistent with this objective, the 
Administration believes that some improvements could be made in the 
system's operation and fairness. Specifically, the Administration 
favors reforms that would: (1) Reduce the system's procyclical bias by 
allowing the insurance fund reserve ratio to vary within a range and 
eliminating triggers that could cause sharp changes in premiums; (2) 
Improve the system's risk diversification by merging the bank and 
thrift insurance funds; and (3) Ensure that institutions appropriately 
compensate the FDIC for insured deposit growth while also taking into 
account the past contributions of many institutions to build fund 
reserves.
    While these improvements are worth pursing, there is no sound 
public policy purpose to be served by an increase in deposit insurance 
coverage limits. There is no financial benefit to savers to be derived 
from increased coverage limits because individuals can today hold 
insured deposits, up to the limits, at any number of banks. The only 
credible benefit to savers is that of greater convenience, but this is 
of potential use to only that small fraction of the population that has 
sufficient savings, which they choose to hold in the form of deposits, 
to have any possible need for coverage in excess of $100,000. Increased 
coverage limits would provide no benefit to the overwhelming majority 
of Americans but, as taxpayers, it would expose them to additional 
risk. Higher coverage limits would mean greater contingent liabilities 
of the Government and weaker market discipline, exposing the insurance 
fund and taxpayers to increased risk of loss. Weighing the ephemeral 
benefits of increased coverage against the significant costs of added 
risk and the erosion of market discipline, the Administration cannot 
support an increase in coverage limits, whether directly or by 
indexing.
    My statement will first discuss those reforms that we think would 
enhance the operation and fairness of the system. I will then review 
why we do not support coverage limit increases.
Reducing the Procyclical Effects of Deposit Insurance Pricing
    Reserves should be allowed to grow when conditions are good to 
better enable the fund to absorb losses under adverse conditions 
without sharp increases in premiums. Allowing the reserve ratio to vary 
within a range would help to reduce the potential procyclical effects 
of deposit insurance pricing.
    The existing designated reserve ratio of 1.25 percent of reserves 
to insured deposits was historically derived roughly as the average 
reserve ratio over part of the FDIC's history. As it is based on an 
average, it is logical to provide for reserve growth above that level 
when conditions are good (and for reserves to decline below that level 
when conditions are unfavorable).
    We support the FDIC's recommendation that it have authority to 
adjust the designated reserve ratio periodically within prescribed 
upper and lower bounds. FDIC should also have greater discretion in 
determining how quickly it achieves the designated reserve ratio that 
it selects. This flexibility would help reduce potential procyclical 
effects by stabilizing industry costs over time and avoiding sharp 
premium increases when the economy may be under stress. In the context 
of these 
reforms, it would also be appropriate to eliminate the current 
requirement that premiums rise to a minimum of 23 cents per $100 of 
domestic deposits when the fund is expected to remain below the 
designated reserve ratio for more than a year.
    We are mindful that efforts to achieve a more counter-cyclical 
policy require that depository institutions build insurance reserves in 
good times to prefund future losses. To do otherwise could leave the 
fund exposed to years of low reserves following a rash of bank failures 
in the future and could increase the likelihood of prolonged high 
premiums (and, at the extreme, taxpayer assistance). Such an outcome 
would be unwelcome both economically and politically. Determining the 
appropriate statutory range for the designated reserve ratio requires 
striking a balance between the burden of prefunding future losses and 
the procyclical burden of replenishing the insurance fund in a 
downturn. Within the range, the actual designated reserve ratio should 
always be under study by the FDIC, with public notice and comment 
concerning any proposed change. A key benefit to giving the FDIC 
greater flexibility to adjust the designated reserve ratio is that it 
may better achieve low, stable premiums over time.

Premiums, Assessment Credits, and Rebates
    The FDIC currently lacks authority to charge over 90 percent of 
banks and thrifts any premium for deposit insurance. The insurance 
funds' existing capacity to absorb losses comes primarily from the high 
premiums paid by institutions in the first half of the 1990's. Some 
large financial companies have rapidly increased insured deposits in 
recent years through their multiple subsidiary depository 
institutions--without compensating the FDIC. According to FDIC data, 
insured deposit growth from sweep programs conducted by two of these 
companies has reduced the Bank Insurance Fund reserve ratio by 4 basis 
points. In addition, hundreds of other recently chartered banks and 
thrifts have never paid insurance premiums.
    To ensure that institutions appropriately compensate the FDIC for 
insured deposit growth, Congress should remove the current restrictions 
on FDIC premium-setting while authorizing the agency to provide 
assessment credits (for example, 
offsets) against future premiums based on each institution's recent 
history of premium payments. We find reasonable proposals by the FDIC 
and others that would initially allocate these credits to institutions 
that contributed to the buildup of insurance reserves in the early-to-
mid-1990's. According to FDIC, the credits would allow many of these 
institutions to continue to pay no premiums for a period of 
several years under reasonable assumptions about the health of the 
economy and banking system. On an on-going basis, assessment credits 
would permit the FDIC to collect proportionally greater payments from 
institutions with rapid insured deposit growth than from those growing 
more slowly.
    As a tool for managing insurance fund reserve levels, we prefer 
assessment 
credits to rebates, which would drain the insurance fund of cash. We 
would also want to avoid placing a ``hard cap'' on the fund that would 
trigger large mandatory cash rebates. Such a cap would conflict with 
the important objectives of allowing reserve growth under good 
conditions and smoothing industry payments over time.
    We also are sympathetic to the FDIC's request for more flexibility 
to vary premiums according to the risk that an institution poses to the 
insurance fund. Ideally, an institution's risk-based premium should 
account for the riskiness of its assets, the structure of its 
liabilities, the strength of its capital base and management, and the 
effect that its failure would have on insurance fund reserves. The 
range in premiums should be sufficiently wide to reflect the spectrum 
of relative financial and managerial soundness among the Nation's 
depository institutions, and thereby to have the desired behavioral 
effects.

Merging the Bank and Thrift Insurance Funds
    We support a merger of the bank (BIF) and thrift (SAIF) insurance 
funds and we urge the Congress to merge the funds as soon as 
practicable regardless of whether it chooses to pursue other reforms in 
the near term. A larger, combined insurance fund would have a greater 
ability to diversify its risks than either fund separately. It would 
make sense to merge the funds while the industry is strong and while a 
merger would not unduly burden either BIF or SAIF members. A merged 
fund would also prevent the possibility that institutions posing 
similar risks could pay significantly different premiums for the same 
FDIC insurance, as was the case in 1995 and 1996. Incentives created by 
a premium disparity could result in a wasteful expenditure of industry 
resources in order to avoid higher assessments. Finally, a merger would 
underscore the fact that BIF and SAIF are already hybrid funds: each 
one insures the deposits of commercial banks, savings banks, and 
savings associations. Indeed, commercial banks now account for 43 
percent of all SAIF-insured 
deposits. A merger would simply recognize the commingling of the funds 
that has already taken place and that is likely to continue.

Deposit Insurance Coverage Limits
    While we support the FDIC's efforts to secure the improvements to 
the deposit insurance system that I have just outlined, we see no sound 
public policy purpose that would be served by an increase in current or 
future coverage limits. Consumers do not need an increase in coverage 
limits and would receive no real financial benefit. An increase in 
coverage limits would reduce--not enhance--competition among banks in 
general but would not predictably benefit any particular class or 
category of banks. Higher coverage limits would mean greater contingent 
liabilities of the Government and weaker market discipline, exposing 
the insurance fund and taxpayers to increased risk of loss.

Higher Coverage Limits Would Not Benefit Consumers
    Last summer, the Treasury Department testified before a House 
subcommittee that we ``see no evidence that the current limit on 
deposit insurance coverage is burdensome to consumers.'' Since then, we 
have continued to look for such evidence and found none. The vast 
majority of bankers with whom we have spoken since that time--from 
institutions of all sizes--have provided no evidence to the contrary. 
We have received no calls, no letters, from consumers demanding 
increases in coverage to avoid the inconvenience of having to place 
deposits in excess of $100,000 at more than one institution.
    Increasing the deposit insurance limit would do very little--if 
anything--for most savers. Consumer finance survey data from the 
Federal Reserve indicate that the median deposit balance is far below 
the current ceiling. Only approximately 3 percent of households with 
deposit accounts held any uninsured deposits, and the median income of 
these households was approximately double the median income of 
households with deposits under $100,000.
    Ample opportunities already exist for savers with substantial 
deposits--including retirees and those saving for retirement--to obtain 
FDIC coverage equal to several times $100,000. Without much difficulty, 
they may place deposits in several FDIC-insured institutions or 
establish accounts within the same institution under different legal 
capacities that qualify for separate coverage (that is, individual, 
joint, IRA). Many consumers feel comfortable putting substantial 
amounts into uninsured but relatively safe money market mutual funds, 
and there are other low-credit risk investments available for 
retirement savings or for other purposes. Thus there is no widespread 
consumer concern about existing coverage limits.

Higher Coverage Limits Would Not Benefit Banks or Promote Competition
    Proponents of higher coverage limits have claimed that they are 
necessary for community banks to remain competitive in attracting 
funds. Yet there is no evidence that community banks have had trouble 
attracting deposits under the existing coverage limits. In fact, the 
Federal Reserve has shown that smaller banks on average have grown more 
rapidly and experienced higher rates of growth in both insured and 
uninsured deposits than larger banks over the past several years.
    Furthermore, because higher coverage limits would apply to all 
depository institutions, multibank holding companies now offering 
$200,000 in coverage through two subsidiary banks would be able to 
offer, for example, $260,000 if the coverage limit was raised to 
$130,000. Thus these companies could continue offering twice the level 
of coverage available from a single-bank company. In fact, given the 
ability of major financial companies to sweep large volumes of funds 
between uninsured investments and insured deposit accounts in several 
subsidiary banks, higher coverage limits may improve the competitive 
position of these companies in deposit-taking vis-a-vis small banks. 
Therefore, it is hard to see how higher limits could improve community 
banks' ability to compete with larger banks for deposits.
    Competition is very essential to keeping banks vital. Banks compete 
for large deposits by demonstrating the soundness of their balance 
sheet and operations to such depositors. This competition for funds 
enhances the entire credit allocation mechanism. In general, raising 
coverage limits would reduce the amount and the rigor of credit 
judgments by large depositors, thereby weakening the competition for 
funds and the efficiency of credit allocation.
    Indeed, there is no credible evidence that increased coverage 
limits would serve to promote competition among banks. I believe that 
one reason the issue of coverage limits has surfaced is precisely 
because the decline in the real value of the coverage limit over the 
last two decades has served to promote a healthy competitive dynamic 
among banks in vying for the attention of customers. Continuing the 
current fixed ceiling on deposit insurance coverage, while permitting 
individuals to hold insured accounts at more than one institution, 
provides consumers with the potential benefits of greater total insured 
deposits if they need them and fosters a competitive discipline on 
bankers to provide quality services to their customers. Indexation of 
deposit insurance coverage limits would remove this discipline and only 
serve to reduce competition from what it otherwise would be.
    Not only would higher coverage limits erode competition among 
banks, but also at the same time banks would face upward pressure on 
premiums. By diluting insurance fund reserves, higher coverage limits 
would mean that more reserves would be necessary just to meet the 
existing designated reserve ratio of 1.25 percent of reserves to 
insured deposits. Recent FDIC estimates indicate that, for example, 
raising the general coverage limit to $130,000 and retirement account 
coverage to double that amount would lower the combined fund reserve 
ratio initially by 4 -5 basis points as existing uninsured deposits 
convert to insured status. As new deposits are brought into the banking 
system by the coverage increase, the total drop in the 
reserve ratio could be 9 -10 basis points. Higher coverage limits for 
municipal deposits would result in an additional decline in the reserve 
ratio.

Higher Coverage Limits Would Increase Insurance Fund and Taxpayer Risks
    Given the lack of potential benefits for consumers or of potential 
improvement in banking system competition, we cannot justify the 
increase in the Government's off-balance sheet liabilities that would 
result from higher deposit insurance coverage limits. These higher 
contingent liabilities enlarge the exposure of the insurance fund, and 
ultimately of taxpayers, to potential future losses.
    Moreover, increasing the overall coverage limit could weaken market 
discipline and further increase the level of risk to the FDIC and 
taxpayers. Proposals for even higher levels of protection of municipal 
deposits than of other classes of deposits would only exacerbate this 
problem. Providing substantially higher coverage for municipal deposits 
would significantly reduce incentives for State and local government 
treasurers to monitor risks taken with large volumes of public sector 
deposits. Should the FDIC largely protect these funds, an important 
source of credit judgment on the lending and investment decisions of 
local banks would be lost.
    Weaker market discipline runs the risk of additional supervisory or 
regulatory measures that might eventually be necessary to offset the 
risks to the insurance fund and taxpayers. Because of the absence of 
identifiable benefits, we would want to avoid actions such as a 
coverage limit increase that would risk the possibility of greater cost 
burdens on our banking system.

Funding of Supervision Costs
    In considering reform of deposit insurance pricing, it is important 
to recognize that a significant portion of insurance fund expenditures 
is not for the resolution of failing institutions, but for the FDIC's 
supervision of almost 5,500 State-chartered commercial and savings 
banks. While these State banks pay fees for the fraction of supervision 
performed by State authorities, they are not charged fees for the 
significant share of supervision that is performed by the FDIC. (State 
banks that are supervised by the Federal Reserve are treated in a 
similar manner.) National banks and savings associations, by contrast, 
are charged for 100 percent of their supervision, and in addition must 
subsidize FDIC's costs to supervise State banks through their 
contributions to the insurance funds (and the fund's earnings on those 
contributions). This uneven distribution of supervision costs is a real 
problem that should be addressed. All of the Federal and State bank 
supervisory agencies should continue to have the resources necessary to 
promote safety and soundness. We look forward to working with Congress 
and the FDIC Board to devise a solution to this problem.
Conclusion
    Let me conclude by reaffirming the Administration's support for 
several of the 
deposit insurance recommendations advanced by the FDIC. We believe that 
these reforms would improve the operation and fairness of the system, 
and we look forward to working with Congress and the FDIC on their 
implementation. However, the Administration does not support an 
increase in deposit insurance coverage limits, whether by raising the 
limit directly or by indexation.
    Thank you for the opportunity to appear before the Committee today.

                               ----------
                PREPARED STATEMENT OF JOHN D. HAWKE, JR.
      Comptroller of the Currency, U.S. Department of the Treasury
                             April 23, 2002

Introduction
    Chairman Sarbanes, Senator Gramm, and Members of the Committee, I 
am pleased to have this opportunity to present the views of the Office 
of the Comptroller of the Currency (OCC) on deposit insurance reform. 
As the current and most recent past chairmen of the Federal Deposit 
Insurance Corporation (FDIC) have noted--and as I strongly agree--the 
system of Federal deposit insurance adopted by the Congress in the 
early 1930's has served this Nation well for the greater part of a 
century. No massive overhaul of the system is required to ensure that 
it will continue to contribute to financial confidence and stability in 
the 21st century.
    Nonetheless, the efforts so far undertaken to address the 
weaknesses in the system uncovered during the banking and thrift crises 
of the late 1980's and early 1990's have not been entirely adequate to 
the task. Indeed, the legislation adopted in response to those crises 
has actually constrained the FDIC from taking sensible and necessary 
actions. This is particularly the case with respect to the FDIC's 
ability to price deposit insurance in a way that reflects the risks 
posed by different depository institutions, and to the funds' ability 
to absorb material losses over the business cycle without causing sharp 
increases in premiums. Failure to address these issues in the current 
financial environment poses the danger that the next major domestic 
financial crisis will be exacerbated rather than ameliorated by the 
Federal deposit insurance system.
    Current legislative proposals in the House and Senate to reform 
deposit insurance address most, albeit not all, of the issues raised by 
the FDIC staff in its excellent and wide-ranging ``Options Paper'' 
released in April 2001. Among these issues are: (1) How much discretion 
the FDIC should have to set premiums reflecting the risks posed by 
individual institutions to the insurance funds; (2) Whether strict 
limits on the size of the insurance funds result in excessive 
volatility of deposit insurance premiums; (3) Whether the deposit 
insurance coverage limit should be increased and/or indexed to changes 
in the price level; and, (4) Whether the Bank Insurance Fund (BIF) 
should be merged with the Savings Association Insurance Fund (SAIF).
    In summary, the OCC recommends that: (1) The FDIC be provided with 
the authority to implement a risk-based premium system for all banks; 
(2) The current fixed DRR be replaced with a range to allow the FDIC 
more flexibility in administering the deposit insurance premium 
structure; (3) Coverage limits on deposits should not be increased; and 
(4) The BIF and SAIF should be merged.
    We believe that deposit insurance reform also provides an 
opportunity to strengthen our supervisory structure by eliminating a 
distortion and unfairness in the current system of funding bank 
supervision. Currently, a portion of the earnings on the insurance 
funds, which State and national banks paid into, is diverted to fund 
the Federal supervision of only one class of institutions, State banks 
supervised by the FDIC. The FDIC has elected not to pass those costs on 
to the banks they supervise. As a consequence, State nonmember banks 
pay only a small percentage of the costs of their supervision. In 
contrast, national banks in excess of $400 million each year to cover 
the full costs of their supervision by the OCC. Ending this anomaly is 
not just a matter of fairness to national banks. It is a necessary 
component of allocating the costs and benefits of deposit insurance in 
an equitable and efficient manner among insured banks. For that reason, 
in addition to our views on the issues addressed by the legislative 
proposals to reform deposit insurance, my testimony today will include 
our suggestion for remedying the inequity that exists in the funding of 
supervision.

Eliminating Constraints on Risk-Based Pricing
    The ability of the FDIC to set premiums for deposit insurance that 
reflect the risks posed by individual institutions to the insurance 
funds is one of the most important issues in the deposit insurance 
reform debate. The banking and thrift crises of the 1980's revealed the 
weaknesses of a flat-rate deposit insurance system in which the great 
majority of sound, prudently managed institutions subsidize the risks 
assumed by a few institutions. The Congress responded to this glaring 
deficiency by enacting the Federal Deposit Insurance Corporation 
Improvement Act (FDICIA) of 1991, which required the FDIC to establish 
a risk-based system of 
deposit insurance premiums, thereby bringing the pricing of deposit 
insurance more in line with the practices of private insurance 
companies. The FDIC's initial efforts to implement such a system made 
meaningful, actuarially-based distinctions among institutions based on 
the risk each institution posed to the insurance funds, but fell short 
of creating a well-differentiated structure.
    Unfortunately, the Deposit Insurance Fund Act (DIFA) of 1996 
diminished the FDIC's discretion to maintain, let alone improve, the 
risk-based structure of deposit insurance premiums. DIFA effectively 
prohibited the FDIC from charging a positive premium to any institution 
in the 1A category--that is, well-capitalized institutions with 
composite CAMELS ratings of 1 or 2--whenever the reserves of the 
deposit insurance funds are at or above the designated reserve ratio 
(DRR) of 1.25 percent of insured deposits. As a result, at December 31, 
2001, 92.5 percent of all insured banks fell into that category, and 
therefore pay nothing for their deposit insurance--even though their 
risk of loss may be far above zero. Thus, today many institutions--some 
of which have never paid any deposit insurance premiums--receive a 
valuable Government service free, and very well-managed institutions in 
effect subsidize riskier, less well-managed institutions. Moreover, 
quite apart from the risk that a specific bank might present, banks are 
not required to pay even a minimum ``user'' fee for the governmentally 
provided benefit represented by the deposit insurance system--a benefit 
without which, as a practical matter, no bank could engage in the 
business of taking deposits from the public.
    Aside from the obvious inequity to institutions that contributed 
heavily to recapitalize the funds after the losses of the 1980's and 
1990's, a system in which the vast majority of institutions pays no 
insurance premium forgoes one of the major benefits of a risk-based 
pricing system--creating an incentive for good management by rewarding 
institutions that pose a low risk to the insurance funds. A mandated 
zero premium precludes the FDIC from charging different premiums to 
banks with different risks within the 1A category, despite the fact 
that within the 1A category there are banks that pose very different 
risks to the funds.\1\
---------------------------------------------------------------------------
    \1\ In its April 2001 Deposit Insurance Reform Options Paper, the 
FDIC reported that ``the 5 year failure rate for CAMELS 2-rated 
institutions since 1984 was more than two-and-a-half times the failure 
rate for 1-rated institutions.'' (p. 13) As shown in Chart 1 on page 
12, the 5 year failure rate for CAMELS 1-rated institutions (commercial 
and savings banks) was 0.7 percent, while that for CAMELS 2 rated 
institutions was 1.8 percent.
---------------------------------------------------------------------------
    Whenever the reserve ratio of the BIF falls below 1.25 percent, 
however, FDICIA requires the FDIC to charge an assessment rate to all 
banks high enough to bring it back to the DRR within 1 year. If that is 
not feasible, the FDIC must impose an assessment rate of at least 23 
basis points. This sharp rise in premiums, or ``cliff effect,'' would 
hit banks the hardest when they are most vulnerable to earnings 
pressure. To avoid creating this procyclical volatility in deposit 
insurance premiums, it would be preferable to offset losses to the 
funds through more gradual changes in premiums based on the level of 
the insurance fund relative to the FDIC's assessment of current risk in 
the banking system. In short, we believe that as risks in the banking 
system change relative to the level of the insurance funds, the FDIC 
should have the authority to adjust premiums on all banks.

Increasing Coverage Limits
    The question of deposit insurance coverage limits is a challenging 
one, in part because it is extremely easy for depositors to obtain full 
insurance of deposits in virtually unlimited amounts through multiple 
accounts. Along with most academic economists and other bank 
regulators, we are convinced that the sharp increase in the deposit 
insurance limit from $40,000 to $100,000 in 1980--at a time when the 
thrift industry was virtually insolvent--was a serious public policy 
mistake that increased moral hazard and contributed to the weakening of 
market discipline that exacerbated the banking and thrift crises of the 
1980's and 1990's. By encouraging speculative behavior, it ultimately 
increased losses to the deposit insurance funds and taxpayers.
    Proponents of an increase in coverage assert that it would ease 
liquidity pressures on small community banks and better enable small 
banks to compete with large 
institutions for deposits. None of these assertions, however, is 
supported by sub-
stantial evidence.
    First, we see no compelling evidence that increased coverage levels 
would offer depositors substantial benefits. Anyone who wants to use 
insured bank deposits as a means of holding their wealth can do so 
today virtually without limits, subject only to the minor inconvenience 
of having to open accounts at multiple banks. Despite the ability of 
depositors to achieve almost unlimited coverage at banks, money 
market mutual funds, which have some of the same features as bank 
transactions accounts and generally offer higher returns than bank 
deposits, today hold over $2 trillion. Because these funds could easily 
be placed in insured accounts, these facts suggest that many depositors 
are not concerned about the additional risk involved in holding their 
liquid funds in uninsured form and that households are comfortable with 
the status quo.
    Second, it is not at all clear that increasing deposit insurance 
coverage would 
result in an increase in the deposits of the banking system. One effect 
could be to cause a shift in deposits among banks. It is far from clear 
that any such redistribution of existing deposits would favor community 
banks. Depositors who multiply 
insurance coverage today by using multiple banks might consolidate 
their deposits in a single institution if coverage were raised, but 
there is no way of determining which institutions would be the ultimate 
beneficiaries when the switching process ended. Moreover, it is quite 
possible that larger, more aggressive institutions might use the 
expanded coverage to offer even more extensive governmentally protected 
investment vehicles to wealthy customers. That could cause an even 
greater shift of deposits away from community banks and increase the 
liquidity pressures felt by some.
    For many of the same reasons we object to an increase in the 
general insurance limit, we are also concerned about proposals to use 
the Federal deposit insurance system to favor particular classes of 
depositors such as municipal depositors. For instance, at year-end 
2001, commercial banks had $162 billion in municipal deposits. The FDIC 
estimated in 1999 that less than one-third of municipal deposits was 
insured. Applying that 1999 ratio to the 2001 total suggests that 
nearly $115 billion of municipal deposits at banks are uninsured. A 
significant increase in the insurance limit for municipal deposits, 
therefore, would undoubtedly raise the level of insured deposits and 
put pressure on the DRR. In addition, an increase in 
insured coverage could spur riskier lending because banks would no 
longer be required to collateralize the municipal deposits with low-
risk securities.

Merger of the BIF and the SAIF
    One of the least controversial issues of deposit insurance reform 
is the merger of the BIF and the SAIF. The financial conditions of 
thrifts and banks have converged in recent years, as have the reserve 
ratios of the two funds, removing one of the primary objections to a 
merger of the funds. As of the fourth quarter of 2001, the reserve 
ratio of the BIF was 1.26 percent, while that of the SAIF was 1.36 
percent. The reserve ratio of a combined fund would have been 1.29 
percent as of the same date. As is described in greater detail below, 
many institutions now hold some 
deposits insured by each fund. But under the current structure, BIF and 
SAIF 
deposit insurance premiums could differ significantly depending on the 
relative performance of the two funds, raising the possibility that 
institutions with similar risks could pay very different insurance 
premiums. This would unfairly penalize low-risk institutions insured by 
the fund charging the higher premiums.
    Despite the tendency for the activities of the banking and thrift 
industries to converge in recent years, substantial differences remain 
in their portfolio composition. For example, residential mortgage loans 
constitute 51 percent of the assets of insured savings institutions but 
only 15 percent of the assets of insured commercial banks. Largely 
because of these differences, merger of the two funds would result in 
significant diversification of risks.
    A related development affecting the potential for diversification 
is industry 
consolidation, which has led to an increased concentration of insured 
deposits in a relatively few institutions and increased the risks to 
the deposit insurance funds. According to the FDIC staff, the three 
largest SAIF-insured institutions held over 15 percent of SAIF-insured 
deposits in 2001, while the corresponding share of the top three BIF-
insured banks was over 13 percent. Merging the funds would reduce these 
concentrations, and thereby the risk that the failure of a few large 
institutions could seriously impair the insurance fund.
    Further, there is significant overlap in the types of institutions 
insured by the two funds. As of March 2001, 874 banks and thrifts were 
members of one fund but also held deposits insured by the other fund, 
and BIF-member institutions held 41 
percent of SAIF-insured deposits. Finally, merger of the BIF and the 
SAIF would undoubtedly result in operational savings as the two funds 
were combined into one.

Increased Flexibility for the Deposit Insurance Funds
    The OCC supports giving the FDIC the authority to establish a range 
for the DRR to replace the present arbitrary fixed DRR of 1.25 percent. 
The FDIC should have the authority to set the range based on its 
assessment of the overall level of risk in the banking system. We also 
believe that in establishing the range, the FDIC should provide notice 
and an opportunity for the public to comment on the proposed range. 
Adoption of a range and elimination of the 23 basis point ``cliff 
effect'' would allow the FDIC more flexibility in administering the 
premium structure and would minimize the likelihood of sharp increases 
in premiums during economic downturns when banks can least afford them.
    When the funds exceed the upper boundary of the DRR range set by 
the FDIC, the FDIC should be authorized to pay rebates or grant credits 
against future premiums. To ensure that rebates or credits to insured 
institutions are equitable, the FDIC should have the authority to 
assess the nature of the institutions' claims on the funds. 
Institutions that have paid little or no insurance premiums to the 
funds have far less of a claim on rebates or credits than those that 
contributed to building up the funds.
    While such rebates or credits seem reasonable on their face, there 
are two obvious principles that should be observed in determining their 
size and allocation. First, a system of rebates and credits should not 
undermine the risk-based premium system. Institutions that paid high 
insurance premiums because they posed a higher risk to the funds should 
not receive larger rebates than less risky institutions of the same 
size. The fact that these high-risk institutions did not fail during 
that period does not alter the fact that they subjected the funds to 
greater than average risks.
    The second principle is that the payment of rebates and credits 
should not have the unintended consequence of exacerbating the 
disparity in supervisory fees that now exists between State and 
nationally chartered banks. Today, the FDIC charges the insurance funds 
for its costs of supervising State-chartered institutions. National 
banks, in contrast, pay the full cost of their supervision despite the 
fact that they have contributed almost 55 percent of the amount in the 
BIF. For example, in 2001, in addition to $400 million in assessments 
that national banks paid to the OCC for their own supervision, national 
banks can be viewed as contributing 55 
percent, or about $273 million, of the $525 million that the FDIC spent 
on State nonmember bank supervision. Failure to take this into account 
in fashioning a rebate program would be unconscionable.

Fee Disparity
    State banks, on average, pay only modest assessments to State 
regulators, which represent about 20 percent of the total costs of 
State bank supervision. Far and away the largest component of State 
bank supervision is that provided by their Federal regulators--the 
Federal Reserve, in the case of State banks that are members of the 
Federal Reserve, and the FDIC, in the case of nonmember State banks. In 
2001, the Federal Reserve and FDIC together spent over $900 million on 
State bank supervision. None of this was recovered directly from the 
banks they supervise. The FDIC absorbs the cost of its supervisory and 
regulatory activities through charging the BIF and SAIF, while the 
Federal Reserve uses its interest earnings to absorb its supervisory 
and regulatory costs. Neither the Federal Reserve nor the FDIC 
assesses State banks for their costs in providing exactly the same 
supervisory functions as the OCC provides for--and assesses--national 
banks. As a result of this subsidy provided by the Federal Reserve and 
the FDIC, there is a continuing in-
centive for national banks to convert to State charters. Indeed, State 
supervisors aggressively proselytize for such conversions, heavily 
exploiting fee disparity as a major part of their sales pitch.
    It should be emphasized that fee disparity has no relationship to 
the relative efficiency of national and State bank supervision. It is 
entirely a consequence of the fact that State banks are not charged for 
the major portion of their supervision costs--that provided by their 
Federal regulators. Indeed, the OCC has a strong externally imposed 
incentive to run its operations efficiently, for if it fails to do so, 
and must turn to its banks to pick up additional costs, it runs the 
risk of causing increased conversions of banks from national charters 
to State charters. Still, the effectiveness of supervision can suffer, 
and serious inequities can result, when unavoidable pressures on 
supervisors' budgets are created. For example, during the wave of large 
bank failures in the late 1980's and 1990's--a period of stress in the 
banking system that had not been seen since the Great Depression--
significant resource demands were placed on bank supervisors in 
responding to severe problems in the banking system. Yet just as these 
demands were being felt, the banking 
system was under severe earnings pressure.
    At the OCC this meant significant increases in direct assessments 
on national banks--14 percent in 1989, another 11 percent in 1991, and 
30 percent in 1992. While there were reductions in assessments in 
subsequent years, one conclusion is inescapable: the OCC assessment 
mechanism works procyclically in times of stress in the banking system. 
At the Federal Reserve and the FDIC, similar cost increases were easily 
absorbed--at the FDIC out of insurance funds and at the Federal Reserve 
out of revenues that otherwise would have been paid over to the 
Treasury Department. In other words, the OCC faces the threat of 
reduced supervisory resources at the very time they are most likely to 
be needed. National banks face a higher burden of supervisory costs at 
the very time they are facing a troubled economy. Just as the need to 
address the 23 basis point ``cliff effect'' has gained attention, so 
also should the procyclical distortions raised by the present system of 
funding 
supervision.
    The question, of course, is what to do about this disparity. 
Proposals to level the playing field by requiring the Federal Reserve 
and the FDIC to impose new fees on State banks have been dead on 
arrival in Congress. We believe it is necessary to come up with a new 
method of funding bank supervision--a method that will strengthen both 
the State and the Federal supervisory processes and ensure that all 
supervisors have adequate, predictable resources available to carry out 
effective supervisory programs without imposing additional fees on 
State banks.

Solution
    There are a number of alternative approaches to solving this 
problem that one might consider, and we believe that now is the ideal 
time to do so, as the whole topic of the role of deposit insurance is 
being reexamined. An idea that we think has considerable appeal would 
draw on the earnings of the FDIC's insurance funds to cover the costs 
of both State and national bank supervision. Today, with the level of 
the combined funds at about $42 billion and generating earnings of 
around $2.5 billion per year, there are considerably more funds 
available to defray the costs of FDIC, OCC, and State supervision than 
those agencies today spend in total. Working together, and using the 
present costs of supervision as a baseline, State and 
Federal supervisors could develop a nondiscretionary allocation formula 
that would reflect not only the breadth of responsibilities of the 
agencies, but also the condition, risk profile, size, and operating 
environment of the banks they supervise. All agencies would remain free 
to impose supplemental assessments if they chose, but competitive 
pressures would presumably work to keep these charges at a minimum.
    This arrangement would offer some meaningful advantages. First, it 
would 
remedy the inequity to national banks that exists today, resulting from 
the fact that the FDIC funds the supervision of only one class of 
banks, State nonmember banks, out of the earnings of the deposit 
insurance funds, to which all banks have contributed. As I mentioned 
earlier, we estimate that national banks have accounted for more than 
half of the contributions to the Bank Insurance Fund.
    Another major advantage to a system under which the OCC and the 
State supervisory agencies would be funded out of the earnings on the 
insurance funds is that it would reinvigorate the dual banking system. 
It would create a regulatory system under which banks choose their 
charters on the basis of factors such as regulatory philosophy, access, 
and the perceived quality of supervision. The result would be 
competition based on characteristics of supervisors that are relevant 
to maintaining a safe and sound banking system.

Conclusion
    The OCC supports a merger of the BIF and the SAIF and proposals to 
eliminate the current constraints on deposit insurance premiums. We 
favor elimination of the current fixed DRR and its replacement with a 
range that would allow the FDIC more flexibility in administering the 
deposit insurance premium structure. We oppose an increase in deposit 
insurance coverage limits at this time. Finally, as the entire role of 
deposit insurance is being subjected to scrutiny by policymakers and 
legislators, it is an opportune time to address the distortions and 
unfairness in the current system of funding bank supervision I have 
highlighted in my testimony.

                PREPARED STATEMENT OF JAMES E. GILLERAN
Director, Office of Thrift Supervision, U.S. Department of the Treasury
                             April 23, 2002

Introduction
    Good morning, Chairman Sarbanes, Senator Gramm, and Members of the 
Committee. Thank you for the opportunity to discuss the Federal deposit 
insurance 
reform initiatives currently under consideration by Congress. The 
Office of Thrift Supervision (OTS) is fully supportive of the ongoing 
efforts to reform our Federal deposit insurance system.
    While our deposit insurance system is the envy of many countries 
because of the protections and stability it provides to our citizens, 
it can be improved. Insured institutions continue to enjoy favorable 
economic conditions, which presents us with the best opportunity to 
improve our deposit insurance system.
    Even as the bank and thrift industries have prospered, the reserve 
ratios for the Bank Insurance Fund (BIF) and Savings Association 
Insurance Fund (SAIF) have steadily declined the last several years. In 
fact, the decline in the BIF ratio has been fairly dramatic, dropping 
from 1.40 percent in June 1999 to 1.27 percent as of 
December 2001. The rate of decline has caused BIF-insured institutions 
to brace for the possibility of having to pay deposit insurance 
premiums in the near future if the BIF reserve ratio drops below 1.25 
percent.
    In the event the SAIF remains at or near its current 1.37 percent 
reserve ratio, which is likely based on our analysis of the current 
risk profile of the SAIF, this will once again create an artificial 
difference in the pricing of Federal deposit insurance, this time in 
favor of the SAIF.
    Federal deposit insurance is a critical component of our financial 
system that enhances financial stability by providing depositors with 
safe savings vehicles. We should not continue to tolerate aspects of 
our deposit insurance system that undermine this stability.
    In my testimony, today, I will address the issues that we believe 
are most important to enacting Federal deposit insurance reform 
legislation.

Federal Deposit Insurance Reform Issues
Fund Merger
     Fund merger would strengthen our deposit insurance system by 
diversifying risks, reducing fund exposure to the largest institutions, 
eliminating possible inequities arising from premium disparities, and 
reducing regulatory burden.
     Banking and thrift industry consolidation and our experience since 
the BIF and SAIF were established in 1989 argue strongly in favor of 
merging the funds. The BIF no longer insures just commercial banks 
holding only BIF-insured deposits, and the SAIF no longer insures just 
savings associations holding only SAIF-insured 
deposits.\1\ Today, many banks and thrifts have deposits insured by 
both funds. The failure of an institution holding both BIF- and SAIF-
insured deposits impacts both funds, regardless of the institution's 
fund membership. Thus, the funds are already significantly codependent 
and any reason for maintaining separate funds based on the historical 
charter identity of each fund--banks in the BIF and thrifts in the 
SAIF--has diminished.
---------------------------------------------------------------------------
    \1\ As of December 31, 2001, BIF-member institutions held 43 
percent of SAIF-insured deposits, and OTS-supervised institutions held 
less than half--49 percent--of SAIF-insured deposits. The BIF insured 
almost one-third of all savings association deposits, including 20 
percent of the deposits of OTS-regulated institutions.
---------------------------------------------------------------------------
     Maintaining the BIF and SAIF as separate funds also reduces the 
FDIC's capacity to deal with problems and introduces unnecessary risks 
to the deposit insurance system. Industry consolidation has greatly 
increased both funds' risk concentration, for example, the possibility 
that one event, or one insured entity, will trigger a 
significant and disproportionate loss. A merged fund would have 
significantly less concentration risk.
     Premium disparity is another potential problem. While the funds 
provide an identical insurance product, keeping them separate raises 
the possibility of premium differentials that could handicap 
institutions that happen to be insured by the fund that charges higher 
rates. Institutions with identical risk profiles, but holding deposits 
insured by different funds, could pay different prices for the same 
insurance coverage. The BIF-SAIF premium differential that existed in 
1995 and 1996 put 
institutions at a significant competitive disadvantage simply because 
they were insured by the higher cost fund. Some institutions reacted to 
the differential by shifting deposits between funds, while others 
sought nondeposit funding sources. Fund merger would eliminate the 
possibility of a destabilizing premium differential.
     Finally, merging the funds would eliminate regulatory burdens. 
Institutions with both BIF- and SAIF-insured deposits are required to 
make arbitrary and complex calculations to estimate the growth rates of 
deposits insured by each fund. Merging the funds would eliminate the 
need for these calculations.

FDIC Flexibility to Set Deposit Insurance Premiums
     The current pricing structure, which restricts how the FDIC sets 
fund targets and insurance premiums, tends to promote premium 
volatility. These restrictions not only hamper the FDIC's ability to 
anticipate and make adjustments to address increasing fund risks, but 
also make the system procyclical. Thus, in good times, the FDIC levies 
no premiums on most institutions. When the system is under stress, the 
FDIC is required to charge high premiums, which exacerbates problems at 
weak institutions and handicaps sound institutions. Increasing the 
FDIC's flexibility to set fund premiums within a target range would 
reduce insured institutions' exposure to overall economic conditions 
and to sectoral problems within the banking and thrift industries.
     Providing the FDIC with increased flexibility in setting fund 
targets and premiums is critical to improving the insurance premium 
pricing structure. The current structure requires the FDIC to charge at 
least 23 basis points whenever a fund is below its designated reserve 
ratio (DRR) and cannot reach its DRR within 1 year with lower premiums. 
The problem is further exacerbated because the FDIC cannot charge any 
premiums to its lowest risk institutions when a fund is at or above its 
DRR and is expected to remain so over the next year. The current system 
tends to force the FDIC to charge either too little or too much 
relative to the actual, long-term insurance risk exposure of a fund. 
Relaxing the DRR target and the restrictions on premium setting will 
substantially improve the existing premium pricing structure.
     OTS supports FDIC flexibility in addressing current and future 
risks in the deposit insurance fund, including relaxing the current DRR 
requirement. The FDIC should have the discretion to set the designated 
ratio of reserves within an appropriate range determined by Congress. 
The range must, however, provide sufficient flexibility to make 
adjustments to account for changing economic conditions.

FDIC Authority to Provide Assessment Credits
     Granting the FDIC authority to issue assessment credits will also 
improve the 
insurance premium pricing structure. It is entirely appropriate that 
the FDIC be provided with sufficient flexibility to extend assessment 
credits to institutions when sustained favorable conditions result in 
lower-than-expected insurance losses. The ability to issue assessment 
credits will also help to reduce assessment fluctuations over time.
     Authorizing the FDIC to issue assessment credits is an important 
element of an effective pricing system. As explained below, assessment 
credit authority would also help address another vexing problem for the 
deposit insurance funds--the ``free rider'' problem.

Addressing the Free Rider Problem
     Providing credits to institutions that have paid assessments into 
the system would address existing inequities in the system attributable 
to free riders that have not contributed to the fund.
     The free rider problem arises from an influx of deposits into the 
system from new institutions that enjoy the benefits of insurance 
coverage without ever paying insurance premiums. This burdens the 
insurance funds. Some financial conglomerates have caused huge sums of 
funds to qualify for insurance coverage by, for instance, converting 
money market accounts into deposit accounts. In some cases, billions of 
previously uninsured dollars have been transferred to insured 
depositories without any contribution to the insurance fund. The result 
is that the amount of funds that need insurance coverage increases 
substantially without additional contributions into the fund to build 
the reserve for losses.
     Perhaps more than eliminating an inequity in the Federal deposit 
insurance system, addressing the free rider problem will eliminate a 
practice that clearly undermines the safety and soundness of the 
Federal deposit insurance funds. Entities that grossly add to the 
amount of outstanding insured deposits without adding to the reserves 
required to insure such deposits exploit the shortcomings of the 
existing insurance premium pricing structure. This is a problem that 
must be addressed.

Deposit Insurance Coverage Levels
Increasing the Current Coverage Level
     Both the House and Senate deposit insurance reform bills propose 
increasing the current $100,000 insurance cap for standard accounts to 
$130,000. While I applaud the efforts to increase the ability of 
institutions--particularly small community-based depositories--to 
attract more deposits, I am unconvinced that increasing the insurance 
cap will achieve this result. I do not think this approach can be 
supported from a cost-benefit standpoint. Increasing the current 
insurance coverage level to $130,000 would incur significant costs for 
insured institutions since premiums would necessarily be increased.
     The benefits of an increase are unclear. I have heard from many of 
our institutions that they see no merit to bumping up the current limit 
for standard accounts. In their view, projected increases in insured 
deposits would not lead to a substantive increase in new accounts. 
Moreover, individuals with amounts in excess of $100,000 already have 
numerous opportunities to invest their funds in one or more depository 
institutions and obtain full insurance coverage for their funds.

Indexing the Coverage Level
     An issue closely related to increasing the current cap is indexing 
the coverage level so that it adjusts periodically for inflation, tied 
to the consumer price index or a similar benchmark. I question the 
practicality of the periodic costs that would be required of insured 
institutions to update their systems and advise customers of the 
change. Insured institutions would bear the costs of disclosing the new 
limit to consumers and changing their logos and signs with respect to 
the maximum insurance coverage every time the limit changes. In 
addition, the Federal deposit insurance funds would be exposed to 
increases in the coverage level from indexing. I also believe there is 
ample opportunity for customer confusion related to any program that 
would automatically increase the level of insured deposits on a 
periodic basis.

Increasing Coverage for Municipal Deposits
     I have similar reservations regarding increasing the insurance cap 
for municipal deposits. Our understanding is that providing insurance 
coverage for municipal 
deposits would have a significant impact on a combined fund's reserve 
ratio. I cannot support the cost of this increase relative to the 
potential benefit derived by a small number of institutions from the 
increase in coverage.

Conclusion
    The time is ripe for deposit insurance reform. Although the 
American deposit insurance system is the envy of countries and 
depositors all over the world, and has worked effectively to enhance 
financial stability and provide savers with confidence that their 
savings are secure, there are significant weaknesses that should be 
addressed.
    I strongly urge consideration of a ``core'' deposit reform bill 
that would: (1) Merge the BIF and the SAIF, (2) Provide FDIC 
flexibility to set insurance premiums 
within a target range, and (3) Eliminate the free rider problem. By all 
accounts, fund merger is an issue whose time has come. Relaxing the 
fixed-target DRR and funding shortfall requirement would also eliminate 
pressure on the system that now exists if a fund drops below its DRR, 
as well as provide the FDIC the necessary flexibility to manage the 
fund. Finally, I believe it is imperative that we use this opportunity 
to eliminate the free rider problem that currently plagues the system.
    Thank you for this opportunity to discuss Federal deposit insurance 
reform. I look forward to working with you, Senator Johnson, on your 
legislation; and thank you, Mr. Chairman, and the Members of the 
Committee for your time and attention to this issue.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                     FROM DONALD E. POWELL

Q.1. Could you provide your thoughts on Comptroller Hawke's 
proposal, especially in light of the FDIC's relationship with 
the State institutions and State banking agencies? Do you think 
what Comptroller Hawke has suggested is workable? If not, do 
you believe there is an alternative that might work better?

A.1. Well funded and independent primary supervisors are in the 
best interest of the FDIC. We certainly do not want to see 
funding problems jeopardize the ability of the financial 
regulators to do their job. However, it is hard to agree that 
the insurance funds should be used to fund the Treasury 
agencies' operations without accountability to the FDIC's board 
of directors for how the money is spent. There may be other 
areas we can agree to, and I hope we can make some progress on 
this going forward.
    I asked the question, why do all of the banking regulators 
maintain separate offices, separate regional offices, separate 
administration staffs, separate computer systems, separate 
contracting offices, separate personnel offices, separate data 
collection and dissemination facilities, separate economic 
analysis and research functions, and separate training 
facilities? The FDIC is prepared to work with the OCC and OTS 
to eliminate back-office inefficiencies. Further, I would offer 
to make available more of the FDIC's supervisory resources to 
help these agencies with troubled banks and thrifts. This would 
compliment all of our interests and allow the agencies to 
realize some savings themselves.

Q.2. It has come to the New England delegation's attention that 
the Boston regional office of the FDIC will be downgraded in 
status, and that field offices in the region may be closed 
shortly as well. Would you mind briefly discussing this issue 
further, and what benefits these actions would pose to the 
industry and to the consumers alike in the region?

A.2. The FDIC's realignment of its regional structure is 
designed to move bank supervision and compliance and consumer 
affairs decisionmaking authority closer to banks and their 
customers. Over the years, decisionmaking authority at the FDIC 
has become concentrated in Washington and the regional offices. 
Even relatively simple functions, such as the review and 
approval of bank safety and soundness and compliance 
examination reports, have not been vested in the field offices 
that conduct the examinations and are closest to the situation. 
Rather, staff in the regional offices and sometimes in 
Washington have handled these functions.
    The changes I announced in February will delegate 
substantial authority and responsibility to our field offices 
nationwide. Under the streamlined procedures the FDIC will 
implement later this year, the responsibility for reviewing and 
approving most examination reports and related correspondence 
will be shifted from our 
regional offices to our field offices. Rather than having to go 
to a regional office or Washington to discuss safety and 
soundness or compliance issues, banks with low-risk profiles 
and their customers will be able to go to their local field 
offices that will be fully empowered to address most issues 
that arise. This means the day-to-day contact between banks and 
the FDIC will be conducted by FDIC staff who are most familiar 
with the institutions and any special local circumstances.
    Our New England operations currently are dispersed among 
five field offices with a combined authorized staff of 152 
safety and soundness and compliance examiners. These offices 
are located in Waltham, MA; Foxboro, MA; Holyoke, MA; Concord, 
NH; and Hartford, CT. The overwhelming majority of FDIC-
supervised institutions in New England will have little or no 
need to deal with any FDIC office other than their local field 
offices, which will have the necessary delegated authority to 
address routine safety and soundness and compliance issues for 
most institutions. We are now in the midst of a comprehensive 
review of our field office infrastructure nationwide to 
determine whether it continues to be supported by our current 
workload. We do not yet know how this review might impact any 
of the five New England field offices. A final decision on 
changes to the existing nationwide field office infrastructure 
will be made in the near future. Regardless of the substance of 
those decisions, however, I want to emphasize that our current 
overall examiner staffing levels in New England accurately 
reflect our 2002 workload projections and will be unaffected by 
realignment of our New England field office infrastructure.
    Large institutions and a few small institutions with higher 
risk profiles will have more substantial contact with regional 
officials. For that reason, our regional structure is being 
intentionally realigned in a manner that ensures that all or 
most of that contact for New England institutions will occur in 
the Boston office. We are retaining case managers, compliance 
review examiners, community affairs professionals and other 
technical staff in the Boston office. We also are retaining an 
executive-level position in the 
Boston office to oversee and direct our safety and soundness 
examination program in New England and will delegate broad 
authority to that individual to resolve bank supervisory 
issues.
    We agree that we must continue to maintain effective 
oversight of FDIC-supervised institutions in New England in 
order to avoid a repetition of the problems that we experienced 
a decade ago. This was a key consideration in our decision to 
retain a dedicated executive and other staff in the Boston 
office to focus exclusively on the safety and soundness of 
FDIC-supervised institutions in the New England States. Under 
our streamlined procedures, even if an institution's issues 
cannot be handled by the local field office, there should be 
little or no need for bank supervisory issues arising from New 
England institutions to be referred to the New York regional 
office. This approach also will ensure that economic conditions 
or potential risks that are unique to the region are fully and 
appropriately considered.
    In addition to moving decisionmaking closer to banks and 
consumers, the FDIC's realignment will achieve a reduction in 
the size and costs of our regional management and support 
infrastructure. Our current eight-region structure has been in 
place since 1987, when we had approximately 8,500 FDIC-
supervised institutions nationwide. The number of FDIC-
supervised institutions has declined by 35 percent, to about 
5,500 since that time, but there has been no corresponding 
reduction in the size of our regional infrastructure. Our plans 
to streamline our regional and field office structure 
nationwide will result in an estimated $11.7 million in savings 
annually in salary and benefits costs. The elimination of five 
authorized positions (three executives and two support 
positions) in the Boston office is one component of these 
savings.
    The decision to realign our Boston and New York offices 
into a single region reflects a continuing decline in workload, 
particularly in the Boston office's jurisdiction. In the 5 year 
period from 1997 to 2002, the number of bank examiners that are 
required in the five New England field offices to perform 
safety and soundness examinations has declined from 215 to 122, 
a 43 percent decline. That is the largest drop of any of our 
eight regions. The realigned region will have 282 safety and 
soundness bank examiners (approximately 18 percent of our 
safety and soundness bank examination workforce nationwide) and 
they will be responsible for 665 FDIC-supervised institutions 
(approximately 12 percent of FDIC-supervised institutions 
nationwide). That is comparable to the current workload in the 
other regions in our realigned structure. This decline in 
workload reflects the significant changes that have occurred in 
the financial industry and is not unique to New England.
    I want to assure you that the FDIC shares your concern that 
we maintain an active and vigilant presence in the New England 
States. I believe that our planned regional realignment has 
been carefully and prudently structured to accomplish that 
purpose. By taking greater advantage of our existing field 
office structure and shifting decisionmaking authority closer 
to the banks and their customers, I believe that we will 
improve service both in New England and across the country.

Q.3. What are the potential costs to the deposit insurance 
system, and to the U.S. taxpayer that uses it, if the system is 
not reformed soon? In other words, if the funds remain 
unmerged, if the designated reserve ratio remains a ``hard 
target,'' and if the premium system remains procyclical, what 
effect will that have on institutions and the customers they 
serve when we have a severe economic downturn and there are 
several more large bank failures?

A.3. If a deposit insurance fund's reserve ratio falls below 
the 1.25 percent DRR, the FDIC is required by law to raise 
premiums by an amount sufficient to bring the reserve ratio 
back to the DRR within 1 year, or charge at least 23 basis 
points until the reserve ratio meets the DRR. Thus, if a fund's 
reserve ratio falls sufficiently below the DRR, then current 
law requires that the average premiums must increase to 23 
basis points, at a minimum. The 
potential for 23 basis point rates is problematic because, 
during a period of heightened insurance losses, both the 
economy in general and depository institutions in particular 
are more likely to be distressed. A 23 basis point premium at 
such a point in the business cycle would drain over $10 billion 
(before taxes) from depository 
institutions in 1 year, assuming current assessment bases. This 
money could be used to create a multiple amount of new loans.
    Because the funds are separate, high rates could apply only 
to members of one fund, which would mean that institutions that 
posed identical risk to the fund could be paying very different 
rates for deposit insurance, simply because of their fund 
membership. These differing rates would lead to competitive 
imbalances and time consuming and wasteful attempts to switch 
deposits from one fund to another, as we saw in the early 
1990's.
    An umnerged fund also creates higher risk for the 
taxpayers. In FDIC simulations of a combined versus separate 
funds, a combined fund was less likely to become insolvent.
    In addition, because we cannot price deposit insurance 
properly for risk right now, some riskier banks are not bearing 
their fair share of deposit insurance costs. At present, 92 
percent of banks and thrifts are well-capitalized and well-
managed and, under the restraints of current law, pay the same 
rate for deposit insurance--zero. Significant and identifiable 
differences in risk exposure exist among these 92 percent of 
insured institutions. To take just one example, since the mid-
1980's, institutions rated CAMELS 2 have failed at more than 
2\1/2\ times the rate of those rated CAMELS 1.
    Over the course of the business cycle, some riskier banks 
will pay too little for deposit insurance. Conversely, some 
less risky banks will pay too much. Because the current law 
does not allow the FDIC to charge appropriately for risk, the 
potential for moral hazard is increased. The FDIC's proposals 
would decrease the potential for moral hazard, resulting in 
safer and sounder banks.

        RESPONSE TO WRITTEN QUESTION OF SENATOR BUNNING
                     FROM DONALD E. POWELL

Q.1. Chairman Powell, I wanted to follow up on my question from 
the April 23, 2002, Senate Banking Committee hearing about the 
cost of FDIC reform proposals to individual banks. Can you tell 
me how much both S. 1945, and the House-passed H.R. 3717 would 
cost a small bank, under $100 million in assets with a 1 or 2 
rating? I realize this question may be somewhat subjective, but 
my Kentucky bankers need to know how much these proposals will 
cost them, if at all, before they can decide whether or not to 
support the legislation.

A.1. Initially, I would point out that there could be a cost to 
individual banks if no legislation is passed. The reserve ratio 
of the Bank Insurance Fund currently is 1.26 percent of insured 
deposits. If the reserve ratio drops below 1.25 percent, the 
FDIC is required by law to increase premiums on all 
institutions to return the reserve ratio to 1.25 percent within 
1 year or charge a minimum premium of 23 basis points until the 
fund reaches that level. There is a potential cost to the 
industry whether or not the legislation passes. The issue is 
really who pays, how much, and when do they pay. The 
legislation would place the assessment burden on riskier, new, 
and fast-growing institutions. In addition, the proposal would 
provide the FDIC with the flexibility to manage the fund within 
a range and avoid the procyclical effect of the current law.
    Disregarding the effect of coverage increases, the net cost 
to the industry of the FDIC's recommendations over the long run 
should be zero. Our goal is not to increase overall revenues, 
rather, to distribute the assessment burden more evenly over 
time and more fairly across insured institutions, so that 
riskier banks pay more.
    Higher coverage complicates this picture. If the reserve 
ratio drops, but the designated reserve ratio (DRR) remains at 
1.25 percent, the industry will pay to get back to 1.25 
percent. The actual assessment burden will be different for 
different institutions. For example: (1) Those who paid in the 
past will have credits and will be able to defer payments 
(please see the attached estimated assessment credits for 
Kentucky institutions); (2) The safest banks will face a 
maximum charge of one basis point annually so long as the fund 
reserve ratio is not below 1.15 percent; and (3) Riskier banks 
likely will pay more than under the current system (this will 
be subject to notice and comment rulemaking). The ultimate cost 
to safer institutions depends on how long their credits last. 
Some institutions may have enough credits to avoid paying any 
assessments to return the fund to the DRR. In any case, much of 
the assessment burden due to higher coverage (if any) will fall 
on riskier, new and fast-growing institutions.

                     *      *      *      *      *

 Estimated Assessment Credits for FDIC-Insured Institutions in Kentucky

    Because many banks will receive an initial assessment 
credit, they should initially be able to offset the credit 
against their premium for some time. Attached are estimates 
based on the best available information of the initial 
assessment credit that each Kentucky bank and thrift would 
receive under S. 1945, as introduced, and under H.R. 3717, as 
amended and adopted by the House of Representatives. *
---------------------------------------------------------------------------
    * Estimates are held in Banking Committee files.
---------------------------------------------------------------------------
    Under both bills, eligible FDIC-insured institutions would 
share a one-time assessment credit pool. That pool would be 
$5.4 billion under H.R. 3717 (12 basis points of the combined 
assessment base of the Bank Insurance Fund and the Savings 
Association Insurance Fund as of December 31, 2001) and $4 
billion under S. 1945 (9 basis points of the combined 
assessment base as of December 31, 2001). Under both bills, 
each institution's share of the assessment credit would be 
calculated by dividing its 1996 assessable deposits by the 
combined industry assessment base. Assessment credits would be 
applied to reduce deposit insurance assessments payable after 
the law becomes effective.
    The attached estimates also show how long the assessment 
credit would last if the institution were charged assessment 
rates of 2, 3, or 4 basis points. Actual rates may differ, of 
course, and will be substantially higher for riskier 
institutions.
    The estimates are only intended to provide illustrative 
examples of how individual institutions might be affected given 
present versions of the bills and given reasonable assumptions. 
The actual effect of the bills could be different.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                      FROM ALAN GREENSPAN

Q.1. Can you elaborate a bit more on why you think that, at the 
very least, there should not be any indexing of deposit 
insurance coverage for individual accounts? Isn't it 
inequitable to subject the value of deposit insurance coverage 
to annual inflationary erosion, when we constantly index Social 
Security and Medicare? Don't you think this difference is 
highlighted even more so since the level of deposit insurance 
coverage has not changed for 22 years?

A.1. The Board understands that not indexing deposit insurance 
means that the real level of insurance coverage per account 
will continue to decline. The Board and many other observers, 
however, believe that raising the level to $100,000 in 1980 was 
a serious mistake, contributing significantly to the thrift 
crisis of the 1980's. In this sense, not increasing the 
insurance cap now helps to reverse a previous policy mistake.
    Equally important, and as I indicated in my statement, 
there is virtually no evidence that either consumers of 
financial services or small banks need an increase in coverage. 
There is every indication that, especially given the 
innovations in financial services in recent years, depositors 
are able to acquire safe assets, that it is not difficult for 
households to diversify their risks by using multiple banks or 
multiple accounts, and that small banks are able to compete 
successfully for uninsured deposits. On balance, this seems 
hardly the time to increase moral hazard or undermine market 
discipline, especially since we can find no problem that an 
increase in coverage is designed to solve.

Q.2. What are the potential costs to the deposit insurance 
system, and to the U.S. taxpayer that uses it, if the system is 
not reformed soon? In other words, if the funds remain 
unmerged, if the designated reserve ratio remains a ``hard 
target,'' and if the premium system remains procyclical, what 
effect will that have on institutions and the customers they 
serve when we have a severe economic downturn and there are 
several more large bank failures?

A.2. Today, both the BIF and the SAIF provide identical 
products to insured depository institutions at the same price. 
However, unless the funds are merged, in a future crisis prices 
in the two funds could easily diverge, thereby creating 
unjustified inequities between insured depositories and 
destabilizing incentives for depositories, and perhaps their 
customers, to move between the funds. Both effects would tend 
to make the banking system less stable precisely at the time 
other policy actions are trying to increase stability. Leaving 
the designated reserve ratio as a ``hard target'' and 
continuing to limit the FDIC's pricing flexibility could be 
even more destabilizing. Under current rules, even fairly mild 
losses to either fund could result in a very large premium 
increase in a crisis. Such an increase would, among other 
things, impair the ability of banks and other insured 
depositories to make loans to households and businesses when 
such credit might be very important to encouraging an economic 
recovery. In addition, under current rules the FDIC is highly 
constrained in its ability to build up the insurance funds in 
good times and draw down the funds in bad times, a limitation 
that is also procyclical. As I indicated in my statement, 
greater flexibility both in managing the funds' reserve ratio 
and in pricing deposit insurance would substantially reduce the 
procycli-
cality of the current deposit insurance system and thus 
facilitate management of any future banking crisis. The Board 
strongly supports increased flexibility in both dimensions and 
urges the Congress to act now when a crisis is not upon us.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                      FROM PETER R. FISHER

Q.1. Can you elaborate a bit more on why you think that, at the 
very least, there should not be any indexing of deposit 
insurance coverage for individual accounts? Isn't it 
inequitable to subject the value of deposit insurance coverage 
to annual inflationary erosion, when we constantly index Social 
Security and Medicare? Don't you think this difference is 
highlighted even more so since the level of deposit insurance 
coverage has not changed for 22 years?

A.1. Unlike all other Government programs where benefits have 
been indexed, the deposit insurance system permits individual 
savers to choose to receive deposit insurance benefits in 
excess of the fixed, nominal limit. In fact, those individuals 
with substantial deposits, at very little inconvenience to 
themselves, may place funds in any number of insured 
institutions in order to obtain 100 percent coverage. And, as 
the FDIC's own website explains, they may also place funds in 
the same institution under different legal capacities that 
qualify for separate coverage. Consequently, the erosion over 
time in the real value of the $100,000 limit--a limit per 
depositor per bank--does not reduce the benefits of FDIC 
insurance available to depositors.
    We believe that the relevant issue is whether the erosion 
in the $100,000 limit by inflation has had, or will have in the 
foreseeable future, a material adverse effect on consumers. We 
see no evidence of such an effect, nor do we see evidence that 
any consumer benefits from indexing would outweigh the risks to 
the insurance funds and taxpayers of weakened market discipline 
and greater Government contingent liabilities.
    In our view, the decline in the real value of the $100,000 
limit over the last two decades has served to promote a healthy 
competitive dynamic among banks in vying for the attention of 
customers. Maintaining the current fixed limit, while 
permitting individuals to hold insured deposits at more than 
one institution, provides consumers with the potential benefits 
of greater FDIC coverage if desired and fosters a competitive 
discipline on bankers to provide quality services to their 
customers. Indexing would reduce this discipline and serve to 
reduce competition from what it otherwise would be.

Q.2. What are the potential costs to the deposit insurance 
system, and to the U.S. taxpayer that uses it, if the system is 
not reformed soon? In other words, if the funds remain 
unmerged, if the designated reserve ratio remains a ``hard 
target,'' and if the premium system remains procyclical, what 
effect will that have on institutions and the customers they 
serve when we have a severe economic downturn and there are 
several more large bank failures?

A.2. Our current deposit insurance system fulfills its primary 
objective of balancing the interests of savers and taxpayers by 
aiming to protect them both from exposure to bank losses and, 
thereby, to promote public confidence in the U.S. banking 
system. If unchanged, we believe it will continue to work as 
is. We support many of the reform proposals, however, because 
we believe they will make meaningful improvements to the 
current system, improvements that may be particularly 
noticeable during periods of economic stress. For example, the 
rigidities in the current pricing structure and reserve ratio 
could exacerbate an economic downturn in which the FDIC 
suffered substantial losses. By allowing the insurance fund 
reserve ratio to vary within a range and eliminating triggers 
that could cause sharp changes in premiums, the deposit 
insurance system should be less procyclical. Similarly, it 
makes sense to merge BIF and SAIF because a larger, combined 
insurance fund would have a greater ability to diversify its 
risks than either fund separately.
    We are mindful that efforts to achieve a more 
countercyclical policy require that depository institutions 
build insurance reserves in good times to prefund future 
losses. To do otherwise could leave the fund exposed to years 
of low reserves in the event of a rash of bank failures in the 
future and could increase the likelihood of prolonged high 
premiums (and, at the extreme, taxpayer assistance). Such an 
outcome would be unwelcome. Determining the appropriate 
statutory range for the designated reserve ratio requires 
striking a balance between the burden of prefunding future 
losses and the procyclical burden of replenishing the insurance 
fund in a downturn. Within the range, the actual designated 
reserve ratio should always be under study by the FDIC, with 
public notice and comment concerning any proposed change. A key 
benefit to giving the FDIC greater flexibility to adjust the 
designated reserve ratio is that it may better achieve low, 
stable premiums over time.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                    FROM JOHN D. HAWKE, JR.

Q.1. Can you elaborate a bit more on why you think that, at the 
very least, there should not be any indexing of deposit 
insurance coverage for individuals' accounts? Isn't it 
inequitable to subject the value of deposit insurance coverage 
to annual inflationary erosion, when we constantly index Social 
Security and Medicare? Don't you think this difference is 
highlighted even more so since the level of deposit insurance 
coverage has not changed for 22 years?

A.1. Under our current deposit insurance system depositors can 
obtain insurance in virtually unlimited amounts through 
multiple accounts. Unlike other Federal entitlement programs, 
such as Social Security and Medicare whose value to recipients 
erodes with increases in the price level, the value of deposit 
insurance coverage that individuals can obtain is not 
meaningfully reduced by inflation, because of the current 
flexibility that depositors have to obtain multiple coverage. 
At worst, inflation simply adds to the transactions costs 
associated with maintaining coverage for individuals who find 
it necessary to open multiple accounts to obtain the in-
surance coverage they desire. Nonetheless, I would not object 
if a provision to index the present coverage level were to be 
included in a comprehensive deposit insurance reform bill.

Q.2. Can you elaborate a bit more on why the proposal you have 
offered dealing with a funding mechanism for State bank 
supervision is a fair one for State banks and national banks 
alike? Do you believe that if a mechanism, such as the one you 
have proposed, is not instituted shortly, that the status quo 
could prove harmful to the national bank system?

A.2. As a matter of fairness to State and national banks, our 
proposal is far superior to the current system. As detailed in 
my written statement, national banks pay the full cost of their 
supervision through assessments they pay to the OCC. In 
contrast, State supervisors levy fees that vary widely and on 
average, cover only about a fifth of the total cost of 
supervising State banks. State banks make no explicit payments 
for the largest component of their supervision--supervision at 
the Federal level provided by the Federal Reserve, in the case 
of Federal Reserve member State banks, and the FDIC, in the 
case of nonmember State banks.
    Our proposal would address these inequities by providing an 
identical mechanism for funding the supervisory activities of 
the FDIC, State supervisors, and the OCC. Each supervisor's 
activities--not solely the FDIC's supervisory activities--would 
be funded from income earned by the insurance funds. As a 
result, going forward, neither State supervisors nor the OCC 
would have to rely solely on assessments on supervised banks to 
fund their activities.
    Under our proposal, the FDIC, OCC, and the State 
supervisors would jointly develop an objective allocation 
formula for the funding of bank supervision. The starting point 
for that process would be the current levels of each agency's 
supervisory expenditures. For an agency like the OCC, whose 
entire mission is bank supervision, all of its operations would 
be funded under the formula. On the other hand, for entities 
that carry out multiple functions, only the entities' direct 
and indirect supervisory expenditures attributable to State-
chartered banks would be funded under the formula.
    The formula would take account of both the number of 
institutions that an agency supervised and the total assets 
under supervision. It would also incorporate the financial 
condition and growth of the institutions. The objective, 
quantitative nature of the formula for determining the amount 
paid to each supervisory agency would provide State supervisors 
with a more regular, predictable source of funds and enable 
them to supervise more effectively and independently.
    Addressing the fee disparity issue would strengthen the 
dual banking system and eliminate an artificial distortion in 
the funding of bank supervision. I agree with the other 
witnesses at the hearing that the national bank charter is and 
will remain an attractive means of offering financial services. 
I am concerned, however, about the potential for a longer term 
erosion in the viability of the national bank charter if 
national banks alone are required to cover the full cost of 
their supervision, as well as a significant portion of the cost 
of the Federal supervision of State banks through their 
contributions to the deposit insurance fund.

Q.3. Comptroller Hawke, I understand that the OCC has prepared 
a ``White Paper'' detailing your proposal on how to deal with 
national bank State bank examination fees. Could you please 
submit that for the record?

A.3. We are pleased to submit our paper, ``Reforming the 
Funding of Bank Supervision,'' for the record.

Q.4. I was also intrigued by Fed Chairman Alan Greenspan's 
comments proposing an alternative funding source for the OCC. 
Would you please comment on the Chairman's idea that the OCC 
should be funded by appropriated money from Congress? Why do 
you think this might be a bad idea? Are there any other 
alternatives besides the current system and an appropriations-
driven system? Do we need to change the current funding system 
in your view?

A.4. If providing appropriated funds to the OCC would subject 
the supervision of national banks to the budget and 
appropriations process, we would oppose the idea.
    Since the very inception of the national banking system, 
Congress has scrupulously insulated bank supervision from the 
political process--just as it has insulated the formulation and 
execution of monetary policy. Today, none of the bank 
regulatory agencies are subject to the appropriations process. 
Removing that critical separation of bank supervision and the 
appropriations process would clearly run the risk of injecting 
political considerations into banking supervision, thus 
undermining the objectivity and integrity of the supervisory 
process.
    The FDIC's operating revenues are taken out of the deposit 
insurance funds, which have been built up over the years 
through the payment of premiums by all insured banks. The 
Federal Reserve System's primary source of income is earnings 
on its holdings of U.S. Treasury securities. After covering its 
expenses, the Federal Reserve returns those funds to the 
Treasury. Thus, one could argue that taxpayer dollars, in 
effect, fund the Federal Reserve System. But this use of 
taxpayer funds is a vastly different process than subjecting a 
banking agency's budget to annual appropriations. Certainly, if 
there were any serious case for subjecting bank supervision to 
the kind of political oversight involved in the budget and 
appropriations process--and we do not believe that there is 
any--it would be impossible to rationalize treating only 
national banks in this fashion, while leaving Federal 
supervision of State banks to be self-funded through the use of 
the Federal Reserve's earnings and the FDIC insurance fund.



























         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                     FROM JAMES E. GILLERAN

Q.1. Can you elaborate a bit more on why you think that, at the 
very least, there should not be any indexing of deposit 
insurance coverage for individual accounts? Isn't it 
inequitable to subject the value of deposit insurance coverage 
to annual inflationary erosion, when we constantly index Social 
Security and Medicare? Don't you think this difference is 
highlighted even more so since the level of deposit insurance 
coverage has not changed for 22 years?

A.1. There are four factors that frame my view on indexing:
    First, current rules governing Federal deposit insurance 
coverage provide substantial latitude to depositors interested 
in obtaining full insurance coverage for all of their savings. 
By distributing their savings among different types of accounts 
and at different depository institutions, the minority of the 
families holding more than $100,000 in deposits can protect 
every dollar of savings with FDIC deposit insurance. Although 
individual accounts are limited to $100,000 deposit insurance 
coverage, American families are not. There does not appear to 
be a need for indexing in order to preserve full coverage of 
individual savings.
    Second, the Federal deposit insurance funds would be 
exposed to higher risks from increases in the coverage level 
from indexing. Current reserves in the Federal deposit 
insurance funds are based on the current exposure of the funds 
from existing insured deposits. Increasing the amount of 
deposits covered by the insurance funds increases the funds' 
exposure because the same amount of reserves must now protect 
more deposits.
    Third, the increase in insured deposits covered by the 
funds from indexing will eventually require higher deposit 
insurance premiums from insured institutions. While it has been 
suggested indexing is an important issue for smaller 
institutions, I have seen no data supporting the notion that 
raising deposit coverage levels will benefit smaller 
institutions. In addition, this creates the possibility that 
larger institutions, able to draw on a much larger (existing 
and potential) customer base, would be able to attract new 
deposits, with the result that smaller institutions will bear 
part of that cost.
    Finally, indexing would incur significant and ongoing 
administrative costs related to disclosing the new limit to 
consumers and changing forms, contracts, signs, and 
informational materials. These costs would ultimately be borne, 
at least in part, by customers in the form of higher fees or 
lower interest rates paid on deposits. Many of the institutions 
I have spoken to regarding this issue have highlighted the cost 
aspects of indexing as a reason why it should be viewed 
negatively by institutions and their customers.

Q.2. What are the potential costs to the deposit insurance 
system, and to the U.S. taxpayer that uses it, if the system is 
not reformed soon? In other words, if the funds remain 
unmerged, if the designated reserve ratio remains a ``hard 
target,'' and if the premium system remains procyclical, what 
effect will that have on institutions and the customers they 
serve when we have a severe economic downturn and there are 
several more large bank failures?

A.2. I support enactment of core deposit insurance legislation 
that merges the funds, gives the FDIC flexibility to set 
premiums based on a target reserve ratio range, and eliminates 
the free rider problem. Without this legislation, a severe 
economic downturn and additional large institution failures 
exposes the funds to the following effects:

 BIF-SAIF Premium Disparity. A premium disparity 
    between the BIF and the SAIF could develop if one of the 
    funds is exposed to proportionally higher losses or deposit 
    growth than the other. This could occur despite the fact 
    that both funds provide identical deposit insurance 
    coverage. The BIF-SAIF disparity of the mid-1990's 
    demonstrated that premium differentials are destabilizing 
    because institutions shift deposits to the less expensive 
    fund or, alternatively, seek nondeposit funding sources to 
    avoid the cost of the higher premium. Fund merger 
    eliminates this problem.

 Increased Concentration Risk. Industry consolidation 
    will continue to increase both funds' concentration risk, 
    for example, the risk that one event, or one insured 
    entity, will trigger a significant and disproportionate 
    loss. As of December 31, 2001, the largest BIF-insured 
    institution, accounted for 7.8 percent of BIF-insured 
    deposits; and the largest SAIF-insured institution, held 
    8.2 percent of SAIF-insured deposits. A fund merger as of 
    December 31, 2001, would have had the largest BIF 
    institution accounting for only 6.9 percent of combined 
    deposits and the largest SAIF member holding only 2.1 
    percent of combined deposits. Fund merger would moderate 
    concentration risk and reduce pressure for higher premiums.

 FDIC Flexibility to Address Problems. A severe 
    economic downturn coupled with several large institution 
    failures could force the FDIC to impose high premiums under 
    the current statutory premium framework. This could 
    increase the risk of failure of other troubled 
    institutions, stress healthy institutions, and hamper the 
    ability of all institutions to finance activities that 
    would help to improve the economy. FDIC flexibility to 
    anticipate insurance fund needs and to build sufficient 
    reserves (within a statutory designated range) while the 
    economy is growing would better equip the funds to address 
    problems during an economic downturn.

 Free Rider Problem. A number of large financial firms 
    continue to shift customer assets into insured accounts 
    without paying insurance premiums for that coverage. This 
    increases the insurance risk to the funds, accelerates the 
    likelihood of a deposit insurance premium, and obligates 
    all member institutions to pay higher premiums when 
    necessary to restore fund reserve ratios.
