[Senate Hearing 108-340]
[From the U.S. Government Publishing Office]



                                                      S. Hrg. 108-340
 
                  THE FEDERAL DEPOSIT INSURANCE SYSTEM
=======================================================================





                                HEARING

                               before the

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

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                                   ON

 THE CONDITION OF THE FEDERAL DEPOSIT INSURANCE SYSTEM AND TO CONSIDER 
               REFORMS WHICH WOULD MAKE IT MORE EFFECTIVE

                               __________

                           FEBRUARY 26, 2003

                               __________

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








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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire        THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina       DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island      JON S. CORZINE, New Jersey

             Kathleen L. Casey, Staff Director and Counsel
     Steven B. Harris, Democratic Staff Director and Chief Counsel
                         Mark Oesterle, Counsel
             Martin J. Gruenberg, Democratic Senior Counsel
   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
                       George E. Whittle, Editor

                                  (ii)












                            C O N T E N T S

1                              ----------                              

                      WEDNESDAY, FEBRUARY 26, 2003

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Enzi.................................................     2
    Senator Carper...............................................     3
    Senator Hagel................................................     3
        Prepared statement.......................................    38
    Senator Corzine..............................................     4
    Senator Sununu...............................................     4
    Senator Schumer..............................................     4
    Senator Allard...............................................     5
    Senator Crapo................................................     6
    Senator Bennett..............................................     7
    Senator Stabenow.............................................     7
    Senator Miller...............................................     7
    Senator Johnson..............................................    22
        Prepared statement.......................................    38
    Senator Dodd.................................................    26
    Senator Sarbanes.............................................    30
    Senator Bunning..............................................    40
    Senator Dole.................................................    40

                               WITNESSES

Alan Greenspan, Chairman, Board of Governors of the Federal 
  Reserve System, Washington, DC.................................     8
    Prepared statement...........................................    41
    Response to written questions of:
        Senator Enzi.............................................    60
        Senator Schumer..........................................    60
        Senator Miller...........................................    61
        Senator Johnson..........................................    61

Peter R. Fisher, Under Secretary for Domestic Finance, U.S. 
  Department of the Treasury.....................................    10
    Prepared statement...........................................    46
    Response to written questions of:
        Senator Enzi.............................................    63
        Senator Schumer..........................................    63
        Senator Miller...........................................    64
        Senator Johnson..........................................    65

Donald E. Powell, Chairman, Board of Directors of the Federal 
  Deposit Insurance Corporation..................................    12
    Prepared statement...........................................    50
    Response to written questions of:
        Senator Enzi.............................................    66
        Senator Schumer..........................................    67
        Senator Miller...........................................    68
        Senator Johnson..........................................    69

John D. Hawke, Jr., Comptroller of the Currency, U.S. Department 
  of the Treasury................................................    13
    Prepared statement...........................................    53
    Response to written questions of:
        Senator Enzi.............................................    71
        Senator Schumer..........................................    72
        Senator Miller...........................................    73
        Senator Johnson..........................................    73

James E. Gilleran, Director, Office of Thrift Supervision, U.S. 
  Department of the Treasury.....................................    14
    Prepared statement...........................................    56
    Response to written questions of:
        Senator Enzi.............................................    74
        Senator Miller...........................................    75
        Senator Johnson..........................................    76

              Additional Material Supplied for the Record

News article by Robert D. Novak, ``Goodbye, Greenspan,'' 
  submitted by Senator Chuck Schumer, dated February 24, 2003....    78

                                 (iii)












                  THE FEDERAL DEPOSIT INSURANCE SYSTEM

                              ----------                              


                      WEDNESDAY, FEBRUARY 26, 2003

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

    The Committee met at 9:40 a.m. in room SD-538 of the 
Dirksen Senate Office Building, Senator Richard C. Shelby 
(Chairman of the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The Committee will come to order.
    Chairman Greenspan, Under Secretary Fisher, Chairman 
Powell, Comptroller Hawke, Director Gilleran, good morning. 
Thank you for coming. Sorry you had to wait a few minutes.
    The purpose of this hearing is to discuss the present 
condition of the Federal Deposit Insurance System and to 
consider reforms which would make it more effective.
    Deposit insurance has been a crucial part of the overall 
banking regulatory structure for almost 70 years. It has 
functioned well in protecting the deposits of millions of 
Americans. In turn, by providing this protection, it has 
virtually eliminated the bank panic phenomenon, thus serving to 
stabilize the banking system and the overall economy.
    These positives aside, however, providing deposit insurance 
creates the real possibility that taxpayers could be forced to 
bear significant liabilities. This is due to the fact that the 
system operates by putting the full faith and credit of the 
Federal Government 
behind every insured deposit.
    Let's be clear on this point--``full faith and credit'' of 
the Federal Government means ``full and direct access'' to the 
taxpayer's wallet. Those of us who participated in the clean-up 
of the savings and loan mess right here in this Committee know 
firsthand the potential magnitude of this cost to taxpayers.
    Such are the tensions within the deposit insurance system: 
It stands to protect individual depositors, thereby protecting 
banks and the overall economy. But this can only be achieved by 
exposing taxpayers to considerable liabilities.
    I believe it is our responsibility to appreciate and 
maintain the appropriate balance between these forces, should 
we entertain any reforms of the system.
    In this regard, I believe that the FDIC has raised some 
reform proposals that appropriately achieve this balance. For 
example: I support building more flexibility into the system to 
provide the regulators greater ability to work with, rather 
than against, the economic cycle; I think developing a more 
finely-tuned, truly risk-based methodology for pricing 
insurance would be a positive development because, under such a 
system, the cost of insurance would be more closely linked to 
risks of claims against the fund; the system would also be 
better served if every institution holding insured deposits 
actually paid some amount for the coverage provided; and, it 
seems the factors which led to the creation of separate banking 
and savings insurance funds no longer exist and greater 
efficiencies could be achieved by combining these funds.
    It is my hope that the witnesses can provide more 
comprehensive analysis regarding these reforms proposals.
    I would like to close by again thanking the panelists for 
appearing today and by pointing out that a narrow window of 
opportunity is presently open--the insurance system is 
basically sound and the banking industry is in relatively good 
condition.
    Working together, I think that we can seize this 
opportunity and move forward common-sense reforms--reforms 
which protect depositors and taxpayers and ultimately make a 
good system better.
    Senator Enzi.

              STATEMENT OF SENATOR MICHAEL B. ENZI

    Senator Enzi. Thank you, Mr. Chairman. I also want to thank 
you for holding this hearing. I want to thank the distinguished 
witnesses for being here today.
    As everyone knows, the House Financial Services Committee 
passed its version of deposit insurance reform last year. And I 
think it is important that the Senate keep pace on this 
critical issues. I am very happy that the Chairman has included 
this as a priority and made this one of the first topics that 
the Committee will address.
    I also want to thank the Members with whom I have worked on 
this issue in the past. There is legislation that we 
cosponsored. I believe this legislation will be an excellent 
starting point that provides good direction for the Committee 
as we deliberate the issue.
    I think a number of issues can be agreed upon by nearly 
everyone, and I would hope that the few remaining issues won't 
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.
    The legislation which I have been supportive of, addresses 
a number of problems in 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. Therefore, they should 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, the 
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 that this issue is of critical importance. 
I thank you for holding this hearing and I look forward to 
working with you and the other Members and for the information 
we will get today.
    Chairman Shelby. Thank you, Senator.
    Senator Carper.

              COMMENTS OF SENATOR THOMAS R. CARPER

    Senator Carper. Thank you, Mr. Chairman. And welcome to our 
witnesses this morning.
    I am the only Democrat here today. I am the only Democrat 
on the Committee who is not running for President.
    [Laughter.]
    Chairman Shelby. Yet.
    [Laughter.]
    Senator Carper. If we get any more Senate Democrats running 
for President, I may get to be leader or something before we 
are done. But I wouldn't bet on that.
    [Laughter.]
    I am delighted that you are each here. Chairman Greenspan 
was just with us 2 weeks ago and spoke at some length about the 
geopolitical uncertainties that we face around the world and 
how those need to be addresses and resolved in order for our 
economy truly to be moving forward.
    We talked a bit about the uncertainties that can hamper and 
hinder an economic recovery. One of the uncertainties that we 
never want to grapple with again is the uncertainty that when 
people put their money in the bank, their credit union, their 
thrift, that that money is safe when they need it and when they 
need it, it is there to be called upon.
    These are fairly complex issues, as you know. And my 
experience both in the House Banking Committee where I served 
with our Chairman and some others here, was that, to the extent 
that the regulators and the industry can find common ground on 
most of these issues, it certainly helps us in figuring out 
what course we should pursue.
    So, we are looking for that consensus here today and we 
thank you for your testimony, and for your stewardship.
    I am going to leave because I have a couple of other 
hearings to attend. When I leave, I am not going to announce my 
departure, but I will be back later this morning and pick up on 
the questions and answers.
    Again, thank you all.
    Chairman Shelby. Senator Hagel.

                COMMENTS OF SENATOR CHUCK HAGEL

    Senator Hagel. Mr. Chairman, thank you. I add my 
appreciation to Senator Enzi's and Senator Carper's comments 
about your initiative in holding this hearing.
    As you know, Mr. Chairman, I am one of the Senators who 
sponsored legislation in the last Congress, and again have 
introduced, along with Senator Enzi and others, a piece of 
legislation which I appreciate again your consideration of in 
this hearing.
    I would add my thanks to our panelists. We appreciate you 
being here this morning. We also appreciate very much what you 
do day-to-day and your colleagues. Please give them our thanks 
as well.
    These are important times. Some, at the risk of being a 
shameless politician, might even dare say, historic times. 
Certainly, they are times that will frame and shape much of the 
history of our country and the world, not just in the financial 
institutions industry, but everything connected to that, and 
everything is connected to what you do. We do not deal with 
these issues in vacuums, whether it is war or peace or 
terrorism. They are driven, much as Chairman Greenspan said 
before this Committee a couple of weeks ago, by the two pillars 
of anything that maintains order and prosperity and growth, and 
those are confidence and stability.
    So, we appreciate you being here, Mr. Chairman. I have a 
statement that I will ask to be submitted for the record.
    Chairman Shelby. It will be made a part of the record, 
without objection.
    Senator Hagel. Thank you very much.
    Chairman Shelby. Senator Corzine.

               COMMENTS OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Mr. Chairman. I also welcome 
all the witnesses, an august group who I think have done a 
great job in protecting our financial system and I am looking 
forward to hearing their comments.
    I think there is a lot of agreement with respect to the 
subject matter. It is one that needs attention while so many 
other major things go on in our world. But I hope that we can 
have a good question and answer session and get this issue 
wrapped up and moved forward.
    Thank you.
    Chairman Shelby. Senator Sununu.

               COMMENTS OF SENATOR JOHN E. SUNUNU

    Senator Sununu. Thank you, Mr. Chairman.
    Given the amount of agreement that there seems to be, I 
only hope that as we go through this legislation, that it is 
really just good policy considerations that drive the structure 
of the final legislation, that we maybe can put aside some of 
the more parochial political dots or drivers in this debate and 
just get the job done. There is a lot of consensus, and I look 
forward to the testimony.
    Thank you.
    Chairman Shelby. Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Thank you, Mr. Chairman.
    I want to commend you for putting together such a 
distinguished panel that can give us a great deal of advice, 
and thank our panelists for taking the time to meet us. 
Chairman Greenspan has been particularly generous with his time 
lately.
    I want to comment on a matter of grave concern to me.
    Just two weeks ago, Chairman Greenspan appeared before our 
Committee as part of our oversight of the Federal Reserve Board 
and he has been very generous with his time in that regard. And 
while some of us may have disagreed from time to time with the 
Chairman, we have always respected his service and recognized 
the importance of an independent Federal Reserve Board. When 
differences have come up, they have been over policy. They have 
not been personal.
    I just have to say, Mr. Chairman, that I am deeply troubled 
by the public reports of the Administration's anger at Chairman 
Greenspan. There seems to be an ongoing orchestrated whisper 
campaign to discredit the Chairman and certainly the views that 
he sent out 2 weeks ago.
    It seems there is a clear message being sent out--you are 
either with us or against us. There can be no independent view.
    Well, in my judgment, Chairman Shelby, this is an extremely 
dangerous precedent. It violates the very structure of the 
Federal Reserve since 1913, I think, when it was first set up. 
It should be independent and there should be no heavy-handed 
attempts to corrupt the objectivity of the Fed that is so vital 
to the confidence of our markets.
    So given the fragile state of those markets, and I come 
from New York, I have to seriously question the judgment when 
some in the Administration publicly pursue this kind of course.
    Two years ago, Chairman Greenspan supported the principle 
of tax cuts. The Administration was very comfortable then with 
his remarks, presumably, because at that time, they could be 
interpreted to support the Administration's position. I did not 
like those. But that is not the issue here.
    I do not believe that the Chairman was taking a Republican 
position then. I do not think he is taking a Democratic 
position now. I think the Chairman speaks with the best 
interests of the economy and the country in mind.
    So all of this whispering and all of this desire to muffle 
the Fed, not to say that they disagree with the views, but to 
say that the Chairman should go, the Chairman has outlived his 
usefulness, I think is very bad, for the Fed, for investors, 
and for our country.
    And so, today, along with Senator Corzine, I will be 
introducing a sense of the Senate resolution supporting the 
independence and objectivity of the Fed and of keeping Chairman 
Greenspan in as long as he wants to.
    I hope every Member of this Committee will join in 
supporting me in this resolution, and I thank you, Mr. 
Chairman.
    Chairman Shelby. Senator Allard.

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Thank you, Mr. Chairman.
    I have to say something briefly about my colleague's 
comments.
    I have been talking with Members of the Administration and 
they were pleased with the testimony from the Chairman. The 
Members of the Administration that I have talked with felt that 
the comments Chairman Greenspan was making were actually quite 
helpful. I think most of the Members on this side thought his 
comments that were made in the past were helpful.
    I do not understand all of the furor or currently, any kind 
of whisper campaign. I have certainly not heard anything about 
that.
    I have always greatly respected Chairman Greenspan and his 
comments and I look forward to hearing his testimony today. In 
fact, my colleagues have already congratulated you, Mr. 
Chairman, for the quality of the testimony you have brought 
before the Committee today. I would like to join that chorus in 
thanking you for getting such good quality here before us.
    As cosponsor of the deposit insurance reform, obviously, I 
am pleased that you have made this one of your priorities, Mr. 
Chairman. The time is right, I believe, to move forward with 
deposit insurance reform. We are approaching the point where 
the FDIC may be forced to impose premiums. Should this be 
necessary, I want to ensure that they have the tools and 
flexibility necessary to maintain an adequate reserve without 
imposing unnecessary or unfair standards on banks.
    I am very pleased that we may be reaching consensus on many 
elements of deposit insurance reform. In fact, I believe that 
there is an agreement on the majority of issues. I am hopeful 
that we can work together in a bipartisan manner to find 
solutions to the remaining concerns.
    I have heard from many of my Colorado banks about the 
importance of the reforms. By moving forward in a careful 
manner, we can ensure that they are best able to serve their 
customers and that American consumers retain their confidence 
in our Nation's banking system. In Colorado, we have a lot of 
smaller banks. Deposit insurance reform has been an important 
issue as far as our community banks are concerned.
    Finally, I would like to offer my sincere thanks to the 
witnesses for being here today. As top Administration 
officials, I can appreciate the incredible demands on all of 
your time. Your testimony at today's hearing will certainly 
provide the expertise necessary to move this issue forward, and 
I do look forward to your testimony.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Crapo.

                 COMMENTS OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman. I would like to 
just echo the comments of my colleague, Senator Allard. I was 
present when the Chairman was giving his testimony as well and 
did not notice anything that I found objectionable in it, nor 
have I heard anything coming from the Administration or 
otherwise. In fact, I have heard in my discussions with 
officials in the Administration that they felt that the 
Chairman's comments have been very helpful in helping the 
country to understand the dynamics that we face in our 
budgeting process this year.
    I want to again thank the Chairman for his continued 
efforts to work with this Congress and with this Administration 
and the people of this country as we deal with some of the more 
difficult economic times that we have faced in a long time.
    I think that with regard to the legislation we are facing 
today, it also needs to have very serious focus. I thank the 
Chairman for holding this hearing and I look forward to the 
information that we will get from this distinguished panel.
    Thank you.
    Chairman Shelby. Senator Bennett.

             COMMENTS OF SENATOR ROBERT F. BENNETT

    Senator Bennett. I will stipulate that the Fed should be 
independent, that Mr. Greenspan should be retained, and that 
The New York Times should be disbelieved.
    [Laughter.]
    Senator Schumer. Mr. Chairman, I would just ask unanimous 
consent to----
    Chairman Shelby. Let's finish our order first.
    Senator Schumer. Okay.
    Chairman Shelby. Senator Stabenow.

              COMMENTS OF SENATOR DEBBIE STABENOW

    Senator Stabenow. Thank you, Mr. Chairman. And welcome to 
all of our guests who are testifying today. Chairman Greenspan, 
it is good to see you again.
    I would like to commend the Chairman for reigniting the 
debate over deposit insurance reform early in the session. We 
appreciate that very much.
    I would commend Senators Johnson and Hagel for the 
excellent work that they have done in putting together a reform 
proposal. Their bill, the Safe and Fair Deposit Insurance Act, 
is a solid and reasoned approach and I was proud to be a 
cosponsor in the last session and to be a cosponsor again this 
session with them.
    It was almost 2 years ago that then-FDIC Chair Donna Tanoue 
brought her case to the Congress that it was time to address 
flaws in the deposit insurance system--while the industry was 
in good shape, she said, and the overwhelming majority of 
institutions remain healthy. I agreed with her then, and agree 
with her now, that we still need to be addressing these issues.
    So, I look forward to working in a bipartisan way, Mr. 
Chairman, and with Members of the Committee, and hopefully, we 
will be successful in passing this important legislation.
    Chairman Shelby. Thank you.
    Senator Miller.

                 COMMENT OF SENATOR ZELL MILLER

    Senator Miller. I do not have any statement, Mr. Chairman. 
Thank you.
    Chairman Shelby. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman. I would just ask 
unanimous consent to submit into the record an article by 
Robert Novak, hardly someone who agrees with The New York Times 
and someone close to the Administration saying, ``Goodbye, 
Greenspan,'' the first sentence of which reads: ``It is 
difficult to exaggerate the aggravation at the White House over 
Alan Greenspan's gratuitous shot at President Bush's tax cuts. 
So angry are the President's advisors that they are willing to 
consider not reappointing Greenspan next year.''
    Chairman Shelby. Without objection, so ordered. I think it 
has been all over America, anyway. So it can come into the 
record.
    [Laughter.]
    Chairman Greenspan, you have a statement. Please proceed as 
you see fit.
    [Laughter.]
    You take as long as you want, Mr. Chairman.
    [Laughter.]
    I hope you are there as long as you want to be.
    [Laughter.]
    We all would stipulate that the Fed is independent, both 
Democrats and Republicans. And gosh, it is going to remain 
independent. Especially under your tenure. I know that.

                  STATEMENT OF ALAN GREENSPAN

              CHAIRMAN, BOARD OF GOVERNORS OF THE

                     FEDERAL RESERVE SYSTEM

    Chairman Greenspan. Thank you, Mr. Chairman. Speaking for 
my colleagues, as well as for myself, we thank you.
    Chairman Shelby. Thank you.
    Chairman Greenspan. Mr. Chairman and Members of the 
Committee, it is a pleasure to appear once again before this 
Committee to present the views of the Board of Governors of the 
Federal Reserve System on deposit insurance reform.
    As I indicated to this Committee last April, the Board 
strongly supports a number of changes to deposit insurance, 
including a wider permissible range for the size of the fund 
relative to insured deposits, reduced variation of the 
insurance premium over the economic cycle, a positive and more 
risk-based premium net of rebates for all insured depositories, 
and merging of the BIF and the SAIF.
    However, the Board continues to be very much in opposition 
to any increase in the deposit insurance coverage limits.
    The reasons for our views are discussed more fully in my 
full statement, which I ask to be included in the record. In 
the next few minutes, I hope to highlight some of the critical 
points.
    Deposit insurance was adopted in this country as part of 
the Great Depression legislative framework for limiting the 
impact of that disaster on the American public. My reading of 
the debates 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.
    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 applied to deposits, as you may 
recall, 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 very beginning, deposit insurance 
involves a trade-off. 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 by inducing greater 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' 
interests. The crafting of reforms of the deposit insurance 
system must struggle to balance these trade-offs.
    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, causing a further reduction in 
market discipline and inducing additional risk-taking by 
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, of course, the economy.
    The Board supports merger of the BIF and the 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 reached 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 important bulwarks 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.
    Our surveys of consumer finances indicate 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 
institutions.
    If the problem that raising the ceilings is seeking to 
address is at depository institutions, it would seem 
disproportionately related to small banks 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, the smaller banks' 
assets and uninsured deposits have expanded at over 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 additional deposit insurance serves a national 
purpose.
    I might add that throughout the 1990's, and into the 
present century, small banks' return on equity has been 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 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 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 
we be exceptionally deliberate in expanding Government 
financial guarantees.
    Thank you, Mr. Chairman. I look forward to your questions.
    Chairman Shelby. Secretary 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 appreciate the opportunity to provide the 
Administration's views on deposit insurance reform. I also want 
to commend Chairman Powell and the FDIC staff for their 
valuable contributions to the discussion of this important 
issue.
    I have a written statement I would like to be a part of the 
record.
    Chairman Shelby. It will be made part of the record.
    Mr. Fisher. Let me summarize our views.
    The Administration strongly supports reforms to our deposit 
insurance system that would, first, merge the bank and thrift 
insurance funds; second, allow more flexibility in the 
management of fund reserves while maintaining adequate reserve 
levels and; third, ensure that all participating institutions 
fairly share in the maintenance of FDIC resources. The 
Administration strongly opposes any increases in deposit 
insurance coverage limits.
    We support a merger of the Bank Insurance Fund, the BIF, 
and the Savings Association Insurance Fund, the SAIF, as soon 
as practicable. A larger, combined insurance fund would be 
better able to diversify risks, and thus withstand losses, than 
would either fund separately. Merging the funds while the 
industry is strong and both funds are adequately capitalized 
would not burden either BIF or SAIF members.
    We support greater flexibility for the FDIC in managing the 
level of fund reserves. Reserves should be allowed to grow when 
conditions are good. This would enable the fund to better 
absorb losses under adverse conditions without sharp increases 
in premiums. In order to achieve this objective and also to 
account for changing risks to the insurance fund over time, we 
support greater latitude for the FDIC to alter the designated 
reserve ratio within statutorily prescribed upper and lower 
bounds. Within these bounds, the FDIC should provide for public 
notice and comment concerning any proposed changes to the 
designated reserve ratio. The FDIC should also have discretion 
in determining how quickly it meets the designated reserve 
ratio as long as the actual reserve ratio is within these 
bounds. If the reserve ratio were to fall below the lower 
bound, the FDIC should restore it to within the statutory range 
promptly, over a reasonable but limited timeframe.
    Every day that they operate, banks and thrifts benefit from 
their access to Federal deposit insurance. For several years, 
however, the FDIC has been allowed to obtain premiums for 
deposit insurance from only a few insured institutions. 
Currently, over 90 percent of banks and thrifts pay nothing to 
the FDIC. Thus, there is little 
opportunity to do what any prudent insurer would do--adjust the 
premiums for risk.
    Today, a bank can rapidly increase its insured deposits 
without paying anything into the insurance fund. Some large 
financial companies have greatly augmented their insured 
deposits in the past few years by sweeping uninsured funds into 
their affiliated depository institutions--without compensating 
the FDIC at all.
    To rectify this ``free rider'' problem and ensure that 
institutions appropriately compensate the FDIC commensurate 
with their risk, Congress should remove the current 
restrictions on FDIC premium-setting. In order to recognize 
past payments to build up current 
reserves, we support the proposal to apply temporary transition 
credits against future premiums that would be distributed based 
on a measure of each institution's contributions to the build-
up of insurance fund reserves in the early to mid-1990's.
    We would prefer to avoid rebates, which could drain the 
insurance fund of cash. Over much of its history, the FDIC 
insurance fund ratio remained well above the current target, 
only to drop into deficit conditions by the beginning of the 
1990's. However, we think a system of ongoing transition 
credits to compensate for the rapid growth of funds in some 
institutions as opposed to others could achieve much the same 
end.
    The improvements to the deposit insurance system that I 
have just outlined are vital to the system's long-term health. 
Increases in FDIC benefits, however, including any increases in 
the level of insurance coverage are not part of the solution to 
these problems and should be avoided.
    When I testified before this Committee last April, I argued 
at some length that an increase in deposit insurance coverage 
limits would serve no sound public policy purpose. Nothing has 
occurred since that would change that view.
    The Administration continues to propose raising coverage 
limits in any form. Unlike other Government benefit programs, 
there is no need for indexation of deposit insurance coverage 
because savers can now obtain all the coverage that they desire 
through multiple banks and through other means. We feel that 
the entire issue of coverage limits, regrettably, diverts 
attention from the important reforms that are needed.
    In conclusion, I reaffirm the Administration's support for 
the three-part framework that I have outlined and I encourage 
this Committee and Congress to give Chairman Powell and the 
FDIC staff the tools they need to run a better deposit 
insurance system for the country.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you.
    Chairman Powell.

                 STATEMENT OF DONALD E. POWELL

              CHAIRMAN, BOARD OF DIRECTORS OF THE

             FEDERAL DEPOSIT INSURANCE CORPORATION

    Chairman Powell. Chairman Shelby and distinguished Members 
of the Committee, thank you for your leadership in holding this 
hearing today. Deposit insurance reform is a top priority of 
the FDIC this year and we appreciate the Committee making it an 
early priority as well.
    An effective deposit insurance system contributes to 
America's economic and financial stability by protecting 
depositors. For more than three generations, our deposit 
insurance system has played a key role in maintaining public 
confidence. While the current system has been effective to 
date, we are committed to working with you and the financial 
services sector to improve it.
    Today, I want to emphasize three elements of deposit 
insurance reform that would do just that: One, merging the Bank 
Insurance Fund and the Savings Association Insurance Fund; two, 
improving the FDIC's ability to manage the merged fund; and, 
three, effectively pricing premiums to reflect risk.
    First, merging the funds. As most of you know, the banking 
and thrift crisis of the last decade left the FDIC 
administering two deposit insurance funds--one to guarantee 
bank deposits, and the other to guarantee thrift deposits. But 
now, 10 years later, industry trends have left no meaningful 
distinction between the two. We should merge the funds into a 
single Deposit Insurance Fund that will be stronger and will 
treat all deposits the same.
    Second, improving the FDIC's ability to manage the merged 
fund. The FDIC is prohibited from charging any premiums to most 
banks in good economic times. That means that during difficult 
economic times, the FDIC is forced by law to levy steep 
premiums on the industry. Doing so would further stress the 
country's financial institutions at the very time when, as a 
matter of economic 
necessity, we would be asking banks to strengthen their balance 
sheets and to extend credit.
    Third, effectively pricing premiums to reflect risk. Under 
current law, safer banks are forced to subsidize riskier banks. 
This is unfair. Just as unfair is the fact that new deposits 
are able to enter the system in good times without paying any 
premiums for deposit insurance. Almost one thousand banks have 
entered the system since 1996 without paying any premiums for 
Federal deposit insurance. We have an opportunity and, in my 
view, the responsibility to the American people to remedy these 
problems.
    So the Federal Deposit Insurance Corporation recommends the 
following:
    --Eliminating the hard targets and triggers in the current 
law.
    --Allowing the FDIC to manage the size of the insurance 
fund within a range.
    --Permitting the FDIC to charge steady, risk-based premiums 
to allow the insurance funds to build up in good times and to 
be drawn down during bad times.
    --Permitting the FDIC to charge all insured institutions 
appropriately for risk at all times so that safer banks do not 
unnecessarily subsidize riskier banks.
    These methods for pricing and managing financial risk are 
best practices in the private sector and we would like to 
manage our system in much the same way.
    With some flexibility in fund management, we can alleviate 
the problems with the current system while strengthening our 
ability to deal with any future crisis. We are not asking for 
absolute discretion. We recognize the need for accountability 
and will work with you to ensure a system that provides it.
    The reforms I just described are critical to improving the 
deposit insurance system. Another issue that has been the 
subject of much discussion is deposit insurance coverage. Some 
have said that coverage should be higher; some have said lower. 
Our position is simply to maintain its value through indexing.
    Again, we appreciate the Committee's leadership in deposit 
insurance reform. I look forward to working with you to get 
this job accomplished.
    Thank you.
    Chairman Shelby. Comptroller Hawke.

                STATEMENT OF JOHN D. HAWKE, JR.

                  COMPTROLLER OF THE CURRENCY

                U.S. DEPARTMENT OF THE TREASURY

    Mr. Hawke. Chairman Shelby and Members of the Committee, I 
am very pleased to have this opportunity to present the views 
of the Office of the Comptroller of the Currency on deposit 
insurance reform.
    For almost 70 years, Federal deposit insurance has been one 
of the cornerstones of our Nation's economic and financial 
stability. Federal deposit insurance restored public confidence 
in the banking system after the Great Depression and made it 
possible for the United States to weather subsequent banking 
crises with minimum disruption to our economy.
    Nonetheless, our current deposit insurance structure is 
flawed. Some of these flaws date to the inception of the 
deposit insurance system. Others have been introduced over the 
years, sometimes with the best of intentions. For example, 
legislation adopted in response to the banking and thrift 
crises of the 1980's and the early 1990's has had the effect of 
preventing the FDIC from taking what it had reason to believe 
were sensible and necessary actions. Due in large part to those 
statutory restrictions, the FDIC cannot price deposit insurance 
in a way that accurately reflects the risks posed by different 
depository institutions and avoids the need for sharp increases 
in premiums if a fund experiences significant losses.
    The Office of the Comptroller of the Currency believes that 
the FDIC should be free to set risk-based premiums for all 
insured institutions. Currently, it is prohibited from charging 
premiums to roughly 91 percent of all insured depository 
institutions. Deposit insurance pricing should create an 
incentive for good management by rewarding institutions that 
pose a low risk to the insurance funds. A system in which the 
vast majority of institutions pay no insurance premium does not 
do that.
    Under our current system, most institutions pay no premiums 
when the funds are well-capitalized. If a fund falls below the 
designated reserve ratio of 1.25 percent of insured deposits, 
the FDIC may be required to charge an assessment rate of at 
least 23 basis points. This sharp rise in premiums is most 
likely to take effect when banks can least afford it--during an 
economic downturn. To avoid this situation, the FDIC should be 
given the authority to 
establish a range for the DRR and to rebuild a fund gradually 
if its balance falls below the bottom of the range.
    If a fund exceeds the upper boundary of the range, the FDIC 
should be authorized to pay rebates or to grant credits against 
future premiums. However, any arrangement for rebates or 
credits should reflect the fact that not all insured 
institutions receive the same services for their deposit 
insurance dollars. The FDIC uses deposit insurance funds to 
offset the cost of supervising State-chartered banks. It would 
be unconscionable in our view for the FDIC to issue credits or 
rebates to all banks without first taking into 
account the subsidy it provides to State-chartered banks, 
provided in large part by national banks.
    Finally, the BIF and SAIF should be merged. There is 
already significant overlap in the types of institutions 
insured by the two funds, and a combined fund would provide 
even greater diversification. Moreover, under the current 
structure, the 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. 
Deposit insurance premiums should be based on the degree of 
risk posed by an institution and not on which fund happens to 
insure a particular institution's deposits.
    Thank you, and I would be glad to address your questions.
    Chairman Shelby. Mr. Gilleran.

                 STATEMENT OF JAMES E. GILLERAN

             DIRECTOR, OFFICE OF THRIFT SUPERVISION

                U.S. DEPARTMENT OF THE TREASURY

    Mr. Gilleran. Mr. Chairman and Members of the Committee, it 
is a pleasure to be with you this morning.
    I would ask that my written statement be placed in the 
record.
    Chairman Shelby. Without objection, it will become part of 
the record in its entirety.
    Mr. Gilleran. In order to get to the questions more 
quickly, just let me say that we too support the merger of the 
funds as being a more logical way in terms of having the same 
assessment charge for like institutions and like condition. And 
we think that the fund will be much safer merged than separate.
    Separately, we are in favor of giving the FDIC more 
flexibility in setting the total reserves and in the method of 
assessment.
    Thank you very much. It is a pleasure to be here.
    Chairman Shelby. Thank you.
    Chairman Greenspan, from an economist's perspective, what 
are the macroeconomic issues involved in the so-called 
procyclical nature of the current system?
    Chairman Greenspan. Well, Mr. Chairman, as you know, if the 
designated reserve ratio was, say, at a fixed point currently 
in the area of 1.25, then one would presume that you would get 
rebates as the economy is rising when the banks do not need 
them.
    Chairman Shelby. At the wrong time.
    Chairman Greenspan. You would get increased premiums as the 
economy was going down at exactly the wrong time.
    And I think the general notion of creating significant 
flexibility on the part of the FDIC to manage that process is 
one of the more important parts of this prospective 
legislation.
    Chairman Shelby. Thank you, Mr. Chairman. Do you have any 
comments, Secretary Fisher?
    Mr. Fisher. [Nods in the negative.]
    Chairman Shelby. Chairman Powell, the FDIC currently 
operates under legal requirements that are quite rigid, to say 
the least. Can you expand on your testimony regarding the 
benefits of a more flexible system? What would a more flexible 
system give you?
    Chairman Powell. It would alleviate exactly what Chairman 
Greenspan just mentioned a moment ago, that is the primary 
focus. But we would operate much like the private sector also.
    Let me emphasize that part of the whole notion of deposit 
insurance reform is based upon risk-based premiums. But to 
answer your question directly, it would be exactly the 
flexibility that Chairman Greenspan mentioned.
    Chairman Shelby. Chairman Greenspan, you mentioned this 
earlier, but just to expand a little. In discussing coverage 
increases, it seems the proposals involve providing a marginal 
benefit of convenience to a select number of depositors while 
consequentially increasing the potential exposure or risk of 
all taxpayers. Is that how you conceptualize that?
    Chairman Greenspan. Yes. Mr. Chairman, I think it is 
probably worthwhile to think in terms of the fact that there is 
not a $100,000 ceiling that exists for depositors because if 
you choose to go higher, with a little effort, and perhaps a 
little cost, you can expand it. And indeed, it is quite 
possible, for example, for a family of four to have, under 
extreme conditions, $2 million worth of deposit insurance at a 
single bank.
    This is probably not a bad structure in that regard in the 
sense that, hopefully, we stay at $100,000, but recognize that 
as the improved capacity of getting multiple accounts occurs, 
what we are 
effectively doing is setting up a system in which those who 
really perceive the need for increased coverage on their 
deposits would pay a modest fee to do it, which is effectively 
the cost of either taking on multiple deposits in an individual 
bank, or going to other banks. And it strikes me, instead of 
having a strict cut-off point, from an economic point of view, 
having a structure as it stands now, has a certain sensibleness 
to it.
    Now, we do not approve of multiple deposits on the grounds 
that we think it is not necessary. But if you are going to have 
a system such as we have, thinking of it in terms of solely of 
the $100,000 limit, in my judgment, is to misunderstand what, 
in fact, the form and scope of the protection is for American 
depositors.
    Chairman Shelby. Secretary Fisher, along the same lines, if 
we were to, and I hope we won't, increasing taxpayer exposure, 
we must be getting something for it. The theory would be we 
would be getting something for it. Is there such a beneficial 
trade-off involved here? If there is, I haven't found it.
    Mr. Fisher. No. I think as I said last year before the 
Committee, it looks like an ephemeral benefit to me. It is 
really just this illusion that it is a convenience factor, and 
maybe modest fees, but very modest, as Chairman Greenspan was 
saying, that savers simply can get more coverage if they desire 
it. So it strikes us that there really is no benefit to the 
consumer, but there is an added risk for the taxpayer.
    Chairman Shelby. Thank you.
    Senator Stabenow, I believe you are the only Democrat that 
is still here.
    Senator Stabenow. Thank you, Mr. Chairman.
    I am wondering if our witnesses might respond to an article 
in the February 19, American Banker that indicated, a survey by 
Synergistics Research Corporation that found that three-fourths 
of the people who bought an annuity through a bank or a credit 
union thought that the annuity was insured like a bank account 
and covered by the FDIC.
    I am wondering if you might respond to that and what might 
be done--it was quite astounding, I thought, that three-fourths 
of those who are investing in annuities believed, in fact, that 
they were covered in the same way. So, Chairman Powell, if you 
could respond, would have any thoughts in terms of addressing 
this confusion on behalf of consumers.
    Chairman Powell. I think it is unfortunate. I think most 
banks do a good job in attempting to make sure that they 
distinguish between what is FDIC insured and what is not FDIC 
insured. But we can do better, from an education standpoint. I 
think we as regulators need to be sure, through the examination 
process, that the literature is clear, that consumers are told 
if a product is not FDIC insured. And hopefully, that survey 
will be better as time goes by.
    Senator Stabenow. Okay. Does anyone else want to respond?
    Mr. Gilleran. It has been my experience, Senator, that 
financial institutions try very hard to separate the deposit-
taking areas from the areas that are selling nondeposit-insured 
products. This is of great concern. I believe on our 
examinations, that we see that the institutions are trying very 
hard to communicate this difference. But this is something that 
we should always emphasize our continued surveillance of, 
because it is important that the consumer knows the difference.
    Senator Stabenow. On a very different topic, given the 
difficult economic times that we have experienced in the last 2 
years, the downturn, obviously, in the economy and in the stock 
market, a lot of people have been leery about investing in 
high-risk, high-yield investments.
    I am wondering if any of you could speak to the observation 
that people are moving to FDIC-insured accounts over other 
places in which they are investing their money. And if the 
economy continues to stall, if in fact that is true, that 
people are moving to FDIC-insured accounts, would this have any 
significant effect on the capitalization of the insurance 
funds?
    Chairman Greenspan.
    Chairman Greenspan. Senator, I think you are pointing out 
an issue which is fairly pronounced in the most recent period 
in the sense that various deposit accounts have gone up 
considerably. We do not have actual data on where those monies 
are coming from, but it is fairly evident that a significant 
part of the acceleration of deposits has been coming from 
accounts which have previously been committed to the stock 
market, and probably to other investments of high volatility as 
well.
    Senator Stabenow. Chairman Powell.
    Chairman Powell. I do not see any undue pressure, though, 
on the funds. However, I think what we are experiencing is a 
flight to safety and if, in fact, deposits are increasing in 
commercial banks, it is just another reason for deposit 
insurance reform--to merge the two funds because the 
combination of the two funds will be much stronger together 
than separate. It is also important to look at some of these 
other issues of deposit insurance.
    Senator Stabenow. Mr. Fisher.
    Mr. Fisher. I think it is worth noting that even without 
the equity market events of the last couple of years, as we 
move to lower and more predictable inflation, the deposit-
taking franchise of our banking system is really quite healthy.
    Obviously, there has been an acceleration that maybe we can 
find in the data that Chairman Greenspan alluded to. However, I 
think the demise of the deposit-taking franchise has perhaps 
been overstated.
    Senator Stabenow. Okay.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Enzi.
    Senator Enzi. Thank you, Mr. Chairman. I want to probe just 
a little bit more on increasing the coverage.
    I am from Wyoming. Our biggest city is 52,752 people. That 
is the biggest city in 96,000 square miles. Of course, we call 
anything a city with a 3,500 population or above. And many of 
those are as far as 100 miles from another town. They may have 
one, maybe two financial institutions in the town. The towns 
feel a little more secure keeping their money in town. When the 
towns are spending money, they are drawing warrants against 
those banks which are, in essence, loans, which when I was 
Mayor, I found out that they had to meet loan requirements as 
well. We almost created a banking crisis building a little 
water system.
    But I know from the last banking difficulties that we had, 
that people thought that they could have multiple accounts and 
be insured. But they weren't, and they lost money that way.
    So, I am getting a lot of questions from people at home as 
to why, if we are going to go to a premium system that is truly 
risk-based, why can't there be an increase in the coverage that 
is provided at the same time, so that people can put more money 
in a single bank in a single account and still feel secure with 
it?
    We are talking about the stability, the security, the 
perception that people have of the banking industry. And they 
are not inclined to try and beat the system by doing multiple 
accounts.
    I am interested in what you think about municipal coverage, 
what you think about retirement coverage, and of course, the 
individual one is important, too. But I think you have all 
expressed something on the individual level. So if you could 
give me some kind of an idea of whether you would consider 
coverage increases for retirement or for municipal accounts.
    I will start with Chairman Powell.
    Chairman Powell. On the retirement accounts, Senator, I 
think they are uniquely important, consistent with the existing 
Government policies that encourages one to save for retirement. 
The FDIC would support an increase in the requirement accounts.
    We do not support increasing coverage for municipal 
deposits. Most commercial banks in most States are required by 
law to securitize those municipal deposits. Thus, the deposit 
is safe. And I think that system has worked very well. That is 
not to say that the FDIC would not be willing to study any 
proposals that would increase the municipal deposit coverage 
for additional fees. But our position today is that we oppose 
that.
    Senator Enzi. Mr. Greenspan.
    Chairman Greenspan. Senator, if the deposit insurance fund 
were truly, fully, a risk-based insurance system in which 
premiums actually directly related to the underlying risks, 
there shouldn't be any coverage limit at all.
    In other words, if, in effect, what is being sold is 
properly priced, then limiting the amount that there should be 
makes no sense, any more than a grocer saying, I won't sell 
more than a dozen apples to you.
    The reason there are limits is the fact that, of necessity, 
the Federal Deposit Insurance System is subsidized. It really 
cannot be otherwise because if you actually impose the premiums 
which truly would be required in a private system to guarantee 
those deposits, no one could afford to pay those premiums.
    And the reason is that, while we call this an insurance 
system, it is really a guarantee system. There is a small 
probability of huge losses because the default of banks, one 
versus another, is not an independent event like, say, life 
insurance.
    There is a very high probability that if you have a major 
systemic problem, the vast majority of banks would be in 
difficulty as they were during the Great Depression.
    You cannot really get full insurance. So that there has to 
be a limit of some form.
    On the retirement account, our data show that the vast 
majority of retirement accounts are well below $100,000. Those 
that are not are the few very large deposits. And the only 
people who, in my judgment, would be helped by a significant 
increase in the coverage limit on, say, IRA's and Kehoes would 
be our very wealthy depositors and those with exceptionally 
high incomes, who shouldn't need it, and certainly have other 
means of protecting themselves.
    The type of problem that you have in Wyoming is a problem, 
I do not deny that. And I think your banks are raising 
important questions.
    There is always the possibility for those who have more 
than $100,000, to buy Treasury bills or other guarantees which 
may give them slightly less interest, but it really is a slight 
difference, and in today's environment, hardly anything.
    So that there are alternate means of protection. And I 
doubt very much if we should make major changes in the overall 
depository system and the insurance system to effectively come 
at a problem which unquestionably exists, but is resolvable in 
another manner.
    My own judgment is that if there is a real need, that means 
will come to those markets to help solve it. But I do not deny 
that when you have a small town, small banks, that there is an 
issue here. If there were a way to handle it in another way, I 
would sense that would be the way to do it.
    Senator Enzi. I see that my time has expired. I will submit 
some written questions so that I can get additional answers.
    I would like to mention, though, that Gillette, Wyoming, is 
also a mining area. We have a lot of blue collar workers that 
work at the mine. They are paid well. And their retirement 
accounts sometimes now are in excess of a million dollars.
    Chairman Shelby. Any job openings there?
    [Laughter.]
    Senator Enzi. They are kind of curious about that.
    Thank you.
    Chairman Shelby. Senator Miller.
    Senator Miller. Continuing along the line of small town 
banks, I would like to address this question to Mr. Fisher. But 
if Chairman Powell wants to jump in, I would appreciate that as 
well.
    I am concerned what the cost will be to community banks of 
my State if the deposit insurance is raised. One of my bankers 
back home told me this last weekend, that some way or another, 
he went into the FDIC website. He had calculated what he 
thought it would cost his bank if the coverage level was 
increased. And he said that it would cost his bank about 
$89,000 to raise it, and that that was about the salary for a 
full-time employee at his bank. You can imagine that he is not 
anxious to increase his insurance coverage if it is going to 
cost him a full-time employee.
    I guess my question is, are you aware of other costs to the 
community banks of this Nation, of my State, of increasing 
coverage?
    Mr. Fisher. I think for the direct cost that perhaps 
Chairman Powell can speak more directly to, clearly, there will 
be increased premium costs if coverage increases are raised, 
and they will have to be passed on directly to banks. There may 
be some dynamic effects if there are going to be added deposits 
that may make those even higher. Certainly, there is going to 
be a direct cost there.
    In terms of the other costs that concern me the most, 
actually, it is some of the perverse incentives that I fear 
might be set up by the proposal on municipal deposits.
    Small, well-run, local-managed banks actually won't be 
benefited, I fear. But they will be put in the condition of 
having to compete by raising the rates against weaker banks 
elsewhere in a State who might be trying to attract the larger 
deposits of municipalities and States.
    I think it sets up some perverse incentives in our banking 
system. It sets up really perverse incentives for the 
custodians of State and municipal funds to look around and shop 
around for higher rates. We are sending them conflicting 
messages.
    The current system gives them more of a focus on security 
of their funds, which I think is more appropriate.
    Mr. Hawke. Senator, if I may address that question, as 
well.
    Senator Miller. Sure.
    Mr. Hawke. Another potential cost for community banks is 
the potential loss of deposits, notwithstanding an increase in 
coverage. It is not at all clear who the winners and losers are 
going to be if deposit insurance coverage is increased by a 
substantial amount. For one thing, it will increase the ability 
of very large, aggressive banks to offer larger volumes of 
insured deposits, and funds may flow out of small banks rather 
than into small banks as a consequence of that. So there is no 
really good factual information about what the consequences of 
an increase in deposit insurance coverage would be.
    Mr. Gilleran. Senator, before coming here, I ran a 
community bank in San Francisco. One of my surprises is the 
fact that since being here 14 months, not one community bank or 
thrift has come forward and requested in any substantial way an 
increase in coverage because they do not believe that they will 
receive more deposits because of it and because of the 
competition that they have. And in addition to that, it will 
increase their costs.
    So one of my big surprises is that I have not seen the 
support from the banks themselves for it.
    Senator Miller. Mr. Powell, do you want to get in on that?
    Chairman Powell. Sure. Senator, I want to be sure that 
everybody understands what we are proposing at the FDIC. We are 
not proposing to increase coverage. We are proposing to index 
coverage.
    To answer your question directly, if the funds are merged, 
if this bill goes through and Congress approves it, the reserve 
ratio would be right at 1.28.
    If deposit insurance coverage increased by $30,000 to 
$130,000, and if retirement accounts increased up to $250,000, 
the cost would be something like $335 million per basis point, 
and the fund would be impacted by 4.4 basis points. That does 
not necessarily trigger additional premiums to the industry 
because the fund would be within the range. Potentially, 
obviously, it could increase premiums to the industry.
    Senator Miller. I thank the panelists. I have another 
question, Mr. Chairman, but I will just submit it.
    Chairman Shelby. Thank you, sir.
    Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman. I want to be the 
first to congratulate the Chairman on his presumed lifetime 
tenure. For a second, I thought you were going to be nominated 
to the Supreme Court by the Senator from New York.
    [Laughter.]
    In your testimony, you talk about raising the ceiling and 
the concern that it would extend the safety net, increase the 
Government subsidy, expand moral hazard, reduce the incentive 
for market discipline, all without providing any clear public 
benefit. Do you have anything good to say about raising the 
ceiling?
    Chairman Greenspan. Senator, I am hard pressed.
    [Laughter.]
    Senator Sununu. Mr. Fisher.
    [Laughter.]
    You shouldn't feel the need. I have found that when I ask 
you questions and you answer my questions, my phone starts 
ringing. So feel free to leave your answer at that, if you are 
comfortable with it.
    Let me ask Mr. Fisher, though, about the last piece there, 
the concern you have about reducing the incentive for market 
discipline. When that incentive is reduced, what does that do 
to the cost of regulation?
    I do not know that you addressed it in your testimony, but 
if there is less incentive out there for pure market 
discipline, does that force us as policymakers or you as an 
organization looking at regulation and regulatory costs to 
incur additional costs to compensate for the loss of market 
discipline?
    Mr. Fisher. Yes, it certainly does, and I think it would 
add to the burden of the bank regulators and supervisory 
functions of my colleagues here on the panel, yes.
    Senator Sununu. Have you tried to quantify that to make any 
specific assessment of how you might have to react?
    Mr. Fisher. No. I think I would be hard pressed to put a 
number on that. Ten or 15 years ago, we have made a lot of 
improvements in the bank supervisory process. We are happy to 
have those.
    I think, though, if we set up some perverse incentives over 
the next 10 years, we find that we have to go back to the mill 
and work on new improvements in the supervisory process.
    Senator Sununu. Yes, go ahead.
    Mr. Gilleran. In response to your question, Senator, in the 
interest of fairness, I have to say, as a former community 
banker, that there are those banks who would be aided. There is 
no question about that. And there are those circumstances where 
you would have a customer who would keep more money with you if 
you were to raise the ceilings. But the problem is, in the 
overall, taking all banks into consideration, that there 
doesn't seem to be enough benefit to increase the cost.
    Senator Sununu. And on that point, though, maybe I should 
ask Mr. Hawke. The general health of the community banking 
system, the smaller banks--and I can speak with anecdotal 
experience in New Hampshire--but could you quantify or attempt 
to quantify the overall health of smaller banks across the 
country?
    Mr. Hawke. I think that the smaller banks are really in 
quite good condition. They are generally better capitalized, 
frankly, than the larger banks.
    Senator Sununu. So although the statement that there may be 
banks that are assisted by raising the cap, where you might 
find specific cases? Is it fair to say that the small banks 
haven't been harmed, collectively, by having a $100,000 cap in 
place?
    Mr. Hawke. I do not think they have been harmed. The point 
I was making was that nobody knows who the winners and losers 
are going to be. Certainly, if coverage were increased, there 
would be some banks who would be able to offer a particular 
customer a higher level of coverage. But there will be another 
bank down the street who will lose a depositor because of the 
move. And until the dust settles and the comings and goings are 
all measured, it is impossible to tell who the winners and 
losers are going to be.
    Senator Sununu. Mr. Chairman.
    Chairman Greenspan. Senator, the Federal Reserve has 
concluded that we can find no problem that an increase in 
coverage is designed to solve. We observe a very viable 
community banking industry. That is not to say that we would 
remain silent in the event that we find that problems do 
arise--because remember, the real value of deposit insurance is 
going down.
    At some point, it will erode to a point where I think it is 
probably wise to address it. It is our view that we are not 
anywhere near that point as yet.
    We do not deny that at some point, you have to either index 
it or raise it because certain problems could arise as a 
consequence of having inadequate coverage. But we are nowhere 
near there.
    Senator Sununu. What is the most significant problem that 
could occur if it goes too low, in the extreme? Just lack of 
confidence? Is that a consumer confidence issue? Is it some 
other systematic risk?
    Chairman Greenspan. The real danger is that we get to a 
level where, in the event of a financial crisis, that consumers 
or depositors would feel sufficiently insecure that we would 
find the equivalent of bank runs occurring similar to those 
which occurred in the 1930's. But we are nowhere near that 
point from any measure that I can see.
    Senator Sununu. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Johnson.

                COMMENTS OF SENATOR TIM JOHNSON

    Senator Johnson. Let me direct this to the non-FDIC 
regulators, whichever of you choose to respond.
    Several of you noted your concern that the current risk-
pricing system places 91 percent of all insured depositories in 
the same system, although not all of these banks and thrifts 
actually pose the same level of risk to the system. It appears 
that all of you support giving the FDIC additional flexibility 
in determining a risk-based pricing system.
    Do you believe that the FDIC has the appropriate knowledge 
about the institutions you regulate to rate the risk of a given 
institution? And do you believe that your agency should play a 
role in evaluating those risks?
    Mr. Hawke. I think that, working together, the FDIC and the 
other primary regulators can come up with an appropriate 
assessment of the risks of the banks that the FDIC insures and 
that we supervise.
    Senator Johnson. Mr. Gilleran.
    Mr. Gilleran. Since Comptroller Hawke and I both serve on 
the FDIC Board, I can say that the working together of the 
primary regulators and the insurer has been excellent and that 
each one of us in our evaluation of the institutions that we 
regulate, we grade them in terms of how they stand within the 
CAMEL's rating system. So the evaluations of the institutions 
are very clear. And therefore, the FDIC has all the information 
they need to do this.
    Senator Johnson. Mr. Greenspan.
    Chairman Greenspan. I agree with that, and I would also 
like to point out that there is an increasing amount of market 
available information which would assist the FDIC in 
calibrating various different risk assessments and premiums.
    We have, obviously, debentures issued by a number of 
institutions. And very recently, there is the evolution of the 
credit derivative default swap market which is giving a market 
sense of what these various risks are.
    So I think, with the combination of the data the FDIC has 
and the primary regulators have, that the FDIC has more than 
enough information to, at least, get a rough calibration of 
what the differential risks are. And that is as good as you can 
do and it is very helpful, in my view.
    Senator Johnson. Mr. Greenspan, in your testimony, you 
emphasized the importance of calibrating the risk-based pricing 
system to force institutions to internalize a more appropriate 
percentage of their actual cost to the deposit insurance funds.
    You noted that the current system where most banks receive 
the same risk rating clearly forces some institutions to 
subsidize other institutions' deposit insurance.
    One reform proposal includes a provision that would cap 
allowable premiums to the most highly rated institutions at one 
basis point regardless of economic conditions. Some have argued 
that such a cap merely shifts the point of subsidy to a smaller 
category of financial institutions, but clearly undermines the 
fundamental reform proposal. Would you please comment on the 
one-basis-point cap proposal?
    Chairman Greenspan. Well, all I would say with respect to 
that is that, if you take the few large institutions, for which 
there is an active market in credit derivative default swaps, 
you will find that one basis point is a very small fraction of 
what the private market's estimate of potential risks of those 
institutions is.
    Senator Johnson. Mr. Fisher, in your testimony from last 
April, you express support for the FDIC's recommendation that 
you have authority to manage the reserve ratio within a range. 
You noted that it is logical to provide for reserve growth 
above 1.25 percent when conditions are good, and for reserves 
to decline below that level when conditions are unfavorable.
    Chairman Greenspan has noted that the FDIC's suggested 
target reserve range be widened in order to reduce the need to 
change premiums abruptly.
    Do you still believe that a range should extend below the 
current designated reserve ratio? And if not, would you please 
provide a rationale for your current thoughts on this issue?
    Mr. Fisher. Certainly, Senator Johnson. Thank you for 
asking that question.
    I think experience teaches us that if the reserve ratio 
moves much below the current 1.25, now, I do not want to put a 
fine point on that, but if you look back to 1934, and if it 
moves below that, it is not going to be stable. This is not a 
question of logic. It is a matter of experience of over 70 
years.
    I can support a modest movement below the current level of 
the designated reserve ratio. But much below that, you find 
that it accelerates and we get into the pickle we were in in 
the early 1990's.
    We do see room for it to grow on the upside, a modest 
movement below the current level, but not much wider than a 
modest movement below, does seem to us to be appropriate.
    Senator Johnson. My time is expired. Thank you very much, 
Mr. Chairman.
    Chairman Shelby. Thank you, Senator Johnson.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    In trying to evaluate the risk of a bank, I am thinking of 
an instance, somebody wants to start a bank. He has no past 
history, no past performance. How does a banker get into the 
market? It seems to me that we run a potential here of making 
it difficult for new banks to get into the market. By doing 
that, you begin to reduce competition in the market.
    I am wondering if the members of the panel would care to 
comment on that. How do you assess risk? I think the natural 
reaction is that when you assess--when somebody's starting a 
bank, they are riskier.
    Mr. Hawke. Senator Allard, by the same token, when a bank 
is chartered, and we charter banks all the time, the initial 
capital that is required of the bank is generally calculated to 
cover anticipated deposit growth over a 3-year period. So 
capital is kind of front-end loaded in the chartering process. 
And by the time a bank is up and running, the examiners are in 
there and they are able to make a pretty good assessment of the 
risk as the bank undertakes its business.
    Senator Allard. You do not believe that that would increase 
the capital requirements of the bank because it is just 
starting, or increase the insurance rates because it is just 
starting?
    Mr. Hawke. The capital is taken into account when the 
charter is issued. I think that it remains to be seen how the 
FDIC would calculate the premiums for a newly chartered bank.
    Chairman Powell. Senator, I do not think there would be any 
burden--I should not say burden--any discrimination to a start-
up bank versus an existing bank. I think the premiums would be 
based upon lots of factors--capital, management, and other 
factors. But I do not think that there would be any 
discrimination.
    Mr. Gilleran. Senator, the capital-setting for a new bank 
takes into consideration where that new financial institution 
is going to be headquartered, a small town or a major city. 
Therefore, the capital levels are flexible that are set between 
the bankers that are proposing the bank and the regulator based 
upon how large you have to grow in order to be profitable in 
the environment that you are in.
    So that a bank proposed for a large city, you would expect 
it to have a larger capitalization than in a smaller community. 
And in the process of setting that capital, you would also take 
into consideration the fact that for the first 3 years, 
generally, that the bank would be in a loss position as it is 
growing its deposit base. The capital does take into 
consideration the growth required to get you up to the point of 
profitability.
    Senator Allard. We seem to have a disagreement between the 
large banks and the small banks as to whether we increase the 
amount that we insure.
    Isn't it true that large banks rely on a too-big-to-fail 
attitude? In the State of Colorado, we have had both industrial 
banks and small savings banks fail. And it seems like there are 
two phenomena contributing to those failures.
    One is that depositors, who thought that they had multiple 
accounts, all of a sudden find out that they are not covered 
because they have several accounts in their name in one way or 
another.
    Then the big banks said, you cannot apply the same 
standards to us because we are too-big-to-fail and if you let 
us fail, the economy is going to be just that much worse and 
you will get yourself in a box.
    I wonder if you could comment about that.
    Mr. Gilleran. Well, I would like to comment on it. I would 
like to say that it is clear that in the community banking 
system, they believe that too-big-to-fail exists. However, I 
personally believe that there is no bank that is too-big-to-
fail. And if a bank does get themselves into trouble, that they 
will be closed no matter what their size is, and the 
stockholders will lose their investment.
    I have to say that in reaction to Senator Sununu's question 
about is there anything good about increasing coverage and what 
would happen if we did not have coverage, is that the coverage 
I believe really supports the continuation of the community 
banking system in this country, which I think is very highly 
prized and very highly regarded.
    We must have a deposit insurance coverage level that is 
adequate to make sure that the community banking system can 
attract deposits. So the deposit level supports the community 
banking system very much. However, I think $100,000 is 
completely enough to do that at this time.
    But in answer to your question, I think that the too-big-
to-fail is something that relates more to the fact that there 
is an inherent risk in a larger bank closing because of the 
fact that many of the smaller banks have their overnight money 
on deposit with them.
    So, therefore, those situations will have to be resolved by 
the FDIC in cooperation with the Treasury. But too-big-to-fail 
is a misnomer. They will fail if they have to.
    Senator Allard. Chairman Greenspan.
    Chairman Greenspan. I agree that there is no such concept 
as too-big-to-fail. What there is, however, is a concept that 
very large institution will be liquidated slowly. That is, the 
shareholders will be out immediately. Management can be 
changed.
    The only possibility that can exist is that the need to 
prevent the types of problem which Chairman Gilleran is 
suggesting, to prevent those, is there is no need to liquidate 
very rapidly, and indeed, we probably would not want that to 
happen. But at the end of the day, they will get liquidated.
    So the time issue is the question here, not whether an 
institution is not too-big-to-fail. It will just fail more 
slowly. But at the end of the day, it will fail.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Dodd.

            STATEMENT OF SENATOR CHRISTOPHER J. DODD

    Senator Dodd. Thank you, Mr. Chairman, and I want to thank 
our witnesses.
    I apologize for getting over here late. But as I told the 
Chairman, we were dealing in the Rules Committee----
    Chairman Shelby. They had important business.
    Senator Dodd. We were dealing in the Rules Committee with 
the budgets of the various committees in the Congress. And I am 
pleased to announce to you, Mr. Chairman, that you have a 
budget for this year.
    Chairman Shelby. Very important.
    [Laughter.]
    Senator Dodd. I know that is of primary importance.
    I am sorry I was not here for the opening statements. But I 
want to thank you, Mr. Chairman. This is the second hearing we 
have held on this subject matter. We had one in the last 
Congress, on this very, very important issue--reforms in the 
Federal Deposit Insurance System.
    I want to thank the regulators here for their diligent 
work. This is not the most exciting subject matter, except for 
those who are directly interested in it, but a critically 
important issue. I also want to thank Senator Tim Johnson, who 
is now the Ranking Member of the Subcommittee for Financial 
Institutions, for his leadership in this area, which has been 
tremendously important.
    I appreciate, Peter, your comments a few moments ago. I 
tried to look over the Committee Membership here and I think 
that, with the exception of just a handful of us who were 
around here in the late 1980's or early 1990's, when we tried 
dealing with the subject matter of the crisis at hand and the 
structural reforms that went along with them, was not the ideal 
environment in which to be legislating. This was a very, very 
difficult time, as Senator Shelby and Senator Sarbanes will 
recall. Senator Bennett, I think you were here as well at the 
time.
    Senator Bennett. Just barely.
    Senator Dodd. It was just tremendously difficult. So it is 
very important that we are doing this proactively ahead of time 
and talking about this, rather than from some event or events 
that could cause us to have to rush back here. So, I thank you 
for all of that. It is tremendously important to be doing it.
    Let me, if I can, because I think a lot of the questions 
here have been covered on this subject matter. But I would like 
to raise with Peter, and you, Mr. Chairman, this consumer 
confidence issue. It is a little bit off subject, obviously, 
but it relates in many ways because what we are talking about 
does hinge on the consumer confidence issues.
    I wonder if you just might share some thoughts with us here 
this morning. We are seeing now these reports of the index 
sinking to 64 from a high of almost 79--not a high, but where 
it was in January. The lowest level since 1993 was reported, a 
17 point drop, was the largest one in September. This was I 
think 13, 14 points, whatever that number is.
    Unemployment rates are going up. Equity markets--I do not 
need to tell you. You all are familiar with this stuff. I 
wonder if you might share with the Committee, in addition to 
the good work being done here on the Federal Deposit Insurance 
System, any thoughts you have this morning on the consumer 
confidence issues and what steps may be taken.
    Peter, maybe you can begin. I see you looking at Alan. That 
is not going to work.
    [Laughter.]
    We are going to start with you, if we can. As I say, it is 
a little off the subject matter, but not entirely, given the 
consumer confidence issues related to the FDIC system. So, I 
cannot have you here and not ask you about this in light of the 
significance of this report.
    Mr. Fisher. Well, obviously, the report was a jarring 
number as it comes out. One of the reasons it is jarring is 
because we do see modestly a continued pace of consumer 
confidence as expressed in their acquisitions of housing and of 
major durable items in the 
auto sector.
    It is not accelerating here, but so we do see their 
behavior on big-ticket items at least holding up. But the 
sentiment number took a big swing and obviously is moving.
    I would defer to the Chairman on the overall status of the 
economy. But we do see corporate earnings coming in a little 
better than people had been expecting. We continue to see 
productivity, continue to see the consumers on the big-ticket 
items of housing and autos holding up their demand. Obviously, 
the sentiment number is something to pay attention to and is a 
cause for concern on the economy going forward.
    Senator Dodd. But it wouldn't cause you to adjust or 
rethink any of the major economic items before the Congress 
coming up in the coming months?
    Mr. Fisher. Well, at least to my own thinking, over the 
last 24 hours since the number came out, it seemed to 
underscore the need for us to focus on improving potential 
growth in the economy over the coming 5 to 10 years and really 
focus on that.
    We want to immunize ourselves as best we can against the 
slow and no-growth economies in Europe and Japan. We should be 
doing the best we can to stimulate growth in our economy.
    Senator Dodd. Mr. Chairman, do you have any comments this 
morning on this?
    Chairman Greenspan. Senator, I think our experience has 
always been that consumer confidence indexes tend to be 
affected by events which consumers are acutely aware of, such 
as the dramatic rise in gasoline prices.
    That has had two effects. One, it has been an actual 
constriction in the available cash that households have for 
other things. Their real incomes in that regard have been taxed 
by this fairly significant rise in gasoline prices. But that 
rise in gasoline prices, of course, is related to the pending 
geopolitical issues which have emerged--specifically, the 
issues in Iraq and Venezuelan problems with respect to crude 
oil capacity which have also emerged.
    So it is a very significant decline. But as Peter said, it 
is not a particular surprise. The order of magnitude is 
certainly a surprise, but not the direction in that regard.
    Mr. Gilleran. Senator, I can report that from the thrift 
industry that supports the home industry in America, 2002 is 
the best year that the industry ever had. And that is, of 
course, fueled by the number of refinancings that are going on 
that are supported by low interest rates. However, new home 
sales are also in there. That is a reflection of the consumer 
confidence. So from the homeownership point of view, consumer 
confidence is very high.
    Senator Dodd. Aren't the foreclosure rates pretty high as 
well?
    Mr. Gilleran. They have gone up a little bit in the fourth 
quarter of 2002. Yet, they are within very acceptable limits, 
and as far as the thrifts are concerned, extremely well-covered 
by reserves.
    Senator Dodd. These numbers do not bother you, then?
    Mr. Gilleran. No.
    Senator Dodd. The consumer confidence numbers.
    Mr. Gilleran. Well, I am always concerned about anything 
that affects the consumer because, eventually, if they do lose 
confidence, it will affect homebuying and that will affect the 
housing industry. But I see nothing right now that is evident 
in the thrift business that would indicate that there is any 
downside to the housing business going forward.
    Senator Dodd. My time is up. Thanks.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    Mr. Powell, you want to move from the hard target of 1.25 
percent to a range. Treasury has indicated they think that 
makes some sense. It does sound like a logical policy position 
to go away from a particular hard target if conditions are 
different. You need some flexibility. Help me understand where 
the hard target came from. Who came up with 1.25 percent and 
what was the rationale?
    Chairman Powell. Well, I think the testimony of Chairman 
Greenspan spoke to that at the last hearing.
    Chairman Greenspan. You remember?
    Chairman Powell. Yes, I do remember it.
    [Laughter.]
    Senator Bennett. Have I touched a nerve here?
    [Laughter.]
    Chairman Greenspan. No. I am not sure I am accurate on 
this, but everyone tells me that what I am about to tell you is 
correct.
    [Laughter.]
    There was a meeting at Camp David a little bit more than 10 
years ago.
    Senator Bennett. I remember it.
    Chairman Greenspan. In which a number of people were 
sitting around discussing exactly what the target should be, 
and nobody said anything.
    I looked at the particular type of table which Peter Fisher 
has in front of him which shows the history. Remember, at this 
time, the reserve ratio was very low. I said, well, recent 
history suggests 1.25. And I never considered that that was 
more than just an evaluation of what the recent past would be 
without any notion that that had any significant meaning. But 
no one else apparently had any other number. So it occurred. It 
is no more meaningful than a number that you could pick out of 
the air, frankly.
    Senator Bennett. So, basically, you made it up.
    [Laughter.]
    Chairman Greenspan. No, I did not make it up.
    [Laughter.]
    I just merely looked at what the recent past had been. 
Whether the recent past was right or wrong was not an issue. I 
was interjecting a comment, and I did not expect it to extend 
as far as it apparently did.
    [Laughter.]
    Senator Bennett. That is the way things happen around here. 
I made a comment on the floor that is now being touted as the 
Bennett Solution to the Estrada Problem.
    [Laughter.]
    Well, that would argue, then, would it not, for looking at 
that particular number to see if it should not be reviewed.
    So looking for areas of agreement on the panel, I hear that 
everybody agrees that the BIF and the SAIF should be merged. 
And that is one thing that we could proceed with that is 
virtually noncontroversial.
    Senator Sarbanes. The Reporter should note they all nodded, 
because none of them answered.
    Senator Bennett. All right. And do I perceive then that 
everybody agrees that the FDIC should have a range rather than 
a hard target?
    And again, they are all nodding.
    Basically, the one thing we are arguing about is whether or 
not the level of coverage should be indexed. And the 
Administration and Chairman Greenspan say no. Chairman Powell, 
you say yes. Can I pin down the other two? Are you yeses or 
noes?
    Mr. Gilleran. No.
    Senator Bennett. You are a no.
    Mr. Hawke.
    Mr. Hawke. I do not have a great deal of trouble with 
indexation, but it raises a couple of problems. One is the 
choice of a base year for indexing. And if you go back to the 
original deposit insurance coverage level and index from 1933 
on, you wouldn't come out to $100,000. The other problem is a 
cost problem for banks if indexation results in a change in the 
deposit insurance coverage limit periodically. There are going 
to be costs for banks in changing their signage and 
documentation to deal with that.
    Mr. Gilleran. There is also the communication problem of 
the thrifts I have talked to, in addition to the cost factors 
and the signage changes. The communicating to the depositor 
what the coverage is during the indexing is an additional cost, 
also.
    I was very surprised in all the thrifts I have talked to, 
there was no support for doing that.
    Senator Bennett. All right. We have unanimity on two issues 
and a four-to-one vote on the other. The only issue remaining 
being risk-based premiums. How close are we to unanimity on 
that one? Everybody thinks we should have risk-based premiums?
    Mr. Fisher. I think we all agree in principle. Others can 
speak. And there may be some nuances between us on the details.
    Chairman Shelby. The record should show that everybody is 
nodding in the affirmative.
    Senator Bennett. All right. This strikes me----
    Chairman Greenspan. I also think it is the FDIC which 
should make those judgments.
    Senator Bennett. Okay. Well, this strikes me as one of the 
more unusual circumstances, Mr. Chairman, where we probably can 
legislate without controversy in this area.
    Chairman Powell would be disappointed in the one issue if 
we go with the majority of the panel. But we have an amazing 
unanimity on all of the other issues we have before us.
    Chairman Shelby. Senator Sarbanes.

              COMMENTS OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Mr. Chairman.
    I want to commend you for holding this hearing focusing on 
a very important issue. I also want to acknowledge the strong 
interest and the leadership of Senator Tim Johnson, who Chaired 
the Financial Services Subcommittee in the last Congress and is 
its Ranking Member now. Senator Johnson has held a number of 
Subcommittee hearings on this issue, in addition to a Full 
Committee hearing that was held.
    I have a couple of issues I want to probe with the members 
of the panel and then I want to try to draw Secretary Fisher 
out on a paragraph in his statement.
    First, my understanding is that since 1996, well-
capitalized banks have not been paying any premiums. Is that 
correct?
    Chairman Powell. That is right.
    Senator Sarbanes. Now, as I also understand, a number of 
banks have been founded since 1996, which I guess were founded 
under the arrangements that enabled them to be termed well- 
capitalized. Their depositors got the benefit of this insurance 
and the institution itself got the economic benefit that flows 
from that. They paid no premiums.
    Second, I understand that there have been these sweeps that 
are now taking place, large amounts being swept into the system 
gaining coverage, again without paying any premiums. Am I 
correct in that regard?
    Chairman Powell. [Nods in the affirmative.]
    Senator Sarbanes. How do we address that problem? Where is 
the fairness in institutions having previously paid premiums, 
in some instances, quite substantial, getting the fund up above 
the level. Then you do not charge any more premium for the 
well-capitalized. I want to keep that distinction in all the 
time. And yet, other institutions come in and they pay no 
premiums at all. How do we address that situation in any 
reform?
    Chairman Powell. Senator, I could not help think as you 
were making those comments, I am guilty.
    Senator Sarbanes. I wasn't trying to make you guilty of 
that. I just want to probe the problem.
    Chairman Powell. I know, I chartered a bank 3 years ago and 
we did not pay any premiums. That is what deposit insurance 
reform speaks to as it relates to the so-called free riders. It 
is unfair and it is wrong. All should pay.
    We also believe that all should pay as it relates to risk. 
Approximately, 91 percent of the banks in America do not pay 
today. They are all in the category of well-capitalized and 
well-managed.
    The FDIC believes that we should fine-tune that also and 
that all of the banks that fall into that 91 percent are not 
all equal. Premiums should be based upon risk as we attempt to 
determine what the risk profile of those institutions are.
    Senator Sarbanes. Presumably, all should pay some premiums 
before you start making the risk distinction. Or am I incorrect 
about that?
    Chairman Powell. Absolutely. All should pay, yes, sir.
    Senator Sarbanes. Up to a point, at least. And then beyond 
that, you may make the risk distinction.
    Chairman Powell. Yes.
    Senator Sarbanes. Otherwise, you are still going to have 
some free riders.
    Chairman Powell. Yes, sir. All should pay.
    Senator Sarbanes. How are we going to do that? How will you 
do that?
    Chairman Powell. We are going to pass deposit insurance 
reform that call for all institutions to pay.
    Senator Sarbanes. I want to touch very quickly on the 1.25.
    The ranges that are being talked about are obviously using 
the 1.25 as a working figure, so to speak, because they stay in 
that range. But is there some independent rationale that has 
been worked out as to what the percentage should be? Shouldn't 
we try to arrive at that? Maybe it should be 3 percent. Or 5 
percent. I do not know. What is the rationale that sets what 
the percentage is?
    Let me underscore that with the other question I wanted to 
ask about this too-big-to-fail point. Now that is the mantra. 
We all say that they cannot be too-big-to-fail because the 
system is basically structured that way.
    But I understand that there are eight financial 
institutions, in the BIF which, if they were to fail and lose 
only 25 percent of their assets, so you are down in a fairly 
low range on this premise--and I can work it up with other 
percentages--25 percent of their assets would completely 
consume the FDIC fund. Is that correct?
    I gather with SAIF, it is only one institution at the 25 
percent figure. If you go to 50 percent of the assets, you get 
16 of the BIF institutions and four of the SAIF institutions.
    Now the failure of only one of those institutions on these 
assumptions would completely exhaust the fund. It seems to me 
we are too exposed to the possibility of a one-institution 
failure in that regard. What can we do about that situation?
    One thing, obviously, is you take the percentage up on some 
rationale geared to this so you at least have more money in the 
fund. Another, I do not know how you would work it out, is some 
kind of way of levying some additional assessment on these very 
large institutions to create--it is almost like a reinsurance 
concept. I do not know whether this works, but I am concerned 
about how serious a potential problem you see this as being?
    Anyone who wants to take a crack at that.
    Chairman Powell. Let me make some comments, Senator. You 
are raising, obviously, some complex, very serious issues.
    The first line of defense obviously is a sound banking 
system. And we as regulators I think are keenly aware that to 
the supervision of these institutions, it is very important 
that they remain safe and sound.
    As it relates specifically to the reserve ratio and the 
exposure of these large institutions, you are correct. I think 
a 25 percent loss of the assets of these institutions, it 
covers about eight institutions, would absorb the fund.
    Senator Sarbanes. Right.
    Chairman Powell. I would also indicate that there is 
something like $750 billion of book value of equity in the 
commercial banking industry in America today, and that we can 
assess the industry before going to the taxpayers to cover any 
loss the fund may take.
    Some would say that there is in excess of $200 billion of 
equity in the banking system today. Supervision is extremely 
important so that the scenario you describe doesn't happen. But 
the FDIC can assess the industry to absorb any losses that 
could, in fact, occur if one of these large institutions 
failed.
    Senator Sarbanes. Does anyone else want to address that?
    Alan.
    Chairman Greenspan. Senator, if I may suggest, this is a 
very difficult issue, as I think you are pointing out. It would 
take some time to do an evaluation. And it strikes me that if 
the Senate were to wait for that evaluation to be completed, 
that too much time would go by.
    It may very well be that we should tentatively accept the 
various different ranges, but put into the legislation a 
requirement for study of what the appropriate ratio should be 
for further evaluation by the Congress.
    Senator Sarbanes. Peter.
    Mr. Fisher. If I could add, underscoring that, really. I 
think one of the reasons for some urgency is because the 
banking system is always changing. Even though we look at the 
funds today and we are comfortable with their health and their 
management, it is an extraordinary series of events that our 
financial sector has been through in the last 2 years and it is 
a wonderful outcome that both the commercial banking system and 
the financial system as a whole has been as resilient as it is.
    But given the ongoing changes and concentration in the 
banking industry, we do not want to take that resilience for 
granted. And that is why some of the urgency that some of us 
feel, to fix the roof while it is not raining and get the funds 
merged and do some of the changes that will get the risk-based 
assessment in that most of us, I think we all agree to the 
principles, is why we feel a sense of urgency.
    If I could just add, I think it may have been before you 
came in, Senator, but, really, this is an area where I feel it 
is much as Justice Holmes said--the life of the law is not 
logic but experience.
    If we look back at the experience of the fund from the 
1930's forward, in good times, it was allowed to grow and get 
above critical thresholds.
    After our experience in the early 1990's, we were fixated 
on not letting it drop. I think now we are all in agreement 
that we would like to see it growing in good times because of 
our lack of confidence that we really know the precise number, 
that this is not a problem that can be answered with logic, but 
perhaps with more experience and with more study of what our 
experience has been.
    Senator Sarbanes. Does the range that is in the bill, in 
your judgment, constitute a sufficient margin for growth in 
good times?
    Mr. Fisher. I think at the high end, the figures that are 
in different bills, 1.5 and in that area, look like a good 
margin of growth. However, we may want to study that further, 
given the changes in the industry.
    As I mentioned earlier, I fear that looking back at the 
experience, when we have seen it drop below the current target 
ratio, much below 1.25, below 1.2, we see the acceleration and 
we get into the very awkward situations we were in in the 
1970's and the early 1990's. So, I can see some room for 
flexibility on the downside, but not a great deal.
    Senator Sarbanes. Mr. Chairman, may I make one more point?
    Chairman Shelby. Go ahead, Senator.
    Senator Sarbanes. My time is now up, but would you take a 
look at your prepared statement, Secretary Fisher?
    Mr. Fisher. Yes, sir.
    Senator Sarbanes. In it you say: ``There are other 
important structural issues that need to be addressed sooner or 
later.'' Could you very quickly elaborate with respect to each 
of the next sentences, what it is that you have in mind?
    Mr. Fisher. Well, I want to be clear, I am not suggesting 
here that these are issues that should be resolved in this 
bill, in a bill that we hope Congress moves on. But we think 
that these are issues that are so connected to the subject at 
hand, we wanted to alert the Committee to them and make the 
Committee aware.
    I think if we are looking at the whole structure of deposit 
insurance for the banking sector, we should evaluate to see 
whether there are lessons we have learned from BIF and SAIF 
that should be applied to the National Credit Union Share 
Insurance Fund.
    And so, I think it is just a question, we have had a lot of 
experience and a lot of focus on the BIF and SAIF. We should 
pause here and make sure that we are learning those lessons and 
applying them to the credit union insurance----
    Senator Sarbanes. Well, could you give us a couple of 
examples of what you are thinking of ?
    Mr. Fisher. I think in all the dimensions, the critical 
areas of reform, whether there are adequate reserves, whether 
risk-based premiums are appropriate. I do not want to purport 
that I have delved myself as far as I perhaps should have into 
that subject, but all the dimensions that we have touched on 
today for the deposit insurance funds.
    I think, as Comptroller Hawke has brought up, there is also 
the fee issue, the fee structure. Again, we do not feel that is 
urgent to be in this bill, but it is something that we think 
needs to be addressed, the fee disparity issues between the 
supervisors.
    Senator Sarbanes. All right.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you, Senator Sarbanes.
    Chairman Greenspan, in your testimony, you referred to the 
fact that deposit insurance dampens the effect of the 
disciplinary forces of free markets. Would you elaborate on 
this point and would you comment on the manner in which 
coverage increases would exacerbate this problem?
    Chairman Greenspan. Mr. Chairman, we need only look at the 
history of banking in the United States. And what you find is 
that, say, 1850 or 1860, you needed very high capital ratios in 
order to attract deposits or essentially to get people to hold 
your currency, which you recall was then issued.
    Chairman Shelby. The confidence level.
    Chairman Greenspan. It is wholly a confidence question.
    Chairman Shelby. Sure.
    Chairman Greenspan. If you get to the years prior to 1933, 
you find that the required level of capital to induce people to 
hold your liabilities was a good deal under where it was 75 
years earlier.
    Chairman Shelby. A lot of erosion.
    Chairman Greenspan. Well, because as the system became more 
complex, there was an ability to have lower levels of capital 
in, say, the 1920's than you had in the 1850's because the 
integration of the system was far more impressive by the 
1920's. But the actual level of capital required when deposit 
insurance came in went down, as it should have, largely because 
there is an ability to have a guarantee of a significant part 
of your liabilities.
    It is fairly apparent that while that had a major effect on 
eliminating bank-runs and eliminating a lot of the crisis 
aspects in the financial system, it did lower the discipline 
that occurs of requiring people who hold your liabilities to 
believe they are at risk and, hence, they impose a degree of 
discipline on you, the depository institution; that discipline 
is clearly lessened by the onset of deposit insurance. And as I 
said in my prepared remarks, it is a trade-off.
    Chairman Shelby. Thank you.
    Last year, the controversy surrounding coverage increased 
block reform from advancing. What are the costs or potential 
hazards 
associated with delaying enactment of reform here?
    Secretary Fisher.
    Mr. Fisher. As I mentioned a few minutes ago, Mr. Chairman, 
I think it has been marvelous and really a sight to behold how 
our financial sector has come through the events of the last 2 
years with the extraordinary disruption of wealth that has 
occurred. But that is not something that we can take for 
granted, that our banking system will remain that resilient 
over the coming decade.
    I think the urgency I feel comes out of the continued 
changes in the industry and that we are sitting still in the 
structure and management of the deposit insurance fund, really 
even on the weaknesses that we have identified from the last 
decade. There may be weaknesses that come to the surface over 
the coming decade that we will also need to address. But we 
haven't even yet addressed the backlog. That is my sense of 
urgency. We cannot take the strength of our banking system for 
granted.
    Chairman Shelby. Thank you.
    It seems to me that all of you here have identified 
significant costs and concerns with proposals to increase 
coverage with little or no identifiable offsetting benefit to 
depositors and institutions. At the same time, you have 
identified several key reforms that are beneficial and I 
believe, indeed, necessary.
    Senator Sununu, do you have another question?
    Senator Sununu. Thank you, Mr. Chairman. I have one final 
question about the risk-adjusted premium structure. And it has 
to do with Mr. Fisher's testimony and Mr. Greenspan's 
testimony. I do not know if it is a big distinction.
    I understand that the Chairman believes that the details of 
the system should be developed by the FDIC, and I certainly 
agree. But I did want to try to understand how significant a 
disagreement this is.
    In Chairman Greenspan's testimony, he talks about the 
FDIC's 2001 proposals. There are provisions that are coupled 
with rebates for stronger entities so that when the fund 
approaches the upper end of the target, the rebates go into 
place. And I think the Chairman also says that varying the 
rebates in this way makes considerable sense.
    In Mr. Fisher's testimony, you talk about a proposal to 
apply temporary transition credits against future premiums and 
then you say explicitly, we strongly oppose rebates which would 
drain the 
insurance fund of cash.
    I would like you both to comment on whether this is a 
substantial disagreement, a significant disagreement, or just 
different use of terminology.
    Mr. Fisher. Let me first point out that I think, I would 
separate in my own logic first the risk-based structure. We 
should begin with a risk-based premium structure administered--
--
    Senator Sununu. And it was noted that you were all nodding 
and I think there is strong agreement there.
    Mr. Fisher. That then sets the base for the premiums the 
companies, banks would pay.
    Senator Sununu. Yes.
    Mr. Fisher. Then, in our view, a model both to deal with 
the current free rider problem and with future free riders 
problems. Both have some transition credit systems where in 
individual years, it is imaginable that banks may pay no 
premiums if their credits were larger than their risk-based 
premiums. And we think that is the process going forward to not 
actually drain money out of the fund, which sets up some 
incentives for the banking sector.
    We think it can get to much the same beneficial effect for 
the fund as rebates and avoid some of the draining that would 
set up banks to encourage asking for rebates we would prefer to 
avoid.
    Senator Sununu. Chairman Greenspan, were you aware of the 
credit proposal? And do you make a distinction between a rebate 
system and a credit system?
    Chairman Greenspan. Senator, the difference between us is 
really quite marginal. The reason for it is that there are a 
number of different ways to get to the same end. We both agree 
on where we wish to be, as indeed, I believe the rest of the 
panel agrees.
    This is a relatively minor issue and I suspect that if we 
were all to sit around and try to find in the context of the 
type of structure which the FDIC eventually decided to 
construct, we would all find it very easy to find a mechanism 
that we would all be comfortable with. If this is the only 
disagreement that we have, it is, indeed, de minimus.
    Senator Sununu. I appreciate that. I was struck by it only 
because of the use of the word strongly in your testimony. I 
appreciate, while it may not be a significant difference of 
opinion, I wanted to make sure that it wasn't anything that 
would preclude you from coming to some consensus. And I am 
pleased to say that this seems to be a situation where everyone 
in the room is not 
silent, as the Chairman says, rebates or suggest anything else, 
and that you will be able to reach consensus.
    Thank you.
    Mr. Fisher. If I could just echo.
    Chairman Shelby. Go ahead.
    Mr. Fisher. I would just add to the broad categories that 
we agreed to that Senator Bennett ran us through, addressing 
the whole free rider problem. That is the big umbrella issue 
here and I think we are all in agreement on the need to address 
the free rider problem.
    Senator Sununu. Thank you, Mr. Chairman.
    Chairman Powell. Senator Sununu, we would be on the credit 
versus the rebate side.
    Senator Sununu. Thanks.
    Chairman Shelby. In light of the support that has been 
talked about here, and in consideration that further delay may 
only make reform more difficult, Secretary Fisher, is it 
possible that in conjunction with other regulators, could you 
develop a legislative proposal that incorporates these key 
reform concepts and submit a draft for the Committee's 
consideration? Working with you, that is what we want to do and 
we want to make sure that we do proper reform, make sure that 
it is substantive, make sure that nobody's getting a free ride.
    Mr. Fisher. Mr. Chairman, we would be happy to work with 
you.
    Chairman Shelby. To talk with the staff.
    Mr. Fisher. And all of the members of the panel.
    Chairman Shelby. And the regulators.
    Mr. Fisher. Let me conclude by noting that we respect and 
cherish the independence of each of the four agencies that 
share the panel with me today. And so, we will work with them 
to coordinate putting forward the best areas of agreement that 
we can on the major areas of reform that we have identified.
    Chairman Shelby. Sure. And where you dissent, perhaps. I 
think that will be very minimal. I hope so, anyway.
    Mr. Fisher. That would certainly be for all of us.
    Chairman Shelby. Thank you all for appearing here today and 
we look forward to moving this if we can get something 
together.
    The Committee is adjourned.
    [Whereupon, at 11:40 a.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF SENATOR CHUCK HAGEL
    Thank you, Mr. Chairman, for holding this hearing today. It is an 
important and timely issue that deserves the full attention of this 
Committee and the Congress.
    I appreciate Senator Johnson's leadership on this issue along with 
the work of Senators Enzi and Reed and the support of Senators Allard 
and Stabenow on the Safe and Fair Deposit Insurance Act of 2003.
    Deposit insurance has been the bedrock of our banking system for 
nearly 70 years. It is especially significant to our Nation's community 
banks as the guarantee on deposits gives people confidence that their 
money will be safe.
    The Federal Deposit Insurance Corporation (FDIC) has 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'' perceptual advantage big banks enjoy.
    Increasing coverage levels to $130,000 will help community banks 
raise core 
deposits and allow them to lend more back into farms, small businesses 
and their communities. This rotation of each dollar invested back into 
the community ensures stability. The viability of community banks is 
dependent on deposit insurance. In order to ensure their ability to 
continue serving 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.
    Let me share with you one example of why our community banks need 
coverage level increases:
    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 will not hold accounts above 
the $100,000 limit, and have often left the bank for competitor banks. 
This may be a viable option in Washington or in 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 Bank of 
America or a CitiBank.
    Customers are not well served by having to drive to the next town 
to do their banking, and the Dalton, Nebraska bank loses deposits. 
Raising the coverage level, even a small amount, will allow communities 
to keep more deposits in their banks and expand their lending capacity.
    A 2001 report by the Federal Reserve Bank of Kansas City supported 
this position by stating: ``. . . a path that could help ease community 
bank funding problems is legislative changes in the form of greater 
deposit insurance coverage. . . .'' Such changes have the potential to 
put community banks in a better position to attract and maintain 
deposits.
    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 happen regardless of a slight increase 
in coverage levels, not because of it.
    The proposals we are discussing 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.
                               ----------
               PREPARED STATEMENT OF SENATOR TIM JOHNSON
    Mr. Chairman, thank you for holding today's oversight hearing on 
the Federal 
Deposit Insurance System. I would like to welcome our distinguished 
panel of witnesses, and thank them for their time and for their 
thoughtful testimony. I would note that we are not giving Chairman 
Greenspan much time to catch his breath from the monetary policy 
hearings 2 weeks ago, but we are always pleased to have him here before 
the Senate Banking Committee.
    While the political landscape has undergone significant change 
since we looked at the issue last year, the underlying need for reform 
has not. In fact, the Bank Insurance Fund has dropped back to 1.25 
percent, underscoring the importance of this discussion. I am pleased 
that Chairman Shelby understands the critical nature of these reforms.
    I have worked very hard over the past 2 years with my colleagues, 
in particular Senator Hagel, to focus attention on the need for deposit 
insurance reform. And I am pleased to see a growing consensus around 
many of the proposals contained in S. 229, the Safety Act. Again this 
year, we have significant support for the Safety Act from Members of 
this Committee, including Senators Hagel, Reed, Enzi, Stabenow, and 
Allard. I believe that the absolutely bipartisan support for the Safety 
Act shows the importance of this issue to our financial system.
    If deposit insurance reform does not grab a lot of headlines, that 
means, as a 
general matter, it is working. Many of the reforms that we put in place 
following the S&L crisis, including prompt corrective action system, 
have been effective in reducing claims on the insurance funds. 
Nevertheless, the FDIC has identified some legitimate problems with the 
current system, and we should enact responsible reforms now while the 
system is relatively healthy.
    In fact, the written testimony of today's witnesses highlights 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, the witnesses seem to 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 
these weaknesses.
    I 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 least indexed to keep pace with inflation.
    Now 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.
    In particular, I want to emphasize the importance of indexing 
deposit insurance to inflation. First, the real value of coverage has 
eroded by over half since 1980. Failure to index going forward means 
that the value of coverage will continue to decline, placing our 
community banks at a competitive disadvantage compared to large bank 
holding companies that currently offer more than $100,000. Second, 
failure to index coverage means that the level will remain subject to 
political forces. The strongest opponents of a coverage adjustment 
point to 1980, and say that the system should not have permitted a 
sudden increase in coverage from $40,000 to $100,000. I would respond 
that if we index coverage, we take the matter out of the political 
arena, and put it on auto-pilot. This is a common sense reform, and I 
believe that it should be a prerequisite for any final reform bill.
    I also believe we should focus on the right level of coverage for 
retirement savings. Retirement coverage merits separate discussion, and 
I would commend to Members of this Committee the record from the 
Financial Institutions Subcommittee hearing that I held on November 1, 
2001.
    In fact, President Bush's continued emphasis on saving for 
retirement reinforces the notion that many retirees would like to have 
more than $100,000 in savings to guarantee a comfortable retirement. 
And those savings are critical, especially given some uncertainty about 
the long-term health of Social Security.
    While many Americans have put those savings to work for them in a 
variety of investments, we have been reminded that while equity markets 
can provide unparalleled opportunities for economic growth, those 
opportunities come with volatility. Younger investors may have enough 
time to ride out ups and downs; however, those of us who are closer to 
retirement age have to make sure we have enough savings in secure 
investments to retire comfortably.
    Yet while Congress has created significant incentives to encourage 
Americans to save for their retirement, we have not taken the necessary 
steps to let our retirees keep their life-savings safe in their local 
communities. We are just waking up to the fact that our current deposit 
insurance coverage of retirement savings is simply inadequate to 
support the cost of retirement in 2003. For these reasons, I would urge 
the Committee to examine the topic of coverage for retirement savings 
separately.
    With that, Mr. Chairman, I once again thank you for holding today's 
hearing, and look forward to hearing from our witnesses.
               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. And 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 a number of my colleagues, the House bill, and 
the Administration's 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.
    I think I am in agreement with most of the experts here, although I 
have a slight disagreement with the FDIC on coverage limits. I even 
agree with the Fed. I have pointed out on the occasions when I think 
Chairman Greenspan is wrong. I think it is only fair I point out when I 
think he is right.
    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 ELIZABETH DOLE
    Mr. Chairman, I would like to express my appreciation for your 
holding this hearing today. As we are all aware, FDIC insurance plays a 
critical role in our Nation's financial system by ensuring consumer 
confidence and stability in the banking system. It has been almost 2 
years since the FDIC issued a position paper recommending various 
reform measures meant to strengthen the system. It is my hope that we 
can move forward with legislation to implement these recommendations in 
a timely manner.
    There are a number of issues involved in FDIC reform for which 
there appears to be widespread consensus. For instance, the merging of 
the Bank Insurance Fund and the Savings Association Insurance Fund into 
a single deposit insurance fund is long overdue. The much-publicized 
failure of thrifts in the late 1980's and early 1990's drastically 
reduced the number of thrifts that participate in the Savings 
Association Insurance Fund, creating greater volatility in the fund. 
The merger is a commonsense way to address this problem.
    Most would also agree that we should remove the current hard target 
for the designated reserve ratio and replace it with a flexible range. 
This change would allow banks to do their job and provide credit when 
it is most important: When the economy is struggling. Both this issue 
and the merger issue were raised by the FDIC in their position paper, 
and I believe these changes will meet with little dissent.
    However, there are some issues that have generated a great deal of 
debate. The first such issue where we will find different views among 
our very distinguished panel of witnesses is on the proposed increase 
of FDIC coverage levels above the current $100,000. My major concern on 
this issue is that increasing coverage levels will result in sharply 
higher premiums, especially at a time in our economy when we need more, 
not less, funds available for consumer and commercial lending. We 
cannot overlook this complication.
    Second, we must deal effectively with the so-called ``free 
riders.'' We have more than 900 new institutions, with billions of 
insured deposits, which have never paid premiums for the deposit 
insurance they receive. Meanwhile, other institutions have greatly 
increased their deposits since 1996 but have not paid any additional 
premiums. This is an issue of basic fairness on which we must act 
equitably.
    I want to thank the witnesses before us today for taking the time 
to share their considerable knowledge on these important issues. I look 
forward to an informative discussion and trust that we can work toward 
a consensus and proper legislative response to these issues.
    Thank you.
                               ----------
                  PREPARED STATEMENT OF ALAN GREENSPAN
       Chairman, Board of Governors of the Federal Reserve System
                           February 26, 2003
    Chairman Shelby, Senator Sarbanes, and Members of the Committee, it 
is a pleasure to appear once again before this Committee to present the 
views of the Board of Governors of the Federal Reserve System on 
deposit insurance. Rather than refer to any specific bill, I will 
express the broad views of the Federal Reserve Board on the issues 
associated with modifications of deposit insurance. Those views have 
not changed since our testimony before this Committee on April 23, 
2002.
    At the outset, I note that the 2001 report of the Federal Deposit 
Insurance Corporation (FDIC) on deposit insurance highlighted the 
significant issues and developed an integrated framework for addressing 
them. Although as before the Board opposes any increase in coverage, we 
continue to support the framework constructed by the FDIC report for 
addressing other reform issues.
Benefits and Costs of Deposit Insurance
    Deposit insurance was adopted in this country as part of the 
legislative effort to limit the impact of the Great Depression on the 
public. Against the backdrop of a record number of bank failures, the 
Congress designed deposit insurance mainly to protect the modest 
savings of unsophisticated depositors with limited financial assets. 
With references being made to ``the rent money,'' the initial 1934 
limit on deposit insurance was $2,500; the Congress promptly doubled 
the limit to $5,000 but then kept it at that level for the next 16 
years. I should note that the $5,000 of insurance provided in 1934, an 
amount consistent with the original intent of the Congress, is equal to 
slightly less than $60,000 today, based on the personal consumption 
expenditures deflator in the gross domestic product accounts.
    Despite its initial quite limited intent, the Congress has raised 
the maximum amount of coverage five times since 1950, to its current 
level of $100,000. The last increase, in 1980, more than doubled the 
limit and was clearly designed to let depositories, particularly thrift 
institutions, 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 thrift institutions 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 thrift institutions but unconcerned about 
the risk because the principal amounts of their $100,000 deposits were 
fully insured by the Federal Government. In this way, the 1980 increase 
in deposit insurance to $100,000 exacerbated the fundamental problem 
facing thrift institutions--a concentration on long-term assets in an 
environment of high and rising interest rates. Indeed, it significantly 
increased the taxpayer cost of the bailout of the bankrupt thrift 
institution deposit insurance fund.
    Despite this problematic episode, deposit insurance has clearly 
played a key--at times even critical--role in achieving the stability 
in banking and financial markets that has characterized the nearly 70 
years since its adoption. Deposit insurance, combined with other 
components of our banking safety net (the Federal Reserve's discount 
window and its payment system guarantees), has meant that periods of 
financial stress no longer entail widespread depositor runs on banks 
and on thrift institutions. Quite the opposite in fact: The asset 
holders now seek out deposits--both 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 importance of the 
security it has brought to millions of households and small businesses 
with relatively modest financial assets. Deposit insurance has given 
them a safe and secure place to hold their transaction and other 
balances.
    The benefits of deposit insurance, as significant as they are, have 
not come without a cost. The very process that has ended deposit runs 
has made insured depositors largely indifferent to the risks taken by 
their depository institutions, just as it did with depositors in the 
1980's with regard to insolvent, risky thrift institutions. The result 
has been a weakening of the market discipline that insured depositors 
would otherwise have imposed on institutions. Relieved of that 
discipline, depositories naturally feel less cautious about 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 risks it takes with its creditors' resources. This 
incentive to take excessive risks at the expense of the insurer, and 
potentially the taxpayer, is the so-called moral hazard problem of 
deposit insurance.
    Thus, two offsetting implications of deposit insurance must be kept 
in mind. On the one hand, it is clear 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, even the 
current levels of deposit insurance may have already increased risk-
taking at insured depository institutions to such an extent that future 
systemic risks have arguably risen.
    Indeed, the reduced market discipline and increased moral hazard at 
depositories 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 thrift institutions to attract 
more resources, at lower costs, than would otherwise be the case. In 
short, insured institutions 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.
    In sum, from the very beginning, deposit insurance has involved a 
tradeoff. Deposit insurance contributes to overall short-term financial 
stability and the protection of small depositors. But at the same time, 
because it also subsidizes deposit growth and induces greater risk-
taking, deposit insurance misallocates resources and creates 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 a further 
increase in moral hazard or reduction in 
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.
Issues for Reform
    The FDIC has made five broad recommendations.
Merge BIF and SAIF
    The Board supports the FDIC's proposal to merge the Bank Insurance 
Fund (BIF) with the Savings Association Insurance Fund (SAIF). Because 
the charters and operations of banks and thrift institutions 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 
expense, and widen the fund base of an increasingly concentrated 
banking system. Most important, because banks and thrift institutions 
receive the same level of Federally guaranteed insurance coverage, the 
premiums faced by each set of institutions should be identical as well. 
Under current arrangements, the premiums faced by equally risky 
institutions could differ significantly if one of the funds falls below 
the designated reserve ratio of 1.25 percent of insured deposits and 
the other fund does not. Should that occur, depository institutions 
would be induced to switch charters to obtain insurance from the fund 
with the lower premium, a result that could distort our depository 
structure. The Federal Government should not sell a single service, 
like deposit insurance, at different prices.
Reduce Statutory Restrictions on Premiums
    Current law requires the FDIC to impose higher premiums on riskier 
banks and thrift institutions but prevents it from imposing any premium 
on well-capitalized and highly rated institutions when the 
corresponding 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 would 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 highly rated institutions when the 
ratio of FDIC reserves to insured deposits exceeds 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 to many institutions when fund reserves meet some 
ceiling level. This free guarantee is of value to institutions even 
when they themselves are in sound financial condition and when 
macroeconomic times are good. At the end of the third quarter of last 
year, 91 percent of banks and thrift institutions were paying no 
premium. That group included many institutions that have never paid a 
premium for their, in some cases substantial, coverage, and it also 
included 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 highly rated banks and thrift 
institutions. And these two variables--capital strength and overall 
examiner rating--do not capture all the risk that institutions could 
create for the insurer. The Board believes that the FDIC should be free 
to establish risk categories on the basis of any economic variables 
shown to be related to an institution's risk of failure, and to impose 
premiums commensurate with that risk. Although a robust risk-based 
premium system would be technically difficult to design, a closer link 
between insurance premiums and the risk of individual institutions 
would reduce moral hazard and the distortions in resource allocation 
that accompany deposit insurance.
    We note, however, that although significant benefits from a risk-
based premium system are likely to require a substantial range of 
premiums, the FDIC 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 on premiums 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 that the market would apply and reduce the 
associated subsidy in deposit insurance.
    Nonetheless, we should not delude ourselves into believing that 
even a wider range in the risk-based premium structure would eliminate 
the need for a Government back-up 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 those incurred 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 systemic risk 
and is thus subject to a far larger extreme loss in the tail of 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--could well require 
premiums that would discourage most depository institutions from 
offering broad coverage to their customers. 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.
    I note that the difficulties of raising risk-based premiums explain 
why there is no real 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 it 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 by 
the private sector, the depository institutions would likely lower 
their offering rates, thereby reducing the amount of insured deposits 
demanded, and consequently the amount outstanding would decline.
Relaxing the Reserve Ratio Regime to Allow Gradual Adjustments
in Premiums
    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 be discontinued for well-capitalized and highly rated 
institutions. 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 the fund ratio is not likely to 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: They lower or eliminate 
fees in good times, when bank credit is readily available and deposit 
insurance fund reserves should be built up, and abruptly increase 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 institutions. The FDIC recommends that surcharges 
or rebates 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 changes in 
premiums. Indeed, we recommend that the FDIC's suggested target reserve 
range be widened 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.
    In addition to supporting a widening of the range for the 
designated reserve ratio, the Board recommends that the FDIC be given 
the latitude to temporarily 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, to enhance 
macroeconomic stability, we prefer a reduction in the specificity of 
the rules under which the FDIC operates and, within the broad 
guidelines set out by the Congress, an increase in the flexibility with 
which the board of the FDIC can operate.
Modify the Rebates System
    Since its early days, the FDIC has rebated ``excess'' premiums 
whenever it considered its reserves to be adequate. This procedure was 
replaced in the 1996 law by the requirement that no premium be imposed 
on well-capitalized and highly rated institutions when the relevant 
fund reached its designated reserve ratio. The FDIC's 2001 proposals 
would reimpose a minimum premium on all banks and thrift institutions 
and a more risk-sensitive premium structure. These provisions would be 
coupled with rebates for the stronger entities when the fund approaches 
the upper end of a target range and surcharges when the fund trends 
below the 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 consequent FDIC exposure. The devil, of course, 
is in the details. But varying the rebates in this way 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.
Indexing Ceilings on the Coverage of Insured Deposits
    The FDIC recommends that the current $100,000 ceiling on insured 
deposits be indexed to inflation. The Board does not support this 
recommendation and believes that the current ceiling should be 
maintained.
    In the Board's judgment, increasing the coverage, even by indexing, 
is unlikely to 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 important bulwarks against bank runs. Thus, the problem 
that increased coverage is designed to solve must be related either to 
the individual depositor, the party originally intended to be 
protected, or to the individual bank or thrift institution. Clearly, 
both groups would prefer higher coverage if it cost them nothing. But 
the Congress needs to be clear about the nature of a specific problem 
for which increased coverage would be the solution.
Depositors
    Our most recent 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 assets 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. A bank would clearly 
prefer that the depositor maintain all of his or her funds at that bank 
and would prefer to reduce the need for depositor diversification by 
being able to offer higher deposit insurance coverage. Nonetheless, 
depositors 
appear to have no great difficulty--should they want insured deposits--
in finding 
multiple sources of fully insured accounts.
    In addition, one of the most remarkable characteristics of 
household holdings of financial assets has been the increase in the 
diversity of portfolio choices since World War II. And since the early 
1970's, the share of household financial assets in bank and thrift 
deposits has generally declined steadily as households have taken 
advantage of innovative, attractive financial instruments with market 
rates of return. The trend seems to bear no relation to past increases 
in insurance ceilings. Indeed, the most dramatic substitution out of 
deposits has been the shift from both insured and uninsured deposits 
into equities and into mutual funds that hold 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. Rather, the data indicate that the weakness in stock prices 
in recent years has been marked by increased flows into bank and thrift 
deposits even without changed insurance coverage levels.
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 related to small banks because 
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 
banks smaller than the largest 1,000 have grown at an average annual 
rate of 13.8 percent, more than twice the pace of the largest 1,000 
banks. Uninsured deposits, again adjusted for the effects of mergers, 
have grown at average annual rates of 21 percent at the small banks 
versus 10 percent at the large 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 additional deposit insurance 
serves a national purpose. I might add that throughout the 1990's and 
into the present century, return on equity at small banks has been 
well-maintained. Indeed, the attractiveness of banking is evidenced by 
the fact that more than 1,350 banks were chartered during the past 
decade, including more than 600 from 1999 through 2002.
    Some small banks argue that they need enhanced deposit insurance 
coverage to compete 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 the FDIC Improvement Act of 
1991 (FDICIA), the 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. The market has clearly evidenced the view, consistent with 
FDICIA, that large institutions are not too big for uninsured creditors 
to take at least some loss should the institution fail. For example, no 
U.S. banking organization, no matter how large, is AAA-rated. In 
addition, research indicates that creditors impose higher risk premiums 
on the uninsured debt of relatively risky large banking organizations 
and that this market discipline has increased since the enactment of 
FDICIA.
    To be sure, the real purchasing power of deposit insurance ceilings 
has declined. But there is no evidence of any significant detrimental 
effect on depositors or depository 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, even if its real value were to erode further.
    Another argument that is often raised by smaller banks regarding 
the need for increased deposit insurance coverage. Some smaller 
institutions say that they are unable to match the competition from 
large securities firms and bank holding companies with multiple bank or 
thrift institution affiliates because those entities offer multiple 
insured accounts through one organization. I note that since the 
Committee's last hearings on this issue, the force of small banks' 
concerns has been reduced by recent market developments in which small 
banks and thrift institutions can use a clearinghouse network for 
brokered deposits that allows them to offer full FDIC insurance for 
large accounts. The Board agrees that such practices by both large and 
small depositories are a misuse of deposit insurance. Moreover, raising 
the coverage limit for each account is not a remedy for small banks 
because it would also increase the aggregate amount of insurance 
coverage that multidepository 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 to inflation. The thrust of our recommendations would call for 
a wider permissible range for the size of the fund relative to insured 
deposits, reduced variation of the insurance premium as the relative 
size of the fund changes with banking and economic conditions, a 
positive and more risk-based premium net of rebates for all depository 
institutions, and the merging of BIF and SAIF.
    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 or that the level of deposit coverage appears to 
be endangering financial stability. Should either of those events 
occur, the Board would call its 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 depository institutions, expand moral hazard, 
and reduce the incentive for market discipline without providing any 
clear public benefit. 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 we be exceptionally deliberate when expanding 
Government financial guarantees.
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                 PREPARED STATEMENT OF PETER R. FISHER
 Under Secretary for Domestic Finance, U.S. Department of the Treasury
                           February 26, 2003
    Mr. Chairman, Senator Sarbanes, and Members of the Committee, I 
appreciate the opportunity to provide the Administration's views on 
deposit insurance reform. I also want to commend Chairman Powell and 
the FDIC staff for their valuable contributions to the discussion of 
this important issue.
    The Administration strongly supports reforms to our deposit 
insurance system that would: First, merge the bank and thrift insurance 
funds; second, allow more flexibility in the management of fund 
reserves while maintaining adequate reserve levels; and third, ensure 
that all participating institutions fairly share in the maintenance of 
FDIC resources in accordance with the insurance fund's loss exposure 
from each institution. The Administration strongly opposes any 
increases in deposit insurance coverage limits.
    Our current deposit insurance system managed by the Federal Deposit 
Insurance Corporation (FDIC) serves to protect insured depositors from 
exposure to bank losses and, as a result, helps to promote public 
confidence in the U.S. banking system. I am concerned today that our 
deposit insurance system has structural weaknesses that, in the absence 
of reform, could deepen over time. I want to emphasize that there is no 
crisis in the FDIC; both of its funds are strong, well-managed, with 
adequate reserves. This is the right time to act--when we do not face a 
crisis--and the Administration supports legislation focused on the 
repair of these structural weaknesses.
    Increases in the FDIC benefits, however, including any increases in 
the level of insurance coverage, are not part of the solution to these 
problems and should be avoided. When I testified before this Committee 
just last April, I argued that an 
increase in deposit insurance coverage limits would serve no sound 
public policy purpose. Nothing has occurred since then to change that 
view. The Administration continues to oppose higher coverage limits in 
any form. Indeed, we feel that the entire issue of coverage limits 
regrettably diverts attention from the important reforms that are 
needed.
Merging the Bank and Thrift Insurance Funds
    We support a merger of the Bank Insurance Fund (BIF) and Savings 
Association Insurance Fund (SAIF) as soon as practicable. A larger, 
combined insurance fund would be better able to diversify risks, and 
thus withstand losses, than would either fund separately. Merging the 
funds while the industry is strong and both funds are adequately 
capitalized would not burden either BIF or SAIF members. A merged fund 
would also end the possibility that similar institutions could pay 
significantly different premiums for the same product, as was the case 
in the recent past and could occur again in the near future without 
this change. A merger would also recognize changes in the industry. As 
a result of mergers and consolidations, each fund now insures deposits 
of both commercial banks and thrifts. Indeed, commercial banks now 
account for 45 percent of all SAIF-insured deposits.
Flexibility in the Management of FDIC Reserves
    Current law generally requires each insurance fund to maintain 
reserves equal to 1.25 percent of estimated insured deposits, the 
``designated reserve ratio.'' When the reserve ratio falls below this 
threshold, the FDIC must charge either a premium sufficient to restore 
the reserve ratio to 1.25 percent within 1 year, or a minimum of 23 
basis points if the reserve ratio would remain below 1.25 percent for a 
longer period. Since the latter would be expected when the banking 
system, and probably the economy as well, were under stress, such a 
sharp increase in industry assessments could have an undesirable 
procyclical effect, further reducing the liquidity precisely when 
liquidity is needed. Were the FDIC fund contributions to come from 
resources that otherwise might be part of capital, every dollar paid 
would mean a potential reduction of 10 or 12 dollars in lending, or as 
much as $12 billion in reduced lending for a $1 billion FDIC 
replenishment.
    Reserves should be allowed to grow when conditions are good. This 
would enable the fund to better absorb losses under adverse conditions 
without sharp increases in premiums. In order to achieve this objective 
and also to account for changing risks to the insurance fund over time, 
we support greater latitude for the FDIC to alter the designated 
reserve ratio within statutorily prescribed upper and lower bounds. 
Within these bounds, the FDIC should provide for public notice and 
comment concerning any proposed change to the designated reserve ratio. 
The FDIC should also have discretion in determining how quickly the 
fund meets the designated reserve ratio as long as the actual reserve 
ratio is within these bounds. If the reserve ratio were to fall below 
the lower bound, the FDIC should restore it to within the statutory 
range promptly, over a reasonable but limited time frame. We would also 
support some reduction in the prescribed minimum premium rate--
currently 23 basis points--that would be in effect if more than 1 year 
were required to restore the fund's reserves.
    Nevertheless, as we learned from the deposit insurance experience 
of the 1980's, flexibility must be tempered by a clear requirement for 
prudent and timely fund replenishment. The statutory range for the 
designated reserve ratio should strike an appropriate balance between 
the burden of prefunding future losses and the procyclical costs of 
replenishing the insurance fund in a downturn. A key benefit to giving 
the FDIC greater flexibility in managing the reserve ratio within 
statutorily prescribed bounds is the ability to achieve low, stable 
premiums over time, adequate to meet FDIC needs in bad times, with the 
least burden on financial institutions and on the economy. We also 
believe that with this reform, the possibility of recourse to taxpayer 
resources is even further removed.
Full Risk-Based Shared Funding
    Every day that they operate, banks and thrifts benefit from their 
access to Federal deposit insurance. For several years, however, the 
FDIC has been allowed to obtain premiums for deposit insurance from 
only a few insured institutions. Currently, over 90 percent of banks 
and thrifts pay nothing to the FDIC. This is an untenable formula for 
the long-term stability of the FDIC.
    Moreover, the current law frustrates one of the most important 
reforms enacted in the wake of the collapse of the Federal Savings and 
Loan Insurance Corporation (FSLIC) and the depletion of FDIC reserves: 
The requirement for risk-based premiums. When 90 percent of the 
industry pays no premiums, there is little opportunity to do what any 
prudent insurer would do: Adjust premiums for risk. Nearly all banks 
are treated the same, and lately they have been treated to free 
service.
    For example, today a bank can rapidly increase its insured deposits 
without paying anything into the insurance fund. As is now well-known, 
some large financial companies have greatly augmented their insured 
deposits in the past few years by sweeping uninsured funds into their 
affiliated depository institutions--without compensating the FDIC at 
all. Other major financial companies might be expected to do the same 
in the future. In addition, most of the over 1,100 banks and thrifts 
chartered after 1996 have never paid a penny in deposit insurance 
premiums. Yet if insured deposit growth by a relatively few 
institutions were to cause the reserve ratio to decline below the 
designated reserve ratio, all banks would be required to pay premiums 
to raise reserves.
    To rectify this ``free rider'' problem and ensure that institutions 
appropriately compensate the FDIC commensurate with their risk, 
Congress should remove the current restrictions on FDIC premium-
setting. In order to recognize past payments to build up current 
reserves, we support the proposal to apply temporary transition credits 
against future premiums that would be distributed based on a measure of 
each institution's contribution to the build-up of insurance fund 
reserves in the early to mid-1990's. In addition to transition credits, 
allowing the FDIC to provide assessment credits on an on-going basis 
would permit the FDIC to collect payments from institutions more 
closely in relation to their deposit growth.
    We strongly oppose rebates, which would drain the insurance fund of 
cash. Over much of its history, the FDIC insurance fund reserve ratio 
remained well above the current target, only to drop into deficit 
conditions by the beginning of the 1990's. Therefore, it is vital that 
funds collected in good times, and the earnings on those collections, 
be available for times when they will be needed.
    There are other important structural issues that need to be 
addressed sooner than later. It would be appropriate to evaluate 
whether there are changes to the National Credit Union Share Insurance 
Fund (NCUSIF) that would be suitable in light of the proposed reforms 
made to FDIC insurance so as to avoid unintended disparities 
between the two programs. Perhaps even more important is the need to 
address the long-term funding of supervision by the National Credit 
Union Administration, particularly in view of recent trends toward 
conversions from Federal to State charters and growing consolidation of 
credit unions. Similarly, there are structural problems in the funding 
of the Office of the Comptroller of the Currency and the Office of 
Thrift Supervision, the resolution of which should not be delayed.
Deposit Insurance Coverage Limits
    The improvements to the deposit insurance system that I have just 
outlined are vital to the system's long-term health. Other proposals, 
however, would not contribute to the strength of the taxpayer-backed 
deposit insurance system and may actually weaken it.
    Increasing the general coverage limit up front or through 
indexation, or raising coverage limits for particular categories of 
deposits, is unnecessary. Savers do not need an increase in coverage 
limits and would receive no real financial benefit. Unlike other 
Government benefit programs, there is no need for indexation of deposit 
insurance coverage because savers can now obtain all the coverage that 
they desire by using multiple banks and through other means.
    Higher coverage limits would not predictably advantage any 
particular size of banks, would increase all banks' insurance premium 
costs, and would mean greater taxpayer exposure by adding to the 
contingent liabilities of the Government and weakening market 
discipline. An increase in coverage limits would reduce--not enhance--
competition among banks in general as the efficient and inefficient 
offer the same investment risk to depositors; in fact, perversely, 
investors would be drawn at no risk to the worst banks, which usually 
offer the highest interest rates.
Higher Coverage Limits Not Sought by Savers
    First of all, the clamor for raising coverage limits does not come 
from savers. The evidence that current coverage limits constitute a 
burden to savers is scant; there has been little demand from depositors 
for higher maximum levels. The recent consumer finance survey data 
released by the Federal Reserve confirm what we found in the previous 
survey, namely that raising the coverage limit would do little, if 
anything, for most savers. Median family deposit balances are only 
$4,000 for transaction account deposits and $15,000 for certificates of 
deposit, far below the current $100,000 ceiling. The same holds true 
even when considering only older Americans, a segment of the population 
with higher bank account usage: Median transaction account balances and 
certificates of deposit total $8,000 and $20,000, respectively, for 
those households headed by individuals between the ages of 65 and 74.
    Examining the Federal Reserve data for retirement accounts shows 
present maximum deposit insurance coverage to be more than adequate. 
The median balance across age groups held in IRA/Keogh accounts at 
insured depository institutions is only $15,000. For the 65 to 69 age 
group, median household IRA/Keogh deposits total $30,000.
    A small group of relatively affluent savers might find greater 
convenience from increased maximum coverage levels. But it is a tiny 
group. Only 3.4 percent of households with bank accounts held any 
uninsured deposits, and the median income of these households was more 
than double the median income of all depositors in the survey.
    Under current rules, these savers have plenty of options, with the 
marketplace presenting new options for unlimited deposit insurance 
coverage without changing Federal coverage limits. At little 
inconvenience, savers with substantial bank deposits--including 
retirees and those with large bank savings for retirement--may place 
deposits at any number of banks to obtain as much FDIC coverage as 
desired. They may also establish accounts within the same bank under 
different legal capacities, qualifying for several multiples of current 
maximum coverage limits. Firms are now developing programs for 
exchanging depositor accounts that could offer seamless means of 
providing unlimited coverage for depositors without any change in the 
current limits.
    One of the fundamental rules of prudent retirement planning is to 
diversify investment vehicles. Many individuals, including those who 
are retired or planning for retirement, feel comfortable putting 
substantial amounts into uninsured mutual funds, money market accounts, 
and a variety of other investment instruments. Just 21 percent of all 
IRA/Keogh funds are in insured depository institutions. There is simply 
no widespread consumer concern about existing coverage limits that 
would justify extending taxpayer exposure by creating a new Government-
insured retirement program under the FDIC.
Coverage Limits and Bank Competition
    Banks, regardless of size, continue to have little trouble 
attracting deposits under the existing coverage limits. Federal Reserve 
data have shown that smaller banks have grown more rapidly and 
experienced higher rates of growth in both insured and uninsured 
deposits than have larger banks over the past several years. After 
adjusting for the effects of mergers, domestic assets of the largest 
1,000 commercial banks grew 5.5 percent per year on average from 1994 
to 2002; all other banks grew 13.8 percent per year on average. Nor are 
smaller banks losing the competition for uninsured deposits. Uninsured 
deposits of the top 1,000 banks grew 9.9 percent annually on average 
over this period, while such deposits at smaller banks grew on average 
by 21.4 percent annually.
Higher Coverage Limits for Municipal Funds Erode Discipline
    Proposals for substantially higher levels of protection of 
municipal deposits than of other classes of deposits would exacerbate 
the inherent moral hazard problems of deposit insurance. Rather than 
keep funds in local institutions, State and municipal treasurers would 
have powerful incentives to seek out not the safest institutions in 
which to place taxpayer funds but rather those offering the highest 
interest rates. Since these are usually riskier institutions, State and 
municipal treasurers would be drawn into funding the more troubled 
banks. Local, well-run, healthy banks might have to pay a premium in 
increased deposit rates to retain municipal business. Today, there are 
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.
Conclusion
    In conclusion, I reaffirm the Administration's support for the 
three-part general framework that I have outlined to correct the 
structural flaws in the deposit insurance system. I encourage Congress 
to pursue these improvements with a steady focus on the important work 
that needs to be done. The Administration does not support legislation 
that raises deposit insurance coverage limits in any form, and we urge 
that Congress avoid such an unneeded and counterproductive diversion 
from real and necessary reform.
                 PREPARED STATEMENT OF DONALD E. POWELL
                  Chairman, Board of Directors of the
                 Federal Deposit Insurance Corporation
                           February 26, 2003
    Chairman Shelby, Senator Sarbanes, and Members of the Committee, it 
is a pleasure to appear before you this morning to discuss deposit 
insurance reform. This remains the top priority of the Federal Deposit 
Insurance Corporation and I appreciate this Committee's continuing 
interest in pursuing reform.
    The need for reform--and the FDIC's reform recommendations--have 
not changed since the last time I testified before this Committee, and 
much of our testimony will sound familiar to most of you. An effective 
deposit insurance system contributes to America's economic and 
financial stability by protecting depositors. For more than three 
generations, our deposit insurance system has played a key role in 
maintaining public confidence.
    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. These flaws can be 
corrected only by legislation.
    Today, I want to emphasize three elements of deposit insurance 
reform that the FDIC regards most critical--merging the funds, 
improving the FDIC's ability to manage the fund, and pricing premiums 
properly to reflect risk. These changes are needed to provide the right 
incentives to insured institutions and to improve the deposit insurance 
system's role as a stabilizing economic factor, while also preserving 
the obligation of banks and thrifts to fund the system. There is 
widespread general agreement among the bank and thrift regulators for 
these reforms.
Merging the BIF and the SAIF
    The Bank Insurance Fund (BIF) and the Savings Association Insurance 
Fund (SAIF) should be merged. There is a strong consensus on this point 
within the industry, among regulators and within Congress.
    A merged fund would be stronger and better diversified than either 
fund standing alone. From the point of view of the insured depositor, 
there is virtually no difference between banks and thrifts. Moreover, 
many institutions currently hold both BIF- and SAIF-insured deposits. 
More than 40 percent of SAIF-insured deposits are now held by 
commercial banks.
    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. Such a price 
disparity has led in the past, and would inevitably lead in the future, 
to wasteful attempts to circumvent restrictions preventing institutions 
from purchasing deposit insurance at the lower price. The potential for 
differing rates is not merely theoretical. The BIF reserve ratio on 
September 30, 2002, stood at 1.25 percent, the absolute minimum 
required by law, while the SAIF reserve ratio stood at 1.39 percent.
    For all of these reasons, the FDIC has advocated merging the BIF 
and the SAIF for a number of years. 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 statutorily mandated designated reserve ratio (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 mandatory 
high average premiums 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, the requirement for high premiums 
could be triggered.
    The statutory provision requiring a 1.25 percent DRR and mandatory 
high premiums when a fund falls sufficiently below the DRR were 
intended to protect the taxpayers and prevent the deposit insurance 
funds from becoming insolvent, as the Federal Savings and Loan 
Insurance Corporation (FSLIC) became during the 1980's. However, these 
provisions, intended as protections, could cause unintended problems. 
During a period of heightened insurance losses, both the economy in 
general and the depository institutions in particular are more likely 
to be distressed. High premiums at such a point in the business cycle 
would be procyclical and would result in a significant drain on the net 
income of depository institutions, thereby impeding credit availability 
and economic recovery. As I will discuss later, there are ways to 
protect the taxpayers while avoiding some of the procyclicality of the 
present system.
    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\ 
Today, 91 percent of banks and thrifts are well-capitalized and well-
managed and pay the same rate for deposit insurance--zero. Yet, 
significant and identifiable differences in risk exposure exist among 
these 91 percent of insured institutions. To take one example, since 
the mid-1980's, institutions rated CAMELS 2 have failed at more than 
two-and-one-half 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. The current system does not charge appropriately for risk, 
which increases the potential for moral hazard and makes 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, almost 1,000 new 
banks and thrifts have joined the system and never paid for the 
insurance they received. Other institutions have grown significantly 
without paying additional premiums.
    These problems can be addressed by eliminating the existing 
inflexible statutory requirements and by giving the FDIC Board of 
Directors the discretion and flexibility to charge regular risk-based 
premiums over a much wider range of circumstances than current law now 
permits.
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; rather, it is to distribute the assessment burden more evenly 
over time and more fairly across insured institutions.
    Under the FDIC's recommendations, the reserve ratio would be 
allowed to move up and down within a specified range during the 
business cycle so that premiums can remain steady. The key to fund 
management would be to maintain the fund within the statutory range and 
to bring the fund ratio back into the range in an appropriate timeframe 
when it moves outside in either direction. As the reserve ratio moves, 
the Board should have the flexibility to use credits, rebates, or 
surcharges in order to keep the ratio within the range. Moreover, 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. To manage the 
insurance fund effectively, the Board must have the flexibility to 
respond appropriately to differing economic and industry conditions.
    While I believe that the FDIC Board needs greater discretion to 
manage the fund, we are not suggesting the FDIC be given absolute 
discretion--there is a need for accountability. The FDIC will work with 
the Congress to develop parameters for an appropriate range for the 
fund ratio. The FDIC also will work with the Congress to provide 
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.
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. The goals of 
risk-based premiums can be accomplished 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 objective indicators are used to the extent possible to 
measure risk in institutions. Any system adopted by the FDIC 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 is 
considering 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. As the result of many discussions with 
bankers, trade-group representatives, and other regulators, as well as 
our own analysis, we are looking at several possible pricing 
methodologies. We actively seek input from the industry and the 
Congress regarding possible pricing schedules that are analytically 
sound.
    For the largest banks and thrifts, it will be necessary to augment 
the financial information banks report with other information, 
including market-based data. The final risk-based pricing system must 
be fair and must not discriminate in favor of or against banks merely 
because they happen to be large or small.
    In short, 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 that there is a need to 
exercise 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. 
Almost 1,000 newly chartered institutions, with more than approximately 
$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.
    New institutions and fast-growing institutions have benefited from 
the assessments paid by 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. One way to address the 
fairness issue that has arisen and to acknowledge the contributions of 
the banks and thrifts that built up the funds during the early 1990's 
is to provide transitional assessment credits to these institutions.
    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 
year-end 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 their higher 
future premiums. Institutions that never paid premiums would receive no 
assessment credit. Institutions that made significant contributions to 
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 during which banks 
that contributed in the past could offset their premium obligations 
through the use of credits.
    The combination of risk-based premiums and assessment credits tied 
to past contributions to the fund would address the issues related to 
rapid growers and new entrants. Regular risk-based premiums for all 
institutions would mean that the fast-growing institutions would pay 
increasingly larger premiums as they gather the 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
    The reforms just described are critical to improving the deposit 
insurance system. Let me conclude my discussion with the most 
controversial, but the least critical, of the FDIC's recommendations, 
the recommendation on coverage. The FDIC's recommendation is simple: 
Whatever the level of deposit insurance coverage Congress deems 
appropriate, the coverage limit should be indexed to ensure that the 
value of deposit insurance does not wither away over time. If Congress 
decides to maintain deposit insurance coverage at its current level, 
indexing will not expand coverage or expand the Federal safety net. It 
will simply hold the value of coverage steady over time. In addition, 
without arguing about the causes and contributing factors of the thrift 
crisis, indexing the limit on a regular basis may prevent possible 
unintended consequences of large, unpredictable adjustments made on an 
ad hoc basis in the future.
Conclusion
    Federal deposit insurance was created in a period of economic 
crisis to stabilize the economy by protecting depositors. By any 
measure, it has been remarkably effective in achieving its goals over 
the years. It is no less important today.
    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, the goal of reform is to 
distribute the assessment burden more evenly over time and more fairly 
across insured institutions. This is good for depositors, good for the 
industry, and good for the overall economy.
    The responsibility of prudently managing the fund and maintaining 
adequate 
reserves are taken very seriously by the FDIC--I must reiterate: It is 
extremely important to depositors, to the industry, and to the 
financial and economic 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 FDIC's recommendations would retain the essential 
characteristics of the present system and improve upon them. While 
Chairman, I will 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 
will do so as well.
    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 FDIC has put 
forward some important recommendations for improving our deposit 
insurance system. We appreciate the Committee's leadership on this 
issue and look forward to working with each of you to get the job done 
this year.
                               ----------
                PREPARED STATEMENT OF JOHN D. HAWKE, JR.
      Comptroller of the Currency, U.S. Department of the Treasury
                           February 26, 2003
Introduction
    Chairman Shelby, Senator Sarbanes, and the Members of the 
Committee, I am pleased to have this opportunity today to present the 
views of the Office of the Comptroller of the Currency (OCC)* on 
deposit insurance reform. For almost 70 years, Federal deposit 
insurance has been one of the cornerstones of our Nation's economic and 
financial stability. It has relegated bank runs to the history books 
and helped our country weather the worst banking crisis since the Great 
Depression without significant adverse macroeconomic effects. Despite 
this admirable history, there are flaws in our current deposit 
insurance structure. In fact, efforts to address weaknesses in the 
system uncovered during the banking and thrift crises of the 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 Federal Deposit Insurance Corporation (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.
---------------------------------------------------------------------------
    *Statement required by 12 U.S.C. Sec. 250. The views expressed 
herein are those of the Office of the Comptroller of the Currency and 
do not necessarily represent the views of the President.
---------------------------------------------------------------------------
     In summary, the OCC recommends that:

 The FDIC be provided with the authority to implement a risk-
    based deposit insurance premium system for all banks.

 The current fixed designated reserve ratio (DRR) be replaced 
    with a range to allow the FDIC more flexibility in administering 
    the deposit insurance premium structure over the business cycle.

 Any program of rebates or credits issued when the fund exceeds 
    the upper end of the DRR range take into account the fact that the 
    FDIC and the Federal Reserve already deliver a substantial subsidy 
    to State-chartered banks by absorbing their costs of Federal 
    supervision, and that deposit insurance premiums paid by national 
    banks pay, in part, for the supervision of State-chartered banks.

 The BIF and SAIF be merged.

 Coverage limits on deposits not be increased.
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 parts of deposit insurance reform. 
While current law mandates that the FDIC charge risk-based insurance 
premiums, it also prohibits the FDIC from charging premiums to any 
institution in the 1A category--in general, 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, 
91 percent of all insured depository institutions pay nothing for their 
deposit insurance even though all institutions pose some risk of loss 
to the FDIC. 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.
    A system in which the vast majority of institutions pay 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. The FDIC should be free to set risk-based premiums 
for all of the insured institutions.
Dampening Procyclicality and Fund Management
    Under current law, whenever the reserve ratio of the BIF or SAIF 
falls below 1.25 percent the FDIC is required either to charge an 
assessment rate to all banks high enough to bring the fund back to the 
DRR within 1 year, or if that is not feasible, an assessment rate of at 
least 23 basis points. This sharp rise in premiums, or ``cliff 
effect,'' is likely to 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 let 
the funds build in good times and to draw down slightly in bad times.
    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. If 
a fund falls below the bottom of the range, we believe it would be 
preferable to allow the FDIC to rebuild the fund gradually to eliminate 
the 23 basis point ``cliff effect.'' Adoption of a range and 
elimination of the ``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.
    If a fund exceeds the upper boundary of the DRR range, the FDIC 
should be authorized to pay rebates or grant credits against future 
premiums. While such credits or rebates seem reasonable, there are two 
principles that should be observed in determining their allocation and 
use. First, a system of rebates or credits should not undermine the 
risk-based premium system. Thus, rebates or credits should not be based 
on an institution's current assessment base. If they were, rebates or 
credits would lower the marginal cost of insurance. For example, if an 
institution with a risk-based premium of three basis points received a 
rebate or credit of two basis points for each dollar of assessable 
deposits, its true premium would only be one basis point. Another 
implication of rebates or credits not undermining risk-based premiums 
is that institutions that paid high insurance premiums in the past 
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. Finally, an institution that is faced with a high premium 
because of high risk should not be allowed to completely offset that 
premium with credits.
    The second principle is that the payment of rebates and credits 
should take into account the fact that not all insured institutions 
receive the same services for their deposit insurance dollars. The FDIC 
uses proceeds from the deposit insurance funds to cover its own costs 
of supervising State-chartered banks, and it does not pass these costs 
on to the banks. In 2001, this amounted to an in-kind transfer from the 
FDIC to State nonmember banks of over $500 million. During this same 
time, by contrast, national banks paid over $400 million in assessments 
to the OCC to cover their own costs of supervision.\1\ In a regime 
under which all institutions were paying premiums, national banks 
should not be required to pay both for their own supervision, and also 
for a portion of the supervisory costs of their State-chartered 
competitors. It would be unconscionable for the FDIC to issue credits 
or rebates to State-chartered banks without first taking into account 
the subsidy it provides to these banks by absorbing their costs of 
supervision--a subsidy that is funded in good part by deposit insurance 
premiums paid by national banks.
---------------------------------------------------------------------------
    \1\ The Federal Reserve pays for its supervision of State member 
banks out of funds that would otherwise be remitted to the Treasury. 
Thus, the taxpayer pays for the supervision of State member banks.
---------------------------------------------------------------------------
Merger of the BIF and the SAIF
    One of the most straightforward 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 third quarter of 2002, the reserve ratio 
of the BIF was 1.25 percent, while that of the SAIF was 1.39 percent. 
The reserve ratio of a combined fund would have been 1.28 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, the 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.
    In addition, a combined fund would insure a larger number of 
institutions with broader asset diversification than either fund 
individually. It would also decrease the exposure of the funds--
especially the SAIF--to a few large institutions. Industry 
consolidation has led to increased concentration of insured deposits in 
a handful of institutions. As of September 30, 2002, the three largest 
holders of BIF-insured deposits held 15 percent of BIF-insured 
deposits. The corresponding share for the three largest holders of 
SAIF-insured deposits was 18 percent. For a combined fund the figure 
would have been 14 percent. For all these reasons, merger of the two 
funds would result in a diversification of risks.
    Further, there is significant overlap in the types of institutions 
insured by the two funds. As of September 30, 920 banks and thrifts, or 
roughly 10 percent of all 
insured depository institutions, were members of one fund but also held 
deposits 
insured by the other fund, and BIF-member institutions held 43 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.
Increasing Coverage Limits
    The question of deposit insurance coverage limits is a challenging 
one, in part because it is easy for depositors to obtain full insurance 
of deposits in virtually unlimited amounts through multiple accounts. 
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. However, there 
is little evidence to support this contention. Over the 12 months 
ending September 30, 2002, deposits at commercial banks with under $1 
billion in assets grew at a healthy 3.8 percent annual rate, while loan 
volume actually declined. As a result, loan-to-deposit ratios at such 
institutions fell from 88 percent to 79 percent.
    In addition, 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, however, 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 the larger, more aggressive institutions might use the 
expanded coverage to offer even more extensive governmentally protected 
investment vehicles to their wealthy customers. That could cause an 
even greater shift of deposits away from community banks and increase 
liquidity pressures.
    For many of the same reasons that 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. Increasing the limit on 
municipal deposits would not provide municipalities with greater 
protection--they can already secure their deposits--and it is by no 
means clear that increasing the deposit insurance limit would result in 
funds flowing into community banks. In addition, an increase in insured 
coverage could spur riskier lending because banks would no longer be 
required to collateralize municipal deposits with low-risk securities.
Conclusion
    The OCC supports a merger of the BIF and the SAIF and proposals to 
eliminate the current constraints on deposit insurance premiums. We 
also 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 believe that 
any credits or rebates issued when the fund exceeds the upper range of 
the DRR must first take account of the subsidy that State-chartered 
banks receive as a result of having the costs of their Federal 
supervision absorbed by their Federal regulators, and the fact that 
deposit insurance premiums paid by national banks in effect pay for a 
large portion of this subsidy.
                               ----------
                PREPARED STATEMENT OF JAMES A. GILLERAN
                 Director, Office of Thrift Supervision
                    U.S. Department of the Treasury
                           February 26, 2003
Introduction
    Good morning, Chairman Shelby, Senator Sarbanes, 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)* fully supports the ongoing efforts to reform our 
Federal Deposit Insurance System.
---------------------------------------------------------------------------
    *Statement required by 12 U.S.C. Sec. 250. The views expressed 
herein are those of the Office of Thrift Supervision and do not 
necessarily represent the views of the President.
---------------------------------------------------------------------------
    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. A large majority of insured depository institutions 
continue to be healthy and profitable, which presents us with the best 
opportunity to improve our deposit insurance system.
    Even as the bank and thrift industries have prospered, the reserve 
ratio for the Bank Insurance Fund (BIF) has steadily declined the last 
several years. The reserve ratio for the Savings Association Insurance 
Fund (SAIF) has reversed its own steady decline by increasing three 
basis points during the second and third quarters of 2002. The decline 
in the BIF ratio has been fairly dramatic, dropping from 1.40 percent 
in June 1999 to 1.25 percent as of September 30, 2002. 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.
    If SAIF remains at or near its current 1.39 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 the 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 affects both 
funds, regardless of the institution's fund membership. Thus, the funds 
are already significantly co-dependent, 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 September 30, 2002, commercial banks held 45 percent of 
SAIF-insured deposits, with 47 percent of SAIF-insured deposits held by 
OTS-supervised thrifts. The remaining 8 percent of SAIF-insured 
deposits were held by FDIC-supervised savings banks.
---------------------------------------------------------------------------
    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 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 September 30, 2002, the largest BIF-
insured institution accounted for 9.0 percent of BIF-insured deposits; 
and the largest SAIF-insured institution held 9.9 percent of SAIF-
insured deposits. A fund merger as of September 30, 2002, would have 
had the largest BIF institution accounting for only 7.7 percent of 
combined deposits and the largest SAIF member holding only 2.5 percent 
of combined deposits. Fund merger would moderate concentration risk and 
reduce pressure for higher premiums.
    Premium disparity is another potential problem. 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 even though both funds provide identical 
deposit insurance coverage. Premium differentials 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 in 1996 demonstrated that 
premium differentials are destabilizing because institutions shift 
deposits to the less expensive fund or seek nondeposit funding sources 
to avoid the cost of the higher premium. Fund merger eliminates this 
problem.
    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. Higher premiums 
also hamper the ability of all institutions to finance activities that 
would help to improve the economy. Increasing the FDIC's flexibility to 
set fund premiums within a target range would reduce insured 
institutions' exposure to overall economic conditions and to sector 
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 and would also address existing 
inequities in the system attributable to ``free riders'' that have not 
contributed to the fund.
Deposit Insurance Coverage Levels
Increasing the Current Coverage Level
    While I support the goal of increasing the ability of 
institutions--particularly small community-based depositories--to 
attract more deposits, I am not convinced 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 significantly would 
result in 
higher 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. I do 
not see the need for indexing in light of the higher risks and costs 
involved. There are four factors that frame my view on indexing.
    First, current rules governing Federal deposit insurance coverage 
already 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 relatively few persons holding 
more than $100,000 in deposits can protect every dollar of savings with 
the FDIC deposit insurance.
    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 through indexing will 
eventually require higher deposit insurance premiums from insured 
institutions. While some argue that indexing is an important issue for 
smaller institutions, I have seen no convincing data supporting the 
notion that raising deposit coverage levels will benefit smaller 
institutions. Indexing also 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 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 institutions and their 
customers should view it negatively.
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 negative 
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 insurance reform 
bill that would: (i) merge the BIF and SAIF and (ii) provide FDIC 
flexibility to set insurance premiums within a target range. 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.
    Thank you for this opportunity to discuss Federal deposit insurance 
reform. I look forward to working with you, Chairman Shelby, and the 
Members of the Committee, and appreciate your time and attention to 
this issue.
         RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI

                      FROM ALAN GREENSPAN

Q.1. Some of the changes in the recommendations proposed seem 
like common sense, particularly issues providing more 
flexibility to the FDIC in setting the reserve ratio and 
returning the fund to that level. Can you please provide me 
with a reason why some of these flexibilities weren't included 
with the legislation when the programs were initially 
instituted?
    When I obtain car insurance, no matter how good a driver I 
am, I pay for the insurance and the benefits I receive. Why is 
it that the law provides that some banks, who admittedly may be 
very well-managed, aren't required to pay for the insurance 
they receive from the fund?

A.1. The Board agrees that it makes sense to provide more 
flexibility to the FDIC in setting the reserve ratio or target 
range and to set risk-based premiums to help return the fund to 
that level or range. The current statutory requirement that 
free deposit insurance be provided to well-capitalized and 
highly rated institutions when the ratio of the FDIC reserves 
to insured deposits exceeds a predetermined ratio maximizes the 
subsidy provided to these institutions and is inconsistent with 
efforts to avoid inducing moral hazard. This free guarantee is 
of value to institutions even when they are in sound financial 
condition and when macroeconomic times are good. At the end of 
the third quarter of last year, 91 percent of banks and thrift 
institutions were paying no premium. 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 on highly 
rated banks and thrift institutions. The Board believes that 
the FDIC should be free to establish risk categories on the 
basis of any economic variables shown to be related to an 
institution's risk of failure, and to impose premiums 
commensurate with that risk. A closer link between insurance 
premiums and the risk of individual institutions would reduce 
moral hazard and the distortions in resource allocation that 
accompany deposit insurance.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER FROM ALAN 
                           GREENSPAN

Q.1. Mr. Greenspan, as your testimony pointed out, with many of 
the changes we are discussing, ``the devil is in the details.'' 
Can you comment on the specific methodologies for evaluating 
risk that you believe the FDIC should consider employing if it 
moves to a risk-based premium system? Can you specifically 
comment on the issue of calculating ``systemic'' risk given, as 
I understand it, the still early stages of our understanding of 
that risk category?

A.1. The Board believes that the FDIC should be free to 
establish risk categories on the basis of any economic 
variables shown to be related to an institution's risk of 
failure, and to impose premiums commensurate with that risk. 
The best methodologies for assessing risk are constantly 
changing based on the evolving modeling techniques and the 
changing economic conditions and financial instruments. As 
well, the banks may react in unexpected ways to any risk-based 
premium system, and so the FDIC should have the flexibility to 
react to any unforeseen consequences.
    Systemic risk is indeed difficult to calculate, but the 
Board does not believe that FDIC premiums should necessarily 
cover all the risks related to systemic crises and fully 
eliminate the subsidy in deposit insurance. To eliminate the 
subsidy in deposit insurance, the FDIC average insurance 
premium would have to be set high enough to cover fully the 
very small probabilities of very large losses and to cover 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 systemic risk and is thus subject to a far larger extreme 
loss in the tail of the probability distributions from which 
full insurance premiums would have to be calculated. Indeed, 
pricing deposit insurance risks to fully fund potential losses 
and cover systemic risk could well require premiums that would 
discourage most depository institutions from offering broad 
coverage to their customers. Since the Congress has determined 
that there should be broad coverage, the subsidy in deposit 
insurance cannot be fully eliminated and the Government has to 
absorb some of the costs of systemic risk, although we can and 
we should eliminate as much of the subsidy as we can.

   RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM ALAN 
                           GREENSPAN

Q.1. My understanding is that the Congress, in 1978, voted to 
allow the FDIC to insure IRA and Keogh accounts at the $100,000 
level while regular savings did not receive that level of 
coverage?
    First, am I correct about this? Second, can you discuss 
your position on coverage of particular categories of deposits 
like retirement savings taking into account this past history?

A.1. First of all, your statement about the 1978 vote is 
correct. In response to your second question, the Board opposes 
increases in deposit insurance coverage for any type of deposit 
at the present time. Raising the coverage limits now would 
extend the safety net, increase the Government subsidy to 
depository institutions, expand moral hazard, and reduce the 
incentive for market discipline without providing any clear 
public benefit. With respect to retirement accounts, according 
to the Board's 2001 Survey of Consumer Finances, the current 
insurance limit is not binding for the vast majority of IRA/
Keogh accounts at insured depository institutions. In addition, 
most households do not exhibit a strong preference for holding 
their retirement accounts in an insured depository. Again, 
according to the 2001 Survey of Consumer Finances, households 
hold slightly less than 22 percent of the value of their IRA/
Keogh accounts in an insured institution.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR JOHNSON FROM ALAN 
                           GREENSPAN

Q.1. One reform proposal includes a provision that would cap 
allowable premiums to the most highly rated institutions at one 
basis point, regardless of economic conditions. Some have 
argued that such a cap merely shifts the subsidy to a smaller 
category of financial institutions, but clearly undermines the 
fundamental reform proposal. Would you please comment on the 
one-basis-point cap proposal?

A.1. The Board believes that the FDIC should be allowed to set 
deposit insurance premiums so as to reflect the risk that a 
given institution poses to the deposit insurance fund. For even 
the safest institutions in the best economic environment, it is 
virtually certain that a premium of one basis point would not 
be sufficient to cover that risk. As I indicated in my 
testimony, the Board has concluded ``that if a cap on premiums 
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 that the market would apply and 
reduce the associated subsidy in deposit insurance.''

Q.2.a. Given that a merged fund would have a ratio of around 
1.28 percent, do you believe that a range that extends from 
1.25 to 1.5 percent provides the FDIC with sufficient 
flexibility to address the procyclicality concerns you have 
expressed?

A.2.a. The Board has no particular numbers in mind for the 
width of the permissible range for the designated reserve ratio 
(DRR). A relatively wide range would allow for more stability 
in premium rates over the economic cycle, an important goal of 
deposit insurance reform. However, although a range for the DRR 
is necessary to reduce procyclicality, it is not sufficient. In 
addition, when the actual reserve ratio (RR) either falls below 
the DRR or the range's lower limit, or rises above the DRR or 
the range's upper limit, it is important for the FDIC also to 
have the flexibility to restore the RR to its proper level in a 
way that does not cause wide swings in premiums. In particular, 
both a large premium increase when the economy is weak and a 
large premium decrease when the economy is strong should be 
avoided.

Q.2.b. Please tell the Committee specifically what range you 
believe would best address the procyclicality of the current 
system, and give a complete explanation of the breadth of the 
range.

A.2.b. Please see the answer to question (a).

Q.3. Please set forth your thoughts as to whether any new 
deposit insurance system should include specific triggers or 
recapitalization schedules should the deposit insurance 
reserves fall below the floor of the range.

A.3. This is a difficult question, and the answer requires a 
careful balancing of the need to limit the procyclicality of 
insurance premiums with the needs to limit taxpayer liability 
and to mange the insurance fund in a sound manner. On balance, 
the Board supports some legislative guidance to the FDIC 
regarding how quickly the insurance fund should be 
recapitalized. However, for the reasons I discussed in response 
to question (a), such guidance also should not hard wire rules 
that would force the FDIC to impose premiums that could 
seriously impair overall economic activity.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI

                      FROM PETER R. FISHER

Q.1. Some of the changes in the recommendations proposed seem 
like common sense, particularly issues providing more 
flexibility to the FDIC in setting the reserve ratio and 
returning the fund to that level. Can you provide me with a 
reason why some of these flexibilities weren't included with 
the legislation when the programs were initially instituted?

A.1. Congress established the current designated reserve ratio 
(DRR) in 1989 and imposed requirements on the FDIC in 1991 to 
maintain the DRR. These requirements came in the wake of the 
collapse of the savings and loan (S&L) deposit insurance fund, 
the appropriation of significant taxpayer resources to protect 
insured deposits at failed S&L's, and the temporary depletion 
of the reserves in the insurance fund for banks. Of paramount 
importance to the Congress and Executive Branch policymakers at 
that time was the need to ensure that, going forward, 
depository institutions themselves, not taxpayers, pay to 
protect insured deposits at failed institutions. Now that the 
FDIC's bank and thrift deposit insurance funds are well-managed 
and have adequate reserves, the Administration believes that 
this is the right time to act to correct certain structural 
weaknesses and improve the system's operation.

Q.2. When I obtain car insurance, no matter how good a driver I 
am, I pay for the insurance and the benefits I receive. Why is 
it that the law provides that some banks, who admittedly may be 
very well-managed, aren't required to pay for the insurance 
they receive from the fund?

A.2. The Federal Deposit Insurance Corporation Improvement Act 
of 1991 did provide the FDIC with the authority to charge every 
institution a risk-based premium. Legislation enacted in 1996, 
however, significantly curtailed this authority by prohibiting 
the FDIC from charging premiums to well-capitalized and well-
rated institutions when the reserve ratio has achieved or 
exceeded the designated reserve ratio. As a result, over 90 
percent of banks and thrifts currently do not pay deposit 
insurance premiums.

Q.3. I know that most of you oppose raising the coverage 
limits. However, if you had to choose, which increase would 
trouble you most--individual, retirement, or municipal.

A.3. The Administration does not support legislation that 
raises deposit insurance coverage limits in any form, and we 
urge that Congress avoid such an unneeded and counterproductive 
diversion from real and necessary reform.

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

Q.1. Mr. Fisher, in your testimony you highlighted what you 
labeled the ``free rider problem,'' which some might view as a 
loaded description of the deposit growth in the fund by certain 
institutions. Is your contention that these banks or thrifts 
were violating the law in some way or somehow unethically 
benefiting in ways not mandated by the law?

A.1. Every day that they operate, banks and thrifts benefit 
from their access to Federal deposit insurance. Yet, under 
existing law, over 90 percent of banks and thrifts currently do 
not have to pay deposit insurance premiums. Working within the 
current deposit insurance rules, some large financial companies 
have greatly augmented their insured deposits in the past few 
years by sweeping uninsured funds into their affiliated 
depository institutions--without having to compensate the 
insurance funds. Other major financial companies might be 
expected to do the same in the future. In addition, most of the 
over 1,100 banks and thrifts chartered after 1996 have never 
had to pay any deposit insurance premiums. To rectify this 
``free rider'' problem, Congress should remove the current 
restrictions on FDIC premium setting.
    There is nothing illegal or unethical in the current 
situation. But the current situation is unsound and inequitable 
as a financial matter.

Q.2. You stated that the reserve ratio would fall below its 
target level due to adverse economic conditions, but you now 
seem to be saying it has fallen due to the success of certain 
institutions in growing deposits. Which is the correct 
explanation?

A.2. The reserve ratio is the ratio of fund reserves to 
estimated insured deposits. Higher insurance losses, possibly 
fueled by adverse economic conditions, could cause fund 
reserves to decline and thereby lower the reserve ratio. In 
addition, higher levels of insured deposits may, by definition, 
reduce the reserve ratio, other factors being equal. Therefore, 
both adverse economic conditions and higher insured deposit 
levels could contribute to a decline in the reserve ratio.

Q.3. Finally, I am interested in how you reconcile support for 
risk-based premiums with your support for on-going assessment 
credits which, as you explain it, ``permit the FDIC to collect 
payments from institutions more closely in relation to their 
deposit growth.'' Are you advocating charging institutions 
based on the risk they pose to the fund or their success in 
growing their deposits?

A.3. We believe that insured depository institutions should 
appropriately compensate the FDIC commensurate with their risk. 
In order to accomplish this, Congress should remove the current 
restrictions on FDIC premium-setting. This would also mean that 
an institution's total payments would rise as its insured 
deposits rose: For two institutions with the same risk profiles 
but different levels of deposits, the institution with more 
deposits should pay more in premiums. Therefore, both risk and 
deposit levels should affect an institution's total premium 
payment.

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

Q.1. ``Retirement Savings Accounts'': My understanding is that 
the Congress, in 1978, voted to allow the FDIC to insure the 
IRA and Keogh accounts at the $100,000 level while regular 
savings did not receive that level of coverage ($40,000 
instead). Am I correct?

A.1. Yes. In 1978, Congress increased the IRA and Keogh account 
coverage limit to $100,000 and then increased the general 
coverage limit to $100,000 2 years later.

Q.2. Can you discuss your position on the coverage of 
particular categories of deposits like retirement savings 
accounts taking into account this past history?

A.2. Examining the Federal Reserve data on retirement (IRA/
Keogh) accounts also shows present maximum deposit insurance 
coverage to be more than adequate. The median balance across 
age groups held in IRA/Keogh accounts at insured depository 
institutions is only $15,000. For the 65 to 69 age group, 
median household IRA/Keogh deposits total $30,000 ($27,500 for 
those 70 or over). Furthermore, at little inconvenience, savers 
with substantial bank deposits including retirees and those 
with large bank savings for retirement--may place deposits at 
any number of banks to obtain as much FDIC coverage as desired.
    One of the fundamental rules of prudent retirement planning 
is to diversify investment vehicles. Many individuals, 
including those who are retired or planning for retirement, 
feel comfortable putting substantial amounts into uninsured 
mutual funds, money market accounts, and a variety of other 
investment instruments. Just 21 percent of all IRA/Keogh funds 
are in insured depository institutions. There is simply no 
widespread consumer concern about existing coverage limits that 
would justify extending taxpayer exposure by creating a new 
Government-insured retirement program under the FDIC.

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

Q.1. One reform proposal includes a provision that would cap 
allowable premiums to the most highly rated institutions at one 
basis point, regardless of economic conditions. Some have 
argued that such a cap merely shifts the subsidy to a smaller 
category of financial institutions, but clearly undermines the 
fundamental reform proposal. Would you please comment on the 
one-basis-point cap proposal?

A.1. We believe that the one-basis-point cap would needlessly 
undermine one of the primary goals of reform, namely, restoring 
the ability of the FDIC to align premiums more closely with 
risk. The cap would constrain the FDIC in how much revenue it 
can collect from that risk group, causing it to have to meet 
its revenue needs primarily from all other risk groups and 
thereby causing the risk-based rates to diverge from what they 
should be.

Q.2. In Chairman Greenspan's testimony, he highlights the 
procyclicality of the current system as one of its major flaws. 
He advocates that the ``suggested target reserve range be 
widened to reduce the need to change premiums abruptly.'' In 
addition, Chairman Greenspan has suggested that ``the FDIC be 
given the latitude to temporarily relax floor or ceiling ratios 
on the basis of current and anticipated banking conditions and 
expected needs for resources to resolve failing institutions.''
    In the Safety Act, we have proposed a range that extends 
from 1 to 1.5 percent. However, others support a range that 
begins at 1.2 or 1.25 percent.
    Please give complete answers to the following three 
questions:
    (a) Given that a merged fund would have a ratio of around 
1.28 percent, do you believe that a range that extends from 
1.25 to 1.5 percent provides the FDIC with sufficient 
flexibility to address the procyclicality concerns you have 
expressed?
    (b) Please tell the Committee specifically what range you 
believe would best address the procyclicality of the current 
system, and give a complete explanation for the breadth of the 
range.
    (c) In addition, please set forth your thoughts as to 
whether any new deposit insurance system should include 
specific triggers or recapitalization schedules should the 
deposit insurance reserves fall below the floor of the range.

A.2. Over much of its history, the FDIC insurance fund reserve 
ratio remained well above the current statutory target, only to 
drop into deficit conditions by the beginning of the 1990's. It 
is vital that funds collected in good times be available for 
times when they will be needed. We believe that a range for the 
designated reserve ratio (DRR) of 1.20 percent to 1.50 percent 
would achieve this objective while substantially reducing the 
procyclical bias of the current 
system.
    As we learned from the deposit insurance experience of the 
1980's, flexibility in managing reserves must be tempered by a 
clear requirement for prudent and timely fund replenishment. 
The lower the fund's reserves, the greater the probability that 
a rash of failures could wipe out the fund's net worth. The 
longer the time that the fund is allowed to operate with 
significantly inadequate reserves, the greater the risk that 
taxpayers might once again shoulder the cost of deposit 
insurance fund losses. Therefore, if the reserve ratio were to 
fall below the lower bound of the statutory range, the FDIC 
should restore it to within the statutory range promptly, over 
a reasonable but limited timeframe. We also support reducing 
the high minimum premium that would be in effect under current 
law when the FDIC is under a recapitalization plan.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI

                     FROM DONALD E. POWELL

Q.1. Some of the changes in the recommendations proposed seem 
like common sense, particularly issues providing more 
flexibility to the FDIC is setting the reserve ratio and 
returning the fund to that level. Can you provide me with a 
reason why some of the flexibilities weren't included with the 
legislation when the programs were initially instituted?
    When I obtain car insurance, no matter how good a driver I 
am, I pay for the insurance and the benefits I receive. Why is 
it that the law provides that some banks, who admittedly may be 
very well-managed, aren't required to pay for the insurance 
they receive from the fund?

A.1. Congress enacted most of the statutory provisions 
governing fund management in 1991, in FDICIA, at the height of 
the bank and thrift crisis. At that time, Congress was 
understandably concerned with protecting the taxpayers and 
ensuring that the deposit insurance funds were sufficiently 
capitalized. For this reason, the designated reserve ratio 
(DRR) was set relatively high (at least 1.25 percent), the FDIC 
was required to charge high average premiums (23 basis points) 
if the reserve ratio could not be brought back up to the DRR 
within a year, and the FDIC was required to institute risk-
based pricing.
    The provision prohibiting the FDIC from charging well-
managed, well-capitalized institutions for deposit insurance so 
long as the fund had achieved (and was expected to remain at or 
above) the DRR was not added until 1996, after the crisis had 
passed. The 1996 legislation (the Deposit Insurance Funds Act 
of 1996) required that banks begin sharing the burden of paying 
FICO bonds, which had been issued in an attempt to recapitalize 
the FSLIC. By 1996, the Bank Insurance Fund was fully 
recapitalized and the Funds Act provided for the capitalization 
of the Savings Association Insurance Fund, so that the pressing 
need to ensure sufficient revenue for the deposit insurance 
funds that existed in 1991 had passed.
    These pieces of legislation had two unintended effects. One 
was to create an extremely procyclical bias. The other was to 
frustrate the mandate in FDICIA to establish a risk-based 
pricing system for deposit insurance. In retrospect, it appears 
that, while the mandatory high premium rates during a 
recapitalization required by FDICIA were probably appropriate 
for the time--the worst banking crisis in U.S. history--these 
rates are not appropriate for less extreme downturns that are 
more likely to occur more often. In addition, other provisions 
of FDICIA, including prompt corrective action and least-cost 
resolution, reduced the likelihood of a repeat of the 1980's 
and 1990's banking crisis. If a crisis were to occur, FDICIA 
mandated that the entire capital of the banking industry 
(currently more than $775 billion) would be available to 
protect the taxpayers.

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

Q.1. Chairman Powell, in past meetings we have had on this 
subject the point has been made that deposit insurance does 
not, in many ways, work like a typical insurance fund. 
Specifically, it has been pointed out that the designated 
reserve ratio is not based on an actuarial model of potential 
losses in the system, but rather is based on historical 
precedent that may or may not be reflective of the true cost of 
that insurance. Assuming the FDIC is given flexibility to 
implement a range of reserve ratios, how will you determine 
what the proper range should be in the absence of typical 
insurance metrics? What specific data will you rely on, for 
example, industry profitability, deposit growth, etc.? Using 
your methodology can you tell us what the correct reserve ratio 
level for the fund should be today?

A.1. There is no single correct reserve ratio or range that is 
appropriate for all circumstances. The selection of a reserve 
ratio or range involves policy trade-offs. For example, while 
it might be possible to establish a reserve ratio or range that 
would protect the fund against all losses, it could require a 
very large fund balance to cover an eventuality with only a 
small probability of occurring. This would remove funds 
unnecessarily from the banking system that could otherwise be 
used to provide additional credit in communities. Therefore, 
the selection of a reserve ratio or range requires a balancing 
of policy goals.
    Federal Deposit Insurance Corporation staff will be able to 
give the FDIC Board the ability to make an informed decision 
about the proper range or target, however, through the use of 
analytical tools and empirical measurements. Generally, this 
will entail applying statistical techniques to market data, 
such as credit ratings and yield spreads, and regulatory data 
to assess changes in insurance fund exposure. Regulatory data 
may include such things as the CAMELS ratings (which are bank 
supervisory ratings), Call Report and Thrift Financial Report 
data and historical failure rates. The FDIC presently uses this 
data in several models to predict failure rates and trends in 
the industry. Ultimately, the goal will be to develop a credit 
risk modeling approach that quantifies the risk associated with 
any particular fund size. Because the amount of protection 
afforded by a particular fund size will vary depending upon 
risk in individual banks and in the industry, this analysis 
will be ongoing.

Q.2. You provided some very good reasons for increasing the 
FDIC's operational flexibility. At the same time, I have some 
concerns. Since the fund operates so differently from a typical 
insurance fund, I worry that without tight operating 
guidelines, political and industry pressures will play a large 
role in influencing operational decisions. If that happens, and 
the public sees the FDIC as a political entity, and not an 
unbiased provider of deposit insurance, the confidence in the 
FDIC could be undermined to the detriment of the whole system. 
If you are given greater flexibility, how will you as Chairman 
ensure that the FDIC avoids this trap?

A.2. You make a good point. In fact, we saw the effects of 
political and industry pressure on the Federal Savings and Loan 
Insurance Corporation (FSLIC) during the thrift crisis of the 
late 1980's. Political and industry pressures are generally 
greatest during a crisis, and a deposit insurer's ability to 
withstand these pressures is the least when it is 
insufficiently funded. For this reason, among others, the FDIC 
is not opposed in principle to a requirement that it adopt a 
mandatory recapitalization plan if the reserve ratio falls 
below a lower bound of 1.0 percent, provided that the 
recapitalization does not have to occur over too short a period 
of time. (Too short a recapitalization period would increase 
the risk of procyclicality and very high premiums.)
    However, the type of operational flexibility we seek is the 
ability to manage the fund and charge risk-based premiums 
during ``normal'' times (which we think could reasonably be 
defined as when the fund is within a range of 1.00 to 1.50 
percent). Our experience has been that in these periods, when 
the FDIC is well-funded and the industry is generally healthy, 
the FDIC is not overly subject to the types of pressures you 
are concerned about.

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

Q.1. My understanding is that the Congress, in 1978, voted to 
allow the FDIC to insure IRA and Keogh accounts at the $100,000 
level while regular savings did not receive that level of 
coverage ($40,000 instead). Am I correct about this? Can you 
discuss your position on the coverage of particular categories 
of deposits like retirement savings accounts taking into 
account this past history?

A.1. You are correct. As a general matter, I do not favor 
creating different deposit insurance coverage limits for 
special categories of deposits. Different coverage limits risk 
customer confusion and raise the possibility that depositors 
will unwittingly hold uninsured deposits. The current rules are 
already sufficiently complex that it is not uncommon for some 
depositors to find that they are not fully insured when a bank 
fails, even when they thought that they were fully insured.
    However, I believe that a sufficient case has been made for 
giving retirement accounts a higher coverage limit. Retirement 
accounts are uniquely important and protecting them is 
consistent with existing Government policies that encourage 
saving. It is not unusual for Americans who take full advantage 
of these incentives to accumulate more than $100,000. An 
increase in coverage for retirement accounts is consistent with 
the public policy goals that the Congress has already 
established. And, as your question mentioned, there is 
precedent for providing IRA's and Keogh's special insurance 
treatment.

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

Q.1. One reform proposal includes a provision that would cap 
allowable premiums to the most highly rated institutions at one 
basis point, regardless of economic conditions. Some have 
argued that such a cap merely shifts the subsidy to a smaller 
category of financial institutions, but clearly undermines the 
fundamental reform proposal. Would you please comment on the 
one-basis-point cap proposal?

A.1. Generally speaking, the deposit insurance premiums should 
reflect risk. In the long-term, the FDIC--or any insurer--must 
charge for risk to survive. Arbitrary caps, like the one-basis-
point cap for the most highly rated institutions, may prevent 
premiums from reflecting risk. If an arbitrary cap means that 
one group of insured institutions pays too little for its 
insurance, others must pay more than their fair share to make 
up the difference. Thus, an arbitrary cap may force one group 
of institutions to subsidize another. An arbitrary cap also can 
increase moral hazard if premiums do not fully reflect risk. 
Thus--even though a one-basis point premium may be reasonable 
for a significant number of institutions during normal times--I 
would prefer not to have the one-basis-point cap mandated by 
statute.

Q.2. In Chairman Greenspan's testimony, he highlights the 
procyclicality of the current system as one of its major flaws. 
He advocates that the ``suggested target reserve range be 
widened to reduce the need to change premiums abruptly.'' In 
addition, Chairman Greenspan has suggested that ``the FDIC be 
given the latitude to temporarily relax floor or ceiling ratios 
on the basis of current and anticipated banking conditions and 
expected needs for resources to resolve failing institutions.''
    In the Safety Act, we have proposed a range that extends 
from 1 to 1.5 percent. However, others support a range that 
begins at 1.2 or 1.25 percent.
    Please give complete answers to the following three 
questions:
    (a) Given that a merged fund would have a ratio of around 
1.28 percent, do you believe that a range that extends from 
1.25 to 1.5 percent provides the FDIC with sufficient 
flexibility to address the procyclicality concerns you have 
expressed?
    (b) Please tell the Committee specifically what range you 
believe would best address the procyclicality of the current 
system, and give a complete explanation for the breadth of the 
range.
    (c) In addition, please set forth your thoughts as to 
whether any new deposit insurance system should include 
specific triggers or recapitalization schedules should the 
deposit insurance reserves fall below the floor of the range.

A.2. As Chairman Greenspan testified, the narrower the range, 
the higher the probability of procyclical bias in the system. 
We suggest a range of 1.00 to 1.50 percent. In our view, a 
floor of 1.20 or 1.25 percent provides few benefits, and works 
against steady premiums, revenue neutrality, and risk-based 
pricing.
    Setting the floor at 1.20 percent versus 1.00 percent would 
have little impact on taxpayer protection. The Federal Deposit 
Insurance Corporation Improvement Act of 1991 (FDICIA) requires 
the FDIC to charge premiums as necessary to maintain adequate 
insurance funds. This means that the capital of the banking 
industry serves as a buffer to taxpayers. The industry capital 
currently exceeds $775 billion, compared to a combined deposit 
insurance fund of $43 billion.
    The floor must be low enough to allow for steady premiums 
in normal times when the industry is healthy. This is an 
important goal of deposit insurance reform. With a floor of 
1.20 percent, the failure of a single, medium-sized institution 
could put the fund in the restoration mode and require 
surcharges. In normal periods when the industry is healthy, the 
fund could be bouncing in and out of restoration mode with the 
result of unnecessarily volatile premiums.
    The point of deposit insurance reform is not to increase 
overall assessment revenue from the industry, but to spread the 
assessment burden more evenly over time and fairly across 
institutions. This means that the level of the range is 
important. A 1.20 percent floor is not significantly different 
from the present 1.25 percent DRR, which is effectively a 
floor. However, under a reformed system, all institutions will 
be assessed premiums at all times, even when the fund is above 
1.20 percent, while under the current system, only a small 
minority of institutions are assessed premiums when the fund is 
above 1.25 percent. Greater revenue under a reformed system 
means a higher fund level, all else being equal. Credits and 
rebates can be used to dampen growth of the fund; nevertheless, 
with a floor of 1.20 percent, the reserve ratio in the future 
is likely to spend long periods of time well above its recent 
levels, reflecting a higher overall cost to the industry.
    Moreover, a higher range for the reserve ratio could have 
consequences for risk-based pricing. As the fund grows in good 
times and the ratio approaches the cap, the deposit insurance 
system becomes self-funding through interest earnings. Credits 
or other mechanisms must be used to suppress premium income, 
and this works against the FDIC's ability to maintain an 
effective risk-based premium system that provides proper 
incentives. A better approach would be to provide a 
sufficiently wide range for the reserve ratio such that premium 
income is necessary on a regular basis, and assessment credits 
only occasionally dilute the incentives provided by the risk-
based premium system.
    When the reserve ratio is not below the lower bound, the 
FDIC should have full flexibility on the timeframe and premiums 
needed to reach the DRR (if there is one). If the reserve ratio 
falls below the lower bound, however, the FDIC is not opposed 
in principle to a requirement that it adopt a mandatory 
recapitalization plan--the shorter the timeframe for the plan, 
the greater the risk of procyclicality and very high premiums. 
Based upon our modeling results, the FDIC would prefer 10 years 
as the minimum period for a recapitalization plan, in order to 
avoid needless procyclicality and high premiums. The FDIC would 
not oppose minimum premiums of five basis points during a 
recapitalization plan, but would be concerned that higher 
minimum rates could be unnecessarily procyclical.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI

                    FROM JOHN D. HAWKE, JR.

Q.1. Some of the changes in the recommendations proposed seem 
like common sense, particularly issues providing more 
flexibility to the FDIC in setting the reserve ratio and 
returning the fund to that level. Can you provide me with a 
reason why some of these flexibilities weren't included with 
the legislation when the programs were initially instituted?

A.1. At the time the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (FDICIA), was enacted into law, the 
Bank Insurance Fund (BIF) was insolvent. Given the then recent 
bankruptcy of the Federal Savings and Loan Insurance 
Corporation and the large taxpayer cost of cleaning up the S&L 
crisis, there was a great emphasis put on quickly 
recapitalizing the BIF. With the benefit of hindsight, it has 
become clear that there needs to be a greater balance between 
the desire to quickly replenish the insurance fund and the 
possible adverse macroeconomic consequences of replenishing the 
fund too rapidly.

Q.2. When I obtain car insurance, no matter how good a driver I 
am, I pay for the insurance and the benefits I receive. Why is 
it that the law provides that some banks, who admittedly may be 
very well-managed, aren't required to pay for the insurance 
they receive from the fund?

A.2. The restriction on well-capitalized, well-run institutions 
paying insurance premiums was not part of the initial risk-
based premium system enacted by Congress as part of FDICIA in 
1991. It was enacted in 1996 as part of the Deposit Insurance 
Funds Act. At that time SAIF members were required to pay a 
65.7 basis point special assessment to capitalize the SAIF, and 
BIF members were, for the first time, required to pay part of 
the interest expense for the FICO bonds--bonds issued to help 
resolve the savings and loan crisis. However, even well-managed 
institutions pose some risk to the deposit insurance fund and 
derive benefits from deposit insurance, and they should pay for 
that insurance.

Q.3. I know that most of you oppose raising the coverage 
limits. However, if you had to choose, which increases would 
trouble you most--individual, retirement, or municipal?

A.3. The problem with raising the insurance limit is not with 
depositors. Depositors can already get all the coverage they 
want simply by splitting up their deposits. However, a higher 
limit would make it easier for individual banks to garner 
deposits, regardless of their financial strength, thus 
increasing moral hazard. This is true regardless of the source 
of the deposit.

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

Q.1. Mr. Hawke, in your testimony you supported the view 
expressed by many others that the ``cliff effect''--the 23 
point assessment by the FDIC to bring the designated reserve 
ratio back to 1.25 percent--is ``likely to hit banks the 
hardest when they are most vulnerable to earnings pressure.'' 
This seems to be contradicted by the current environment where 
we are seeing strong deposit growth, yet the fund has fallen 
close to the 1.25 percent floor. Can you comment on this 
situation?

A.2. While the reserve ratio for the Bank Insurance Fund (BIF) 
has fallen close to the 1.25 percent floor, this happened 
during a time when over 90 percent of insured institutions were 
not paying anything for deposit insurance. Thus, all growth had 
to be funded out of earnings on the fund after FDIC expenses--
including the expenses of supervising State nonmember banks. If 
the FDIC had been allowed to charge premiums--as is being 
proposed--the BIF would not be hovering close to the 1.25 
designated reserve ratio (DRR).
    In addition, the 23 basis point premium is only triggered 
if the fund is not expected to get back to the DRR within a 
year. Even if deposit growth were to push the BIF reserve ratio 
below 1.25, it would do so by only a few basis points, and it 
would not be necessary to charge 23 basis points, or anything 
near there, to return the fund to the DRR within a year.
    It would require substantial losses for the fund to fall 
sufficiently below the DRR as to trigger the 23 basis point 
cliff effect. This is most likely to occur during an economic 
downturn when banks are most likely to be subject to earning 
pressures.

Q.2. Can you point to a specific instance or period of time 
during which the ``cliff effect'' has weakened the national 
economy or a regional economy or contributed to the failure of 
a specific bank?

A.2. Prior to 1989, the FDIC charged a fixed premium of 8.33 
cents per $100 of domestic deposits, although until the mid-
1980's, rebates lowered the effective premium to about half of 
that. Starting in 1990 the FDIC raised assessments to 12 cents, 
then to 19.5 cents for the first half of 1991 and to 23 cents 
for the second half. The assessment rate remained at this level 
until 1995, when the reserve ratio of the BIF reached 1.25 
percent of insured deposits. Thus, we have had only one 
experience during which assessments were at or near the 23 
basis point level. The country was in recession in the early 
1990's, and there was much talk of a credit crunch. While no 
one can know for sure, had we had lower deposit insurance 
premiums and greater credit availability during this period, it 
might have helped pull the country out of recession earlier.

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

Q.1. My understanding is that the Congress, in 1978, voted to 
allow the FDIC to insure IRA and Keogh accounts at the $100,000 
level while regular savings did not receive that level of 
coverage ($40,000 instead). Am I correct about this?

A.1. Yes, you are correct.

Q.2. Can you discuss your position on the coverage of 
particular categories of deposits like retirement savings 
accounts taking into account this past history?

A.2. The increased coverage level on the IRA and Keogh accounts 
enacted in 1978, allowed the depositors with retirement savings 
of $100,000 to escape Regulation Q interest rate ceilings--
which did not apply to accounts of $100,000 or more--and still 
get the benefits of Federal deposit insurance. Regulation Q no 
longer applies, and Americans who wish to put in excess of 
$100,000 of retirement savings in insured deposit accounts can 
easily do so by putting those funds in more than one 
institution. Thus, unlike 1978, the depositors would not really 
benefit from an increase in coverage on retirement accounts.
    I would oppose raising the coverage limit on retirement 
accounts for the same reason I oppose raising the coverage 
limit on any other type of account. A higher limit would make 
it easier for individual banks to garner deposits, regardless 
of their financial strength, thus increasing moral hazard.

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

Q.1. One reform proposal includes a provision that would cap 
allowable premiums to the most highly rated institutions at one 
basis point, regardless of economic conditions. Some have 
argued that such a cap merely shifts the subsidy to a smaller 
category of financial institutions, but clearly undermines the 
fundamental reform proposal. Would you please comment on the 
one-basis-point cap proposal?

A.1. Premiums should be based on the risk an institution poses 
to the insurance fund. There should not be any arbitrary caps 
on the assessments the FDIC may charge a class of institutions.

Q.2. In Chairman Greenspan's testimony, he highlights the 
procyclicality of the current system as one of its major flaws. 
He advocates that the ``suggested target reserve range be 
widened to reduce the need to change premiums abruptly.'' In 
addition, Chairman Greenspan has suggested that ``the FDIC be 
given the latitude to temporarily relax floor or ceiling ratios 
on the basis of current and anticipated banking conditions and 
expected needs for resources to resolve failing institutions.''
    In the Safety Act, we have proposed a range that extends 
from 1 to 1.5 percent. However, others support a range that 
begins at 1.2 or 1.25 percent.
    Please give complete answers to the following three 
questions:

Q.2.a. Given that a merged fund would have a ratio of around 
1.28 percent, do you believe that a range that extends from 1.2 
to 1.5 percent provides the FDIC with sufficient flexibility to 
address the procyclicality concerns you have expressed?

A.2.a. There are a number of elements to addressing the 
procyclicality of the current deposit insurance system. A range 
for the reserve ratio is one of them. Other important elements 
include more flexible insurance pricing including the ability 
to charge premiums to all institutions based on risk, 
regardless of the level of the fund, so that the fund can build 
during good times, and eliminating the mandatory 23 basis point 
minimum assessment when the fund is not expected to reach the 
1.25 designated reserve ratio. Eliminating the 23 basis points 
mandatory premium combined with the ability to build the fund 
above the bottom of the range, should give the FDIC the 
flexibility it needs to address procyclicality.

Q.2.b. Please tell the Committee what range you believe would 
best address the procyclicality of the current system, and give 
a complete explanation for the breadth of the range.

A.2.b. The range should depend on overall economic conditions 
and risks in the banking industry, and is best determined by 
the FDIC Board through the rulemaking process.

Q.2.c. In addition, please set forth your thoughts as to 
whether any new deposit insurance system should include 
specific triggers or recapitalization schedules should the 
deposit insurance reserves fall below the floor of the range.

A.2.c. I believe it is desirable to have a recapitalization 
schedule if the fund falls below the bottom of the range. While 
care should be taken to assure that such a schedule takes into 
account possible adverse macroeconomic consequences, our 
experience with the savings and loan crisis teaches us the 
dangers of not addressing shortfalls in a deposit insurance 
fund in a timely and comprehensive manner.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI

                     FROM JAMES E. GILLERAN

Q.1. Some of the changes in the recommendations proposed seem 
like common sense, particularly issues providing more 
flexibility to the FDIC in setting the reserve ratios and 
returning the fund to that level. Can you provide me with a 
reason why some of these flexibilities weren't included with 
the legislation when the programs were initially instituted?

A.1. We defer to the FDIC for a legislative history on the 
deposit insurance programs instituted pursuant to the laws 
affecting the Federal deposit insurance funds.

Q.2. When I obtain car insurance, no matter how good a driver I 
am, I pay for the insurance and the benefits I receive. Why is 
it that the law provides that some banks, who admittedly may be 
very well-managed, aren't required to pay for the insurance 
they receive from the fund?

A.2. The Deposit Insurance Funds Act of 1996 provided that once 
the designated reserve ratio (DRR) was reached, insurance 
premiums could no longer be collected for well-capitalized 
institutions (CAMELS rated 1 or 2). Today, 92 percent of 
institutions pay no insurance premiums. We agree with the other 
Federal banking agencies and the Treasury Department that risk-
based premiums are an important component of deposit insurance 
reform.
    With respect to the specific history of the legislation, we 
defer to the FDIC.

Q.3. I know that most of you oppose raising the coverage 
limits. However, if you had to choose, which increase would 
trouble you most--individual, retirement, or municipal?

A.3. The benefits of increasing coverage are unclear, 
particularly a significant increase in a category that results 
in higher costs for 
insured institutions--whether from increased premiums or costs 
related to customer notice, signage, forms, and agreements.
    With respect to individual accounts, many OTS-regulated 
institutions have stated that they see no merit to bumping up 
the current coverage limit, or to index it. In their view, 
projected increases in insured deposits would not lead to a 
substantive increase in new accounts. Moreover, as observed by 
Chairman Greenspan, 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 
deposit insurance coverage. For these same reasons, we see 
little merit in carving out and increasing the current coverage 
limit for retirement accounts.
    We have similar reservations regarding increasing the 
insurance cap for municipal deposits. The FDIC staff has 
indicated that providing insurance coverage for municipal 
deposits could have a significant negative impact on a combined 
fund's reserve ratio. We cannot support the cost of this 
increase relative to the potential benefit derived by a small 
number of institutions from an increase in coverage for 
municipal deposits.

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

Q.1. My understanding is that the Congress, in 1978, voted to 
allow the FDIC to insure IRA and Keogh accounts at the $100,000 
level while regular savings did not receive that level of 
coverage ($40,000 instead). Am I correct about this?
    Can you discuss your position on the coverage of particular 
categories of deposits like retirement savings accounts taking 
into account this past history?

A.1. In 1974, Congress increased deposit insurance coverage 
from $20,000 to $40,000 generally and to $100,000 for deposits 
of States and localities. In 1978, coverage was increased to $ 
100,000 for IRA and Keogh retirement accounts. Two years later, 
coverage for all accounts was increased to $100,000 by 
provisions of the Depository Institutions Deregulation and 
Monetary Control Act.
    While Congress has occasionally carved out special 
categories for increased deposit insurance coverage in the 
past, the merits of this approach under our current system are 
not convincing. As Chairman Greenspan testified at the hearing, 
it is currently possible for a family of four to obtain 
substantially in excess of $1 million in deposit insurance 
coverage at a single institution. Thus, there does not appear 
to be a need to increase the cap on retirement savings accounts 
or any other type of account for individual depositors.
    There is also little credible evidence to support the 
notion that a coverage increase, whether it be across the board 
or for particular categories of deposits, will increase the 
ability of the institutions--especially small, community-based 
institutions--to attract more deposits. It is plausible, 
however, that raising the deposit coverage cap would actually 
increase costs for insured institutions by requiring higher 
premiums and--particularly with respect to indexing--increasing 
costs related to customer notice, signage, forms, and 
agreements.

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

Q.1. One reform proposal includes a provision that would cap 
allowable premiums to the most highly rated institutions at one 
basis point, regardless of economic conditions. Some have 
argued that such a cap merely shifts the subsidy to a smaller 
category of financial institutions, but clearly undermines the 
fundamental reform proposal. Would you please comment on the 
one-basis-point cap proposal?

A.1. Providing the FDIC Board with flexibility to levy premiums 
that correctly reflect the insurance risks posed by insured 
depository institutions is a critical element of deposit 
insurance reform. Provisions that limit the FDIC's ability to 
set premiums undermine the objective of an effective risk-based 
premium system. A one-basis-point cap on premiums for the most 
highly rated institutions would subsidize risk-taking behavior 
by those institutions and thereby weaken the economic 
incentives important to the health and stability of the deposit 
insurance system. We oppose a one-basis-point cap on the FDIC's 
premium-setting authority.

Q.2. In Chairman Greenspan's testimony, he highlights the 
procyclicality of the current system as one of its major flaws. 
He advocates that the ``suggested target reserve range be 
widened to reduce the need to change premiums abruptly.'' In 
addition, Chairman Greenspan has suggested that ``the FDIC be 
given the latitude to temporarily relax floor or ceiling ratios 
on the basis of current and anticipated banking conditions and 
expected needs for resources to resolve failing institutions.''
    In the Safety Act, we have proposed a range that extends 
from 1 to 1.5 percent. However, others support a range that 
begins at 1.2 or 1.25 percent.
    Please give complete answers to the following three 
questions:

Q.2.a. Given that a merged fund would have a ratio of around 
1.28 percent, do you believe that a range that extends from 
1.25 to 1.5 percent provides the FDIC with sufficient 
flexibility to address the procyclicality concerns you have 
expressed?

A.2.a. OTS supports providing the FDIC Board with maximum 
flexibility to set a reserve ratio within a range that protects 
the long-term viability and stability of the deposit insurance 
funds. The difficulty is in establishing a floor that promotes 
the long-term safety and soundness of the deposit insurance 
fund while also providing sufficient flexibility to the FDIC 
Board to address the procyclicality issue. It may be 
appropriate for the FDIC Board to target a reservation ratio 
within a range that extends somewhat below 1.25 percent, but we 
would have concerns with a floor lower than 1.15 percent. 
Providing the FDIC Board with flexibility to charge premiums 
commensurate with risk and to build the fund above the bottom 
of the range are equally important in addressing procyclicality 
concerns. A more fundamental concern is the safety, soundness, 
and long-term viability of the fund. We believe that a target 
reserve ratio range of 1.15 percent to 1.50 percent deposit 
strikes an appropriate balance among these concerns.

Q.2.b. Please tell the Committee specifically what range you 
believe would best address the procyclicality of the current 
system, and give a complete explanation for the breadth of the 
range.

A.2.b. A reserve ratio target of between 1.15 percent and 1.5 
percent of insured deposits provides substantial flexibility to 
the FDIC Board without unduly jeopardizing the safety and 
soundness of a combined deposit insurance fund. This range 
would allow the FDIC to build reserves in anticipation of 
deposit insurance losses and to absorb losses without 
triggering premium increases to rebuild the fund during times 
of stress for insured institutions.
    Based on insured deposits as of December 31, 2002, a 35-
basis-point range represents a dollar range of $11.86 billion 
for a merged insurance fund. As of December 31, 2002, a merged 
deposit insurance fund would have had a reserve ratio of 1.29 
percent (with combined reserves of $43.80 billion), which would 
have exceeded the 1.15 percent target range floor by $4.84 
billion, yet still be $7.02 billion below the 1.50 percent 
ceiling of the target range on that date. Thus, a 1.15 percent 
to 1.50 percent target range provides flexibility to the FDIC 
Board with significant parameters in which to set reserves, 
while maintaining substantial reserve levels even at the bottom 
of the target range.

Q.2.c. In addition, please set forth your thoughts as to 
whether any new deposit insurance system should include 
specific triggers or recapitalization schedules should the 
deposit insurance system reserves fall below the floor of the 
range.

A.2.c. Triggers that impose a sharply higher premium in times 
of stress for insured institutions worsen the procyclicality of 
the deposit insurance system. Providing the FDIC Board with 
flexibility to recapitalize the deposit insurance fund within a 
reasonable timeframe and with a premium lower than that 
required under current law would help avoid problems associated 
with procyclicality and reduce the impact on institutions 
during times of economic stress.
Robert D. Novak

                          Goodbye, Greenspan?

    Washington--It is difficult to exaggerate the aggravation at the 
White House over Alan Greenspan's gratuitous shot at President Bush's 
tax cuts. So angry are the President's advisers that they are willing 
to consider not reappointing Greenspan next year to a final term as 
Chairman of the Federal Reserve Board.
    The conventional wisdom is that shaky financial markets could not 
withstand the loss of Dr. Greenspan, exalted in Wall Street as master 
of the universe. Similar predictions about nonreappointment of past Fed 
Chairmen Paul Volcker and Arthur Burns proved groundless. With the 
expiration of Mr. Greenspan's Chairmanship 16 months away, adverse 
impact on investors could be discounted by early disclosure of the 
President's intentions.
    Greenspan's prestige is so overpowering that hand-wringers will 
tell Bush that he dare not prevent Greenspan from serving his final 2 
years at the Nation's central bank. Still, senior officials privately 
mention Robert Glenn Hubbard, Chairman of the Council of Economic 
Advisers, as a possible replacement. A more conventional choice they 
ponder is William McDonough, the Fed's second-ranking official as New 
York Federal Reserve Bank President. Furthermore, the White House is in 
the 
market for additional names.
    The White House and the independent Federal Reserve have been in an 
effective nonaggression pact for two decades. Since the middle of the 
Reagan Administration, the White House has said nothing about the Fed's 
handling of monetary policy. Accordingly, Greenspan could unwisely 
tighten money in the face of a coming recession with impunity.
    In return, Greenspan has assented to any fiscal policy by any 
President--from Bill Clinton's 1993 tax increase to George W. Bush's 
2001 tax cut. In a departure, however, Greenspan's recent testimony to 
Congress placed him in a clearly adversarial relationship with the 
President. On February 11, he told the Senate Banking Committee there 
was no need for the Bush tax cuts and warned of increasing 
budget deficits.
    This was something Bush and his inner circle did not expect or 
appreciate, and Greenspan's characteristic modification in House 
testimony February 12, earned him a rebuff from Democrats but not a 
reprieve from the White House. He had made it harder for Bush to win 
his major domestic initiative.
    Consequently, senior White House aides began to consider the 
decision the President soon will face. Although only two Fed governors 
have completed the single 14 year term since it was established in 
1936, Greenspan has served on the Board nearly 15 years--6 years 
filling an expired term and 9 years for a full-term. The 14 years end 
in 2006, and Greenspan cannot be reappointed. His latest 4 year term as 
Chairman expires on June 20, 2004. Thus, Bush must decide whether to 
give Greenspan a fifth term as Chairman, which would be cut short after 
2 years.
    Given this situation, the White House yearns for a new face at the 
Fed--such as Glenn Hubbard. The Bush inner circle was not happy about 
Hubbard's feud with Lawrence Lindsey, then the National Economic 
Adviser. Nevertheless, Hubbard survived the purge of the Bush economic 
team, and was dispatched by the White House February 12, to answer 
Greenspan's claim that the Bush tax cut is ``premature.'' Hubbard, a 
Harvard Ph.D. Economist who is only 44 years old, would be an 
articulate young voice at the Fed.
    McDonough, who has announced his retirement from the New York Fed 
effective in July after an unusually long 10 years in charge there, 
would be a safer pick than Hubbard. A nominal Democrat who admires and 
supports Bush, he was considered for Secretary of the Treasury late 
last year. He is a traditional central banker well-respected by the 
investor community. McDonough is 68 years old, but that is nearly a 
decade younger than Greenspan, who celebrates his 77th birthday March 
6.
    ``You have been in this position for a long time, some would say 
too long,'' Republican Senator Jim Bunning told Greenspan after he 
criticized the tax cuts. That sentiment is shared at the White House, 
which wants Hubbard, McDonough, or any Federal Reserve Chairman who 
will not be a back shooter. The question is whether Bush has the nerve 
to fire Alan Greenspan and the skill to get away with it.
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