[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.
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\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.
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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.
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\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.