[Federal Register Volume 60, Number 158 (Wednesday, August 16, 1995)]
[Rules and Regulations]
[Pages 42680-42741]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-20170]



      

[[Page 42679]]

_______________________________________________________________________

Part IV





Federal Deposit Insurance Corporation





_______________________________________________________________________



12 CFR Part 327



Assessments; Retention of Existent Assessment Rate Schedule for SAIF-
Member Institutions; Final Rules

  Federal Register / Vol. 60, No. 158 / Wednesday, August 16, 1995 / 
Rules and Regulations  
=======================================================================
-----------------------------------------------------------------------

[[Page 42680]]


FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 327

RIN 3064-AB58


Assessments

AGENCY: Federal Deposit Insurance Corporation.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: The Board of Directors (Board) of the Federal Deposit 
Insurance Corporation (FDIC) is amending the FDIC's regulation on 
assessments to establish a new assessment rate schedule of 4 to 31 
basis points for institutions whose deposits are subject to assessment 
by the Bank Insurance Fund (BIF). In addition, the Board is amending 
the assessment schedule to widen the existing assessment rate spread 
from 8 basis points to 27 basis points. The Board is further amending 
the assessments regulation to establish a procedure for adjusting the 
rate schedule semiannually as necessary to maintain the designated 
reserve ratio (DRR) at 1.25 percent.
    The Board is adopting the new assessment schedule to satisfy the 
requirements of section 7(b) of the Federal Deposit Insurance Act that, 
once the reserve ratio of the BIF reaches the DRR of 1.25 percent of 
total estimated insured deposits, rates be set to maintain the DRR. The 
new schedule will apply to the semiannual period in which the DRR has 
been achieved (which is expected to occur in the second quarter of 
1995) and to semiannual periods thereafter, subject to modification 
semiannually by the FDIC. Specifically, the new assessment schedule, 
which will reduce BIF assessment rates for all but the riskiest 
institutions, will become effective on the first day of the month after 
the month in which the DRR is achieved. Assessments collected at the 
previous assessment schedule that exceed the amount due under the new 
schedule will be refunded, with interest, from the effective date of 
the new schedule.

EFFECTIVE DATE: September 15, 1995.

FOR FURTHER INFORMATION CONTACT: Frederick S. Carns, Chief, Financial 
Markets Section, Division of Research and Statistics, (202) 898-3930; 
Christine Blair, Financial Economist, Division of Research and 
Statistics, (202) 898-3936; Connie Brindle, Chief, Assessment 
Operations Section, Division of Finance, (703) 516-5553; Claude A. 
Rollin, Senior Counsel, Legal Division (202) 898-3985; or Martha 
Coulter, Counsel, Legal Division (202) 898-7348, Federal Deposit 
Insurance Corporation, Washington, DC 20429.
SUPPLEMENTARY INFORMATION:

I. Background

    On February 16, 1995, the Board published for public comment a 
proposal to lower the assessment rate schedule for BIF members to 4 to 
31 basis points from the current schedule of 23 to 31 basis points. The 
Board further proposed to amend the assessment rate matrix to widen the 
existing rate spread from 8 basis points to 27 basis points. 60 FR 9270 
(Feb. 16, 1995). The Board is now adopting the proposed amendments with 
minor modifications.
    Under the assessment schedule currently in effect, BIF members have 
been assessed rates for FDIC insurance ranging from 23 basis points for 
institutions with the best assessment risk classification to 31 basis 
points for the riskiest institutions. This assessment schedule was 
based on the requirements of section 7(b)(2)(E) of the Federal Deposit 
Insurance Act (FDI Act), 12 U.S.C. 1817(b)(2)(E). That provision was 
enacted as part of section 302 of the Federal Deposit Insurance 
Corporation Improvement Act of 1991 (FDICIA) (Pub. L. 102-242, 105 
Stat. 2236, 2345) which completely revised the assessment provisions of 
the FDI Act by requiring the FDIC to: (1) Establish a system of risk-
based assessments; (2) establish assessment rates sufficient to provide 
revenue at least equivalent to that generated by an annual 23 basis 
point rate until the BIF reserve ratio 1 achieves the DRR of 1.25 
percent 2 of total estimated insured deposits; (3) when the 
reserve ratio remains below the DRR of 1.25 percent, set rates to 
achieve that ratio within one year or establish a recapitalization 
schedule to do so within 15 years; and (4) once the DRR is achieved, 
set rates to maintain the reserve ratio at the DRR.

    \1\ The reserve ratio is the dollar amount of the BIF fund 
balance divided by the estimated insured deposits of BIF members.
    \2\ The DRR of 1.25 percent is equivalent to $1.25 for each $100 
of estimated insured deposits.
---------------------------------------------------------------------------

    Due to the health of the banking industry, current projections 
indicate that the BIF may have recapitalized sometime during the second 
quarter of 1995, although recapitalization has not yet been verified. 
The actual month of recapitalization cannot be confirmed until data 
from the June 30, 1995, Reports of Condition and Income (call reports) 
is processed, which the FDIC expects to occur early in September. 
Accordingly, to implement the statutory provisions which will apply 
once the DRR is reached, the Board is adopting an assessment rate 
schedule for BIF members of 4 to 31 basis points that will become 
effective the first day of the month after the month in which the DRR 
is achieved. Assessments collected at the previous rate schedule that 
exceed the amounts due under the new schedule after the DRR has been 
achieved will be refunded in one or more payments, with interest, from 
the effective date of the new schedule (or, in the case of June 30 
overpayments, from June 30 or, if later, the actual payment date). As 
proposed, the Board is further adopting a process to adjust rates 
semiannually without a new notice-and-comment rulemaking proceeding, 
using an adjustment factor of 5 basis points.
    At the request of Board Member Jonathan Fiechter and interested 
outside parties, the Board held a hearing at FDIC headquarters in 
Washington, D.C. on March 17, 1995, to provide the opportunity for 
interested parties to express orally their views on the proposals to 
decrease assessment rates for members of the BIF while retaining the 
existing 23 to 31 basis point assessment schedule for members of the 
Savings Association Insurance Fund (SAIF), on the competitive impact of 
the disparity between BIF and SAIF rates, and on possible solutions for 
recapitalizing the SAIF and paying the interest on Financing 
Corporation bonds. Every person or organization that requested an 
opportunity to testify was accommodated.
    A total of twenty witnesses were heard by the full FDIC Board 
during the day-long hearing. They included the American Bankers 
Association (ABA), the Independent Bankers Association of America 
(IBAA), America's Community Bankers, the Savings Association Insurance 
Fund Industry Advisory Committee, the National Association of Home 
Builders, representatives of several bank and thrift state 
associations, individual bank and thrift executives, a private sector 
attorney, and an independent consultant. The written testimony of each 
witness as well as the hearing record are included in the FDIC's public 
comment file on the two proposals.
    In total, the FDIC received over 3,200 comments on the BIF proposal 
(together with the comments received on the Board's proposal to retain 
the existing assessment rate schedule for members of the Savings 
Association Insurance Fund), including the testimony from the public 
hearing. After taking account of duplicates, 2,891 comments were 
tabulated representing 2,310 individual BIF member respondents, 454 

[[Page 42681]]
individual SAIF member respondents, 61 trade associations and 66 other 
individuals/organizations.
    Following is a discussion of: (1) The statutory framework for 
setting assessment rates, (2) the new assessment rate spread, (3) the 
new assessment rate schedule, (4) the method for applying the schedule 
in the semiannual period during which the DRR is achieved, and (5) the 
process for limited adjustment of the new schedule in future semiannual 
periods. A summary of the comments received is included with the 
specific issue(s) addressed by the parties submitting comments.

II. Statutory Framework for Setting Assessment Rates

A. Introduction

    Section 7(b) of the FDI Act governs the Board's authority for 
setting assessment rates for members of the BIF. 12 U.S.C. 1817(b). 
Section 7(b)(1) (A) and (C) require that the FDIC maintain a risk-based 
assessment system, setting assessments based on (1) the probable risk 
to the fund posed by each insured depository institution taking into 
account different categories and concentrations of assets and 
liabilities and any other relevant factors; (2) the likely amount of 
any such loss; and (3) the revenue needs of the fund. Section 
7(b)(2)(A) of the FDI Act requires the Board to set semiannual 
assessments to maintain the BIF reserve ratio at the DRR once the BIF 
is recapitalized,3 taking into consideration the fund's: (1) 
Expected operating expenses; (2) case resolution expenditures and 
income; (3) the effect of assessments on members' earnings and capital; 
and (4) any other factors that the Board may deem appropriate. Section 
7(b)(2)(A)(iii) further directs the Board to impose on each institution 
a minimum assessment of not less than $1,000 semiannually. When the 
reserve ratio remains below the DRR, the statute explicitly directs the 
Board to set rates that will at a minimum generate revenue equivalent 
to the amount generated by an average assessment rate of 23 basis 
points. FDI Act, section 7(b)(2)(E).

    \3\ The DRR of the BIF currently is 1.25 percent of estimated 
insured deposits. FDI Act, section 7(b)(2)(A)(iv). The Board may 
increase the DRR to such higher percentage as the Board determines 
to be justified for a particular year by circumstances raising a 
significant risk of substantial future losses to the fund. However, 
the Board is not authorized to decrease the DRR below 1.25 percent. 
Id.
---------------------------------------------------------------------------

    For the first time since the current provisions of section 7(b) 
were enacted in 1991, the determination that the BIF has achieved the 
DRR is imminent and, therefore, the minimum 23 basis point average 
assessment requirement will no longer apply. Accordingly, the Board 
must now establish an assessment schedule that satisfies the directive 
of section 7(b)(1) to establish a risk-based assessment system, based 
on the statutory factors which must be considered in that 
determination; and the directive of section 7(b)(2) to maintain the BIF 
reserve ratio at 1.25 percent, considering the statutory factors which 
must inform that decision. As a practical matter, there is significant 
overlap between the factors to be considered under section 7(b)(1) and 
those to be considered under section 7(b)(2). For example, in 
determining risk-based assessments, the Board must consider the 
probability and likely amount of losses to the fund. When setting 
assessments to maintain the reserve ratio at the DRR, the Board must 
consider the same underlying data but denominated as ``case resolution 
expenditures''. Thus, these determinations are interdependent and any 
decision concerning an appropriate assessment schedule will consider 
and balance all of the statutory factors that underlie these two 
directives.
    In the current favorable economic environment even with assessment 
rates as low as prudently possible consistent with the Board's 
fiduciary responsibilities to the insurance fund, the FDIC recognizes 
that the reserve ratio may grow beyond 1.25 percent as a result of the 
impact on the fund balance of revenues generated from risk-based 
assessments, the $1,000 semiannual minimum assessment, and investment 
income. Under these circumstances, any new assessment schedule adopted 
by the Board must be the result of balancing the directive to maintain 
a risk-based assessment system (and the statutory factors attendant 
thereto) and the directive to set rates to maintain the DRR (and the 
statutory factors attendant thereto). As discussed more fully below, 
the statute and the legislative history provide little guidance as to 
how to weigh the wide range of statutory factors that go into this 
decision. The following sections address the Board's interpretation of 
the interplay of the directives of section 7(b) and include a 
discussion of comments received on the related issues in the proposal.
B. Maintain ``At'' the DRR

    The Board is adopting the proposed interpretation of the statutory 
requirement to maintain the reserve ratio at the DRR in which the Board 
views the DRR as a target. Pursuant to section 7(b)(2)(A)(i) of the FDI 
Act, the Board must set semiannual assessments to maintain the reserve 
ratio of the BIF at the DRR taking into consideration the following 
factors: (1) Expected operating expenses; (2) case resolution 
expenditures and income; (3) the effect of assessments on members' 
earnings and capital; and (4) any other factors the Board may deem 
appropriate.4 Section 7(b)(2)(A)(iii) limits the Board's 
discretion to set assessment rates by imposing a minimum semiannual 
assessment of $1,000 per BIF member.5

    \4\ The directive to ``set rates to maintain the reserve ratio 
at the designated reserve ratio'' was enacted as part of the 
amendments to section 7 made by the FDIC Assessment Rate Act of 1990 
(Assessment Rate Act). Pub. L. 101-508, 104 Stat. 1388, 1388-14. The 
Assessment Rate Act is Subtitle A of Title II of the Omnibus Budget 
Reconciliation Act of 1990. See, discussion of legislative history 
in the proposed regulation. 60 FR 9270 at 9272 (Feb. 16, 1995).
    \5\ As enacted in FDICIA, section 7(b)(2)(A)(iii) of the FDI Act 
provides that the semiannual assessment for each member of a deposit 
insurance fund shall be not less than $1,000. Accordingly, BIF 
members must pay the greater of their risk-based rate or $2000 each 
year.
---------------------------------------------------------------------------

    As stated in the proposal, the Board views the DRR as a target 
around which the actual reserve ratio would fluctuate, rather than as a 
rigid ceiling above which the reserve ratio could not rise even 
slightly.6 The Board based this interpretation on (1) the 
impossibility of controlling the economic factors which affect the size 
of the BIF; (2) the legislative history of section 7(b); and (3) the 
other statutory directives of section 7(b) that the FDIC establish a 
system of risk-based assessments and impose a minimum semiannual 
assessment of $1,000 (either of which may cause the reserve ratio to 
exceed 1.25 percent in the current economic circumstances). The Board 
further stated that in the event the reserve ratio exceeds the DRR due 
to economic factors beyond its control (such as the level of investment 
income) or as a result of effectuating other statutory directives (such 
as the requirement to have a risk-based assessment system), the Board 
considers that it will have complied with the statute because the Board 
will have set rates to maintain the reserve ratio at 1.25 percent in 

[[Page 42682]]
accordance with statutory requirements for a risk-based assessment 
system and a minimum semiannual assessment. The Board is adopting this 
interpretation with added discussion to clarify the need to balance the 
directives of section 7(b) and the statutory factors which must be 
considered in that balancing decision.

    \6\ Treating the DRR as a target would necessarily include the 
concept of fluctuations above and below the target. If the reserve 
ratio falls below 1.25% in a semiannual period, the Board could 
adjust the assessment schedule in the next semiannual period to 
restore the ratio. Section 7(b)(3)(A) of the FDI Act contemplates 
precisely that. That section provides that, after the DRR is 
achieved, if the reserve ratio falls below the DRR, the Board is 
required to set semiannual assessments sufficient to increase the 
reserve ratio to the DRR within one year or in accordance with a 
recapitalization schedule promulgated to restore the reserve ratio 
to the DRR within 15 years. Conversely, when the reserve ratio rises 
above the DRR for any period, the Board could adjust the assessment 
schedule downward to reflect the increase.
---------------------------------------------------------------------------

1. Comments
    The appropriate interpretation of the directive to ``maintain the 
reserve ratio at the designated reserve ratio'' was one of the issues 
that elicited the greatest response from commenters. Of the 864 
respondents that addressed this issue, 851 (813 BIF members, 30 trade 
associations, 4 SAIF members and 4 other individuals or organizations) 
believed that the DRR of 1.25 percent should be interpreted as a 
precise number or a ceiling and that all assessment revenue (and in 
some cases investment income) in excess of 1.25 percent should be 
returned to BIF members. Thirteen respondents (8 BIF members, 2 trade 
associations, 2 SAIF members and 1 other individual) agreed with the 
Board that the DRR is necessarily a target about which the reserve 
ratio will fluctuate. As noted above, the concept of the DRR as a 
precise number above which the BIF may not rise necessarily requires a 
mechanism to return excess assessments. See Section II.D below for a 
discussion of comments addressing the FDIC's authority to provide 
rebates. By contrast, the Center for Study of Responsive Law/Essential 
Information interpreted the statutory DRR as a floor and urged the FDIC 
to establish a higher range for the DRR with a target average of 1.63 
percent using 1.25 percent as the floor and 2.0 percent as the ceiling.
    Numerous commenters stated that the Board may not intentionally set 
assessments at a level which, based on its own projections, will 
increase the reserve ratio above the DRR. Accordingly, many have 
asserted that by setting the proposed assessment schedule at 4 to 31 
basis points, the Board will have, in effect, knowingly set the rates 
to increase the DRR above 1.25 percent without making the required 
statutory finding to increase the DRR. This assertion was based on a 
misreading of a chart publicly distributed at the Board meeting on the 
proposals indicating that under the proposed rate schedule, the reserve 
ratio would rise to 1.30 percent in 1995 and 1.33 percent in 1996 and 
remain above the DRR until the year 2001. The projections in the chart 
did not reflect the possibility of semiannual changes that the Board 
might make to the assessment schedule.
    For example, the primary argument of the ABA is that the Board 
cannot intentionally set assessments to generate assessment income 
which its own predictions show will increase the reserve ratio above 
the DRR. According to the ABA, to do so would render meaningless the 
requirement that the Board must make a determination that circumstances 
raising a significant risk of substantial future losses to the fund 
justify an increase in the DRR. Similarly, the IBAA stated that in 
light of its own projections, FDIC appears to be managing the fund at a 
level higher than 1.25 percent.
2. The Board's Rationale for Interpreting the DRR as a Target
    As described more fully below, the Board continues to believe that 
viewing the DRR as a target to be maintained over time is the correct 
position because: (1) It reflects the inconstancy of economic factors 
which make it impossible for the FDIC to maintain the reserve ratio 
precisely at 1.25 percent; (2) it better comports with Congress' view 
of the DRR as a target as indicated by the legislative history and the 
practical impact of Congress' elimination of the FDIC's rebate 
authority in section 7(d); and (3) it gives effect to other provisions 
of section 7(b), most importantly, the requirement for a risk-based 
assessment system. A discussion of each of these elements of the 
Board's rationale follows.
    (a) Management of Reserve is Imprecise. The first element upon 
which the Board based its interpretation of the ``maintain at'' 
requirement is the FDIC's inability to control economic factors which 
affect the size of the reserve ratio, thereby making it impossible to 
manage the BIF precisely at 1.25 percent. Changes in the reserve ratio 
are a function of the amount of insured deposits, investment earnings, 
assessment revenue (which, in turn, is a function of the risk profile 
of the industry and revenue received from the statutory minimum 
assessment), and revenue from corporate-owned and other assets, none of 
which is in the complete control of the FDIC. In addition, operating 
expenses and insurance losses, including the provision for future 
losses, will vary. Even with regard to the elapsed time between the 
setting of rates for an upcoming semiannual assessment period and the 
end of that period, there is a potential for variations in all of these 
factors, thus making it impossible to manage the reserve ratio 
precisely at the DRR.
    Moreover, Congress must have understood that the reserve ratio 
cannot be maintained precisely at 1.25 percent because such an 
interpretation would require that amounts in excess of 1.25 percent be 
returned to the industry. In the current economic environment, the fund 
will likely grow beyond the DRR as a result of investment income and 
revenue generated by the risk-based assessment system. Thus, an 
interpretation which requires the FDIC to maintain the reserve ratio 
precisely at 1.25 percent would necessarily require a mechanism for 
providing assessment credits (known as rebates) to BIF members for 
amounts in excess of 1.25 percent. However, as discussed more fully in 
Section II.D below, in FDICIA Congress deleted the FDIC's authority in 
section 7(d), 12 U.S.C. 1817(d), to provide rebates. In addition, 
Congress can be presumed to have been aware that at no time in its 62-
year history has the FDIC rebated investment income to the industry, 
including the period from 1989-1990 which was the only time that the 
FDIC had the authority to rebate investment income. Indeed, even if the 
FDIC's last-existing rebate authority had not been removed on January 
1, 1994, investment income could not be rebated and could cause the 
reserve ratio to rise even with minimal assessments.
    (b) Legislative History. The second element upon which the Board 
based its interpretation of the ``maintain at'' requirement is the 
legislative history of section 7(b). Section 208 of the Financial 
Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) 
amended section 7(b) of the FDI Act to establish a DRR and set the 
level at 1.25 percent. Pub. L. 101-73, 103 Stat. 183, 206. Prior to 
FIRREA, beginning in 1980, the FDI Act required or authorized the Board 
to adjust the amount of assessment income transferred to the insurance 
fund, and thereby to increase or decrease the rebate amount, based on 
the actual reserve ratio of the fund within a range from 1.10 percent 
to 1.40 percent, with 1.25 percent as the target.\7\

    \7\ Consumer Checking Account Equity Act of 1980, enacted as 
Title III of the Depository Institutions Deregulation and Monetary 
Control Act of 1980, Pub. L. 96-221, 94 Stat. 132, 148.
---------------------------------------------------------------------------

    FIRREA also prescribed minimum annual assessment rates which could 
be increased from the scheduled levels, ``if necessary to restore the 
fund's ratio of reserves to insured deposits to its target level within 
a reasonable period of time.'' [Emphasis added.] H.R. Conf. Rep. No. 
222, 101st Cong., 1st Sess. 396 (1989).
    The legislative history of Congressional hearings in the year prior 


[[Page 42683]]
to enacting FIRREA is replete with references to the 1.25 percent 
reserve ratio as a target. Thus, when the DRR was established, Congress 
viewed the DRR as a target level.
    The next year, in 1990, the Senate Banking Committee clearly 
considered the DRR a target as is demonstrated in the section-by-
section analysis of S. 3045, the language of which was almost identical 
to the Administration bill, S.3093, which was ultimately enacted as the 
Assessment Rate Act of 1990. That analysis repeatedly referred to 1.25 
percent as the ``target level''. Finally, FDICIA section 104, 
Recapitalizing the Bank Insurance Fund, amended the assessment rate 
provisions of section 7(b)(1)(C) (in effect December 19, 1991, through 
December 31, 1993) as follows:

    If the reserve ratio of the Bank Insurance Fund equals or 
exceeds the fund's designated reserve ratio under subparagraph (B), 
the Board of Directors shall set semiannual assessment rates for 
members of that fund as appropriate to maintain the reserve ratio at 
the designated reserve ratio. [Emphasis added.]

    This language is particularly compelling because its genesis was in 
S. 543, the same bill which removed the FDIC's rebate authority and 
which was the source of FDICIA's amendments to section 7 of the FDI 
Act. Thus Congress appears to have recognized that the reserve ratio 
would not remain precisely at a target DRR and could exceed that level.
    (c) Other Statutory Directives of Section 7(b). The third element 
upon which the Board has based its interpretation of the ``maintain 
at'' directive consists of the other mandates of section 7(b): to have 
an effective risk-based assessment system and to impose a minimum 
semiannual assessment of $1,000.
    The Board believes that to be effective, the risk-based assessment 
system must incorporate a range of rates that provides an incentive for 
institutions to control risk-taking behavior while at the same time 
covering the long-term costs of the obligations undertaken by the 
deposit insurer.
    Specifically, section 7(b)(1)(C) of the FDI Act required the FDIC 
to establish a risk-based assessment system for calculating an 
institution's assessments based on:
    (i) The probability that the deposit insurance fund will incur a 
loss with respect to the institution, taking into consideration the 
risks attributable to--
    (I) Different categories and concentrations of assets;
    (II) Different categories and concentrations of liabilities, both 
insured and uninsured, contingent and noncontingent;
    (III) Any other factors the Corporation determines are relevant to 
assessing such probability;
    (ii) The likely amount of any such loss; and
    (iii) The revenue needs of the deposit insurance fund.
    Within the scope of these broad factors, the FDIC was granted 
complete discretion to design a risk-based assessment system.\8\ See, 
i.e., S. Rep. No. 167, 102d Cong., 1st Sess., 57 (1991).

    \8\ One statutory restraint, however, is that the system must be 
designed so that as long as the BIF reserve ratio remains below the 
DRR, the total amount raised by semiannual assessments on members 
cannot be less than the total amount resulting from a flat rate of 
23 basis points. FDI Act, section 7(b)(2)(E). Although this 
provision will cease to be effective when the BIF reaches the DRR, 
it may again become operative if the reserve ratio remains below the 
DRR at some future time. The Board interprets the minimum assessment 
provision of section 7(b)(2)(E), which requires weighted average 
assessments of 23 basis points, as applying only when the reserve 
ratio remains below the DRR for at least a year.
---------------------------------------------------------------------------

    It is clear from the legislative history of FDICIA that Congress 
viewed the flat-rate assessment system as providing perverse incentives 
for institutions to undertake risky activities funded by insured 
deposits because they were not being charged for that risk, in effect 
penalizing well-managed institutions. S. Rep. No. 167, 102d Cong., 1st 
Sess. 56 (1991). By contrast, risk-based assessments were intended to 
reduce risk to the BIF by encouraging banks to confine themselves to 
safe and sound activities and decreasing the subsidization of risky 
banks by more prudent institutions. Id.
    The ABA has asserted that a risk-based assessment system is 
unnecessary when the BIF does not need assessment income and that the 
requirement for such a system applies only to determining the spread 
between the highest and lowest rates in the assessment schedule. Once 
the spread is determined, then the appropriate schedule is based solely 
on the revenue needs of the fund. The Board disagrees with this 
interpretation because it gives effect only to the statutory 
requirement that the revenue needs of the fund be taken into account 
when establishing or revising risk-based assessment rates. Such an 
interpretation would ignore the compelling legislative history 
indicating Congress' firm determination that banks be assessed on the 
basis of the risk that their activities pose to the BIF and that they 
be subject to appropriate economic disincentives to risky behavior.
    In summary, the Board believes that to be effective, the risk-based 
assessment system must incorporate a range of rates that provides an 
incentive for banks to control risk-taking while at the same time 
taking into account the long-term costs of the risks borne by the 
deposit insurer. The Board is well aware that the assessment income 
generated by an effective risk-based assessment system and the minimum 
semiannual assessment may, in the current economic situation, cause the 
reserve ratio to rise above the target DRR of 1.25 percent. Even so, as 
discussed more fully below, this does not eliminate the necessity for 
the Board to balance the directives of section 7(b) to have an 
effective risk-based assessment system while at the same time setting 
rates that will maintain the reserve ratio at the target DRR by giving 
full consideration to the enumerated statutory factors that are the 
determinants of the assessment schedule.

C. Balancing

    As discussed below, the main purpose of S. 543 (the bill that 
contained the language of current section 7(b)) was to assure that the 
BIF would be recapitalized so that taxpayer funds would not be at risk. 
Accordingly, while the statute is specific with respect to the actions 
the Board must take to set rates when the reserve ratio is below the 
DRR, neither the statute nor the legislative history provides guidance 
with respect to how the FDIC is to balance the various requirements of 
section 7(b) once the DRR is achieved. Nor does the legislative history 
provide guidance as to the appropriate timeframe for forecasting losses 
so that the reserve ratio can be maintained at 1.25 percent, thereby 
ultimately protecting the taxpayers.
    It is clear from the legislative history that in enacting FDICIA, 
Congress was focused almost entirely on a future where the reserve 
ratio would be below the DRR, and that the main goal of S. 543 was to 
assure that the taxpayers would not be required to rescue the banking 
industry as they so recently had been called upon to do with the S&L 
industry. For example, on May 29, 1991, Robert Glauber, Under Secretary 
of the Treasury testified before the House Ways and Means Committee 
``The Administration's projections are that the BIF will decline 
substantially over the next five years, reaching a negative net worth 
of over $22 billion by the end of 1996.'' S. Hrg. No. 30, 102d Cong., 
1st Sess. 8 (1991). The report of the Senate Banking Committee on S. 
543 cited Congressional Budget Office projections indicating that the 
BIF could be recapitalized within 15 years without imposing premiums as 
high as 30 basis 

[[Page 42684]]
points or more. However, the Committee declined to cap premiums at 30 
basis points in the event those projections proved too optimistic. S. 
Rep. No. 167, 102d Cong., 1st Sess. 30 (1991). Similarly, Senator John 
Kerry expressed concern at the requirement of the bill that the banking 
industry pay back any Treasury borrowings, stating that that funding 
approach could prove to be impossible. Id. at 230. S. 543 itself 
contained an elaborate scheme for expedited congressional authorization 
to extend the 15-year recapitalization schedule if necessary.
    The following remarks of Congressman Gerald Kleczka during floor 
debate in the House reflect the skepticism that banks would be able to 
recapitalize the BIF:

    Mr. Chairman, one of the Members of the House a short time ago 
asked, Where are we going to look to bail out the banks? And he 
answered it himself by saying the banks.
    Well, I say to you, that is total nonsense. The bank bailout, 
whether or not this bill passes, has already started. The bank 
insurance fund, the FDIC, is broke. This legislation asks for a $70 
billion Treasury loan, which in my estimation will never be repaid 
by the banks.
    In fact, with the pending bank failures on the line today, it is 
estimated that $70 billion will not last through the end of next 
year. At that point we are going to loan them more money, more 
money, and to say that this is not going to turn into another S&L 
crisis, I say, hold on, you are in for a rough ride, because I say 
that is what is going to happen.

137 Cong. Rec. H8939 (daily ed. Nov. 1, 1991).

    Until now, the Board's discretion in setting risk-based assessments 
has been limited by the 23 basis-point minimum average assessment 
requirement and the concomitant need to moderate the detrimental impact 
of a very high rate on weak institutions which taken together were the 
most crucial determinants of the assessment schedule. Once the DRR is 
achieved, however, the 23 basis-point minimum requirement will become 
inapplicable. Therefore, the Board for the first time must decide as a 
prudent insurer what assessment schedule would achieve an effective 
risk-based assessment system based on long-term deposit insurance 
experience as well as short-term loss predictions consistent with its 
obligation to protect the BIF (and ultimately the taxpayers).
    The statute is silent with respect to the appropriate timeframe the 
Board should use to project losses. Although section 7 requires the 
Board to set assessments semiannually to maintain the reserve ratio at 
the DRR, to assert--as did various commenters--that the Board is 
limited to reviewing the next six months when setting rates is without 
foundation in either the statute or the legislative history and 
disregards the recent past history of bank failures, the rapid 
deterioration and collapse of seemingly healthy institutions, and the 
increasing volatility of numerous economic factors affecting both the 
industry and the BIF. Moreover, such a position ignores Congress' 
primary goal in enacting FDICIA--that the fund not decrease to the 
point that taxpayer funds are needed to rescue the BIF.
    In fact, the legislative history of FDICIA indicates that Congress 
intended the FDIC to set premiums in much the same manner as private 
insurance companies, where the insured's premium is a function of the 
risk posed to the insurer. For example, in his opening remarks at the 
Senate Banking Committee hearing on risk-based premiums on April 19, 
1991, Senator Alan Dixon stated, ``I think it is fundamentally 
important for the Federal Deposit Insurance Corporation to price its 
product like every other insurance company--that is, according to risk 
of loss.'' S. Hrg. No. 355, 102d Cong., 1st Sess. 1197 (1991). 
Accordingly, the Board believes it appropriate as part of its process 
for setting assessments to look to the practices of private sector 
insurers to inform its decisionmaking. As manager/administrator of the 
deposit insurance fund, the Board has a fiduciary obligation to manage 
the fund in a prudent manner to preserve the fund on behalf of both the 
banking industry and the taxpayers, who are ultimately the insurers of 
last resort for the banking industry.
    Standard private sector insurance involves one party, the insured, 
who seeks protection against a specific risk by paying a premium to 
another party, the insurer, who agrees to compensate the insured for 
any losses resulting from the risk specified in the contract.\9\ 
However, federal deposit insurance differs from private insurance 
because deposit insurance is intended to be a pledge or guarantee meant 
to convey confidence to prevent the spread of bank runs and because it 
provides an unconditional guarantee to depositors that their insured 
funds are safe regardless of the risks undertaken by an insured 
depository institution.\10\

    \9\ Congressional Budget Office, Reforming Federal Deposit 
Insurance, (1990) xv.
    \10\ Id. at xvi.
---------------------------------------------------------------------------

    Private insurance companies typically operate through a self-
sustaining fund by basing the level of capital needed in reserve on 
actuarial assessments of past and potential losses. The insurer charges 
different premium rates to different clients based upon an assessment 
of their risk of loss.\11\ Private insurers uniformly underwrite 
specified risks that are similar in quality and variety by using 
historical data to set premium rates to cover long-term costs of any 
given risk category.\12\ In banking, however, the difficulty for the 
deposit insurer is determining when the revenues of any particular 
category are sufficient to cover expected costs.\13\ In casualty 
insurance, for example, the events insured against are independent of 
each other and are uncorrelated over time. By contrast, bank failures 
are not evenly distributed or uncorrelated but tend to be clustered as 
a function of economic conditions or shocks.\14\ This makes it more 
difficult to set rates so that the long-run revenues are sufficient to 
cover the long-run costs of each risk category.

    \11\ Id. at 28.
    \12\ Id.
    \13\ FDIC, A Study of the Desirability and Feasibility of a 
Risk-Based Deposit Insurance Premium System, A report pursuant to 
Section 220(b)(1) of the Financial Institutions Reform, Recovery, 
and Enforcement Act of 1989, submitted to the United States Congress 
by the Federal Deposit Insurance Corporation, at 11 (1990).
    \14\ Id.
---------------------------------------------------------------------------

    In the absence of legislative direction, the Board believes that it 
is compelled to give effect to the statutory directive to have a 
meaningful risk-based assessment system and the directive to set rates 
to maintain the reserve ratio at the DRR, by balancing the various 
statutory factors which underlie those directives and which, 
ultimately, are the determinants of an appropriate assessment schedule. 
Neither of these directives, nor any single statutory factor, may be 
given effect at the expense of the other. Thus, for example, in 
weighing the requirement to set assessments at a target DRR, the 
``revenue needs of the fund'' factor may not be interpreted, as has 
been suggested by some commenters,\15\ in such a way that the risk-
based assessment system becomes meaningless when the fund attains the 
DRR.

    \15\ See, discussion of ABA comments at Section IV.A., infra.
---------------------------------------------------------------------------

D. Rebates

    The Board is adopting its proposed interpretation that the Board 
lacks rebate authority because that authority was eliminated by 
Congress in FDICIA. As discussed below, this position is based on: (1) 
The statutory history of sections 7 (d) and (e); (2) the fact that 
Congress repealed the rebate authority in section 7(d); and (3) the 
legislative history indicating that Congress 

[[Page 42685]]
intended that lower rates would be the substitute for rebates.
    In the proposal, the Board reviewed the FDIC's authority to provide 
rebates of amounts by which the reserve ratio exceeds the DRR based on 
both former and current statutory provisions in FDI Act sections 7(d) 
and 7(e) respectively, and the legislative history of those provisions. 
Based on that review, the Board proposed a statutory interpretation 
that: (1) The FDIC's authority to provide rebates was eliminated by 
Congress in FDICIA effective with the adoption of the statutorily 
mandated risk-based assessment system on January 1, 1994; and (2) 
section 7(e) does not provide rebate authority, but rather pertains to 
the method of providing refunds of assessment overpayments.\16\

    \16\ Section 7(e) provides that the FDIC:
    (1) May refund to an insured depository institution any payment 
of assessments in excess of the amount due to the Corporation or (2) 
may credit such excess toward the payment of the assessment next 
becoming due from such depository institution and upon succeeding 
assessments until the credit is exhausted.
---------------------------------------------------------------------------

    In FDICIA, Congress provided for establishment of a risk-based 
assessment system that, after the DRR was achieved, would provide the 
FDIC with the flexibility to set a broader range of assessment rates. 
In 1990, Congress had already provided the FDIC with the authority to 
adjust assessment rates upward to ensure that the BIF received 
sufficient revenue.\17\ In FDICIA, Congress intended that same rate 
adjustment authority to operate in lieu of providing rebates in the 
event that the established rates resulted in collection of excess 
assessment revenue. Therefore, Congress eliminated the rebate 
provisions of section 7(d) in their entirety as being obsolete because 
the ability to adjust rates would take the place of a rebate mechanism. 
This is clear from the following discussion of section 212(e)(3) in the 
Senate Report on S. 543:

    \17\ See, discussion of Assessment Rate Act, infra, note 4.

    Section 212(e)(3) replaced current section 7(d) with a new 
section 7(d) recodifying current section 7(b)(9). The deleted text, 
providing for assessment credits to insured institutions when 
deposit insurance fund reserve ratios exceed designated reserve 
ratios, is obsolete in light of the standards for establishing 
assessments set forth in new section 7(b)(2)(A)(i) [setting rates to 
maintain at the DRR]. Under section 7(b)(2)(A)(i), funds that, under 
current section 7(d), would have been rebated to insured depository 
institutions through assessment credits will now be rebated through 
---------------------------------------------------------------------------
reduced assessments.

138 Cong. Rec. S2073 (daily ed. Feb. 21, 1992). (Emphasis added.)

    In response to the Board's proposed interpretation regarding the 
FDIC's rebate authority, a total of 482 respondents generally disagreed 
with the FDIC's position; one trade association appeared to accept the 
interpretation and it requested a legislative change to restore the 
rebate authority. Of those in disagreement, seven BIF members, four 
trade associations and one individual explicitly disagreed with that 
interpretation, asserting that the FDIC did, in fact, have authority to 
provide rebates. A total of 400 commenters (383 BIF members, 3 SAIF 
members, 12 trade associations and 2 other commenters) largely without 
any discussion of the FDIC's legal authority, indicated that when the 
BIF reserve ratio exceeds the DRR as a result of assessment income, the 
FDIC should return to BIF members all assessments above 1.25 percent 
because those funds could be better used servicing local communities. 
In addition, 48 commenters (46 BIF members and 2 trade associations) 
responded that assessment income in excess of 1.25 percent other than 
the $1,000 statutory semiannual minimum should be returned. Finally, 21 
commenters (15 BIF members and 6 trade associations) asserted that when 
the reserve ratio exceeds the DRR, the FDIC should return both 
assessments and investment income above 1.25 percent.
    Based on its interpretation of the DRR as a ceiling on the amount 
of funds that may lawfully be retained in the BIF, the ABA has asserted 
that all amounts (including investment income) in excess of a reserve 
ratio of 1.25 percent must be rebated to the industry. The ABA has 
argued that returning excess reserve amounts by means of lowering 
subsequent assessments is merely one method of accomplishing the 
statutory intent to return funds; where that method does not suffice to 
accomplish that goal, the statute should be interpreted to find an 
alternative method. Accordingly, notwithstanding the statutory history 
of section 7(e) and the repeal of section 7(d), it argued that the FDIC 
could rely on an interpretation of the plain meaning of section 7(e) to 
implement the statutory purpose.
    The New York Clearing House (Clearing House) stated that the FDIC 
has rebate authority pursuant to the plain meaning of section 7(e) and 
that there is no legislative history to indicate that that section 
should be interpreted other than in accordance with a plain reading. 
Further, the rebate authority is particularly important because the 
Clearing House does not believe that the FDIC will be able to maintain 
the reserve ratio at 1.25 percent by semiannual rate adjustments only, 
without some form of rebate mechanism. Citicorp also criticized the 
FDIC's interpretation, indicating that the inability to provide rebates 
when the reserve ratio exceeds 1.25 percent makes the determination of 
the proper rate schedule all the more critical.
    The IBAA similarly argues that, without such authority, the FDIC 
will be unable to manage the BIF at the DRR as required and that the 
FDIC's interpretation ignores the discretion to set rates given to it 
by Congress in connection with the risk-based assessments system. The 
IBAA and the Bankers Roundtable noted that although the authority of 
section 7(d) was removed, the statute does not expressly prohibit the 
FDIC from providing rebates pursuant to some other authority.
    The Board is unconvinced by the alternative interpretation offered 
by commenters that rebate authority exists in section 7(e), which 
authorizes the FDIC to refund or credit to an insured institution any 
assessment payment in excess of the amount due to the FDIC. The Board 
does not believe it can ignore unequivocal action by the Congress to 
eliminate rebate authority by, in effect, re-creating that authority 
through a new interpretation of section 7(e) absent some indication in 
the legislative history that Congress intended section 7(e) 18 to 
serve as a substitute for section 7(d) of the FDI Act.

    \18\ Section 7(e) has been consistently interpreted by the FDIC 
since 1950 to provide authority to refund erroneous overpayments of 
assessments. The FDIC has never interpreted that section as 
providing rebate authority.
---------------------------------------------------------------------------

    Moreover, the FDIC has not located any legislative history 
indicating that Congress intended section 7(e) to take the place of 
section 7(d). Therefore, for the reasons discussed above, the Board 
continues to believe that the better interpretation of the statute is 
that the FDIC has no authority to grant rebates and that to do so would 
be in violation of the statute and contrary to legislative history.

III. New Rate Spread

    The Board is adopting without modification the proposal to increase 
the rate spread from 8 basis points in the current assessment schedule 
to 27 basis points in the new schedule.
    As discussed in Section II.B.2(c), the fundamental goals of risk-
based assessment rates are to reflect the risks posed to the insurance 
fund by 

[[Page 42686]]
individual insured institutions and to provide institutions with 
incentives to control risk taking. In the existing assessment schedule, 
the maximum rate spread is 8 basis points. See Table 1. Institutions 
rated 1A pay an annual rate of 23 basis points while institutions rated 
3C pay 31 basis points. There is a substantial question as to whether 8 
basis points represents a sufficient spread for achieving these goals.

BILLING CODE 6714-01-P
      

[[Page 42687]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.000
    


BILLING CODE 6714-01-C

[[Page 42688]]

    As discussed in the proposal, the current assessment rate spread 
for BIF institutions has been criticized widely by bankers, banking 
scholars and regulators as overly narrow, and there is considerable 
empirical support for this criticism. Using a variety of methodologies 
and different sample periods, the vast majority of relevant studies of 
deposit insurance pricing have produced results that are consistent 
with the conclusion that the rate spread between healthy and troubled 
institutions should exceed 8 basis points.19 While the precise 
estimates vary, there is a clear consensus from this evidence that the 
rate spread should be widened.

    \19\ For a representative sampling of academic studies on this 
issue, see Estimating the Value of Federal Deposit Insurance, The 
Office of Economic Analysis, Securities and Exchange Commission 
(1991); Berry K. Wilson, and Gerald R. Hanweck, A Solvency Approach 
to Deposit Insurance Pricing, Georgetown University and George Mason 
University (1992); Sarah Kendall and Mark Levonian, A Simple 
Approach to Better Deposit Insurance Pricing, Proceedings, 
Conference on Bank Structure and Competition, Federal Reserve Bank 
of Chicago (1991); R. Avery, G. Hanweck and M. Kwast, An Analysis of 
Risk-Based Deposit Insurance for Commercial Banks, Proceedings, 
Conference on Bank Structure and Competition, Federal Reserve Bank 
of Chicago (1985).
---------------------------------------------------------------------------

    FDIC research likewise suggests that a substantially larger spread 
would be necessary to establish an ``actuarially fair'' assessment rate 
system. Insurance premiums are actuarially fair when the discounted 
value of the premiums paid over the life of the insurance contract is 
expected to generate revenues that equal expected discounted costs to 
the insurer from claims made by the insured over the same period. A 
1994 FDIC study used a ``proportional hazards'' model to estimate the 
expected lifetime of banks that were in existence as of January 1, 
1993. The study estimated the actuarially fair premium that each bank 
must pay annually so that the cost of each bank failure to the FDIC 
would equal the revenue collected through insurance assessments. The 
estimates indicated a rate spread for 1A versus 3C institutions on the 
order of magnitude of 100 basis points.20

    \20\ See, Gary S. Fissel Risk Measurement, Actuarially Fair 
Deposit Insurance Premiums and the FDIC's Risk-Related Premium 
System, FDIC Banking Review (1994), at 16-27, Table 5, Panel B. 
Single-copy subscriptions of this study are available to the public 
free of charge by writing to FDIC Banking Review, Office of 
Corporate Communications, Federal Deposit Insurance Corporation, 550 
17th Street, N.W., Washington, D.C. 20429.
---------------------------------------------------------------------------

    In the proposal, the Board expressed concern that rate differences 
between adjacent cells in the current matrix do not provide adequate 
incentives for institutions to reduce the risk they pose to BIF by 
improving their condition, which is a fundamental goal of risk-based 
assessments. Larger differences are consistent with historical 
variations in failure rates across cells of the matrix, viewed in 
connection with the preponderance of evidence regarding actuarially 
fair premiums.21 The precise magnitude of the differences is open 
to debate, given the sensitivity of any estimates to small changes in 
assumptions and to selection of the sample period. However, the Board 
believes that larger rate differences between adjacent cells of the 
matrix are warranted. Accordingly, the Board proposed for comment an 
increase in the spread between the lowest and highest rates in the 
assessment schedule to 27 basis points from the current 8 basis point 
spread.

    \21\ Id., at Tables 2 and 5.
---------------------------------------------------------------------------

    Of the 357 commenters (332 BIF members, 4 SAIF members, 16 trade 
associations and 5 other organizations/individuals) who addressed the 
issue of the increased spread, 298 respondents supported the proposal. 
Of those, 217 respondents (including 9 trade associations and 203 BIF 
members) expressly approved of the increase to 27 basis points; an 
additional 70 respondents (including 1 trade association and 69 BIF 
members) indicated support for increasing the spread but didn't 
specifically mention the proposed increase to 27 basis points. Forty 
commenters (including 4 trade associations and 35 BIF members) 
expressed the opinion that the proposed spread was too great; by 
contrast, 12 commenters, all of whom were BIF members, thought the 
spread should be wider than proposed. Finally, 18 commenters (including 
2 trade associations and 12 BIF members) expressed reservations about 
the increased weight given to the subjective supervisory ratings in 
determining an institution's risk classification.
    Among the commenters supporting the proposed increase, numerous 
respondents expressed the opinion that the proposal would provide BIF 
members with greater incentive to control risk while at the same time 
rewarding well-managed institutions for limiting risk. For example, 
Banc One Corporation noted, ``Prudent, healthy institutions should not 
have to pay for ill-advised activities and high-risk institutions.'' 
The New York Clearing House stated that ``the larger spread is more 
actuarially equitable, in that it reduces the burden that the strongest 
institutions must bear to support the weakest.'' The Bankers Roundtable 
indicated its support for incentive-based regulation coupled with a 
strong spread between the lower- and higher-risk institutions. The 
Roundtable noted that ``risk-based premiums should address all the 
strengths of an institution, not merely capital. As the schedules now 
contemplate and as other regulators who examine and evaluate 
institutions assess, strong management and strong internal risk control 
systems are important as well.''
    Forty commenters opposed the proposed 27 basis-point spread. For 
example, the ABA asserted that the current spread should be retained 
because it provides a strong incentive for banks to move into the 
lower-risk categories as evidenced by the increase in 1A institutions 
between 1993 and 1995 from 60 percent to 90 percent of the industry. 
The ABA also indicated concern about the emphasis on the supervisory 
rating because of its subjectivity. America's Community Bankers 
expressed similar reservations and indicated that it would be better to 
give more weight to capital because it is both a more objective and 
more controllable factor. Orange National Bancorp commented that 
examiners have too much individual discretion in assigning risk 
classifications. It recommended that a standard model for such 
evaluations be implemented if one is not already in place. The 
California Bankers Association (CBA) opposed the increased spread 
because of the belief that it too closely correlates with local 
economic conditions that are beyond the control of the institution. 
Thus, adverse local economic conditions may result in higher risk 
classifications at a time when the institution can least afford it. The 
CBA further noted that ``[a] primary objective of deposit insurance 
should be to spread uncontrollable risk among similarly situated 
institutions. To impose additional premiums when that risk is actually 
realized is analogous to charging a person a universal health insurance 
rate, and then increasing that rate when the person actually becomes 
sick and requires care.'' (Emphasis in original.) The CBA proposed as 
an alternative a narrowing of the spread to mitigate the penalties 
imposed on a bank for falling into a higher risk category due to the 
effects of a local economic downturn.
    By contrast, the twelve commenters who indicated that the spread 
should be wider indicated that the proposed assessment schedule did not 
adequately reflect the true risk to the BIF. Several commenters raised 
concerns about the insufficient distinction between the riskiness of 
low-risk banks. For example, Wells Fargo Bank stated that 

[[Page 42689]]
``[n]inety percent of banks should not be included in the lowest risk 
category.''
    A number of commenters indicated support for the proposal that the 
nine-cell matrix should remain in place pending an in-depth review of 
the risk classification system. Expressing its support for deposit 
insurance rates as an appropriate incentive for banks to control risky 
activities, the IBAA recommended that the FDIC implement the premium 
reduction before considering modifications to the nine-cell matrix. The 
ABA indicated that bankers support keeping the risk classification 
system simple, and it would not, therefore, support any revisions to 
the matrix involving the creation of more categories or a new, super-
capitalized category. In Citicorp's view, ``any change in the number of 
cells will create disputes while producing very little additional 
equity'' without greater explanation of the underlying rationale for 
any increase. Citicorp called for frequent reviews an institution's 
risk so that the risk classification is based on current evaluations.
    The Board is adopting the proposed increase in the spread from 8 to 
27 basis points without modification. Having carefully considered the 
comments on the proposal, the Board nonetheless continues to believe 
that the assessment rate matrix should be adjusted in the direction of 
an actuarially fair rate structure, as described above. In addition, as 
in the proposal, the Board has decided not to adopt changes to the 
nine-cell assessment rate structure at this time. Accordingly, as 
proposed, the new rate matrix retains the existing nine cells.
    While the Board appreciates the concern expressed in the comments 
regarding the additional weight placed on supervisory evaluations as a 
result of the increased rate spread, the use of such evaluations as a 
risk measure is well-established. Historically, deteriorations in 
supervisory ratings are associated with a substantially higher 
incidence of failure.
    When the Board adopted the existing 8-point rate spread in 1992, it 
expressed the conviction that widening the spread was desirable but 
declined to do so because of the potential hardship for troubled 
institutions and possible additional losses for the insurance 
fund.22 At that time, however, a wider rate spread would only have 
been accomplished through an increase in the assessment rate paid by 
weaker institutions. In contrast, under the new schedule the Board is 
now adopting, the rate spread will be widened by means of a reduction 
in the rates applicable to stronger institutions.

    \22\ In the FDIC's 1993 proposal for the existing statutorily 
mandated risk-based premium system, the Board sought comment on 
whether the assessment rate spread embodied in the existing system, 
i.e., 8 basis points, should be widened. Of the 96 commenters 
addressing this issue, 75 favored a wider rate spread. In adopting 
the existing 8 point rate spread in 1993, the Board expressed its 
conviction that widening the rate spread was desirable in principle, 
but chose to retain for the time being, the 8 point rate spread. The 
Board expressed concern that widening the rate spread while keeping 
assessment revenue constant, might unduly burden the weaker 
institutions which would be subject to greatly increased rates. 
However, the Board retained the right to revisit the issue at some 
future date. 58 FR 34357 (June 25, 1993).
---------------------------------------------------------------------------

    Under the new schedule, all BIF-insured institutions except those 
with assessment risk classification 3C will enjoy a reduction in their 
assessment rates, with a consequent beneficial impact on earnings and 
capital. The only adverse effect on earnings and capital conceivably 
could result from the increase in the rate spread from 8 basis points 
to 31 basis points. Under the current assessment schedule, weaker 
institutions are competing with institutions that pay an assessment 
rate of 23 basis points. Under the new schedule, where all but 
institutions in the 3C category will pay reduced rates, the weaker 
institutions will be competing with a large group of BIF members that 
will be paying a rate of only four basis points. In principle, if the 
BIF members classified as 1A pass along their reduced assessments to 
their customers, the weaker institutions may be forced to pay more for 
deposits or charge less for loans to stay competitive.
    The FDIC performed an analysis simulating the effects of the wider 
rate spread on all insured institutions under the assumption that the 
weaker institutions would have to absorb the entire increase in spread 
in the form of a higher cost of funds. The result was that apart from 
institutions that have already been identified by the FDIC's 
supervisory staff as likely failures, the wider spread is expected to 
have a minimal impact in terms of additional failures.
    A widening of the spread to 27 basis points is consistent with the 
implications of the best empirical evidence on this issue and with the 
Board's previously stated conviction. Moreover, the increased 
differences between adjacent cells in the matrix provides additional 
incentive for weaker institutions to improve their condition and for 
all institutions to avoid excessive risk-taking. This is consistent 
with the Board's desire to create adequate incentives through the 
assessment rate structure to encourage behavior that will protect the 
deposit insurance fund against excessive losses.
    Nonetheless, the Board remains unwilling at this time to increase 
further the maximum rate other than by means of the adjustment factor 
discussed below, without further study regarding the overall insurance 
pricing structure for the industry.

IV. New Assessment Schedule

    In light of its interpretation of section 7(b) discussed above and 
based on its consideration of the required statutory factors, the Board 
is adopting in the final rule its proposed new assessment rate schedule 
ranging from a rate of 4 basis points for institutions with a risk 
classification of 1A to 31 basis points for institutions rated 3C (see 
Table 1) and, as noted above, a spread of 27 basis points. As discussed 
below, the adoption of this schedule reflects the Board's determination 
that the FDIC's insurance responsibilities require it to look beyond 
the immediate timeframe in estimating losses and the revenue needs of 
the fund, and to take account of the variability of the factors 
influencing the BIF reserve ratio, variability that can be substantial 
even within a single assessment period.

A. Comments

    The FDIC received 1401 comments (1364 BIF members, 11 SAIF members, 
14 trade associations and 12 other organizations or individuals) that 
either expressed general support for the proposed decrease in rates or 
specifically mentioned support for the proposed schedule of 4 to 31 
basis points. However, 347 commenters (320 BIF members, 3 SAIF members, 
22 trade associations, 1 organization and 1 individual) expressed 
dissatisfaction with the rates specifically. As discussed in Section 
II.B.1, most of the commenters argued that the proposed rates are too 
high to comply with the FDIC's requirement to maintain the BIF at its 
DRR. Eleven commenters stated that the proposed schedule was too low. 
Finally, forty commenters (7 BIF members, 23 SAIF members, 1 trade 
association and 9 other organizations/individuals) urged the FDIC not 
to decrease BIF rates.
    Those commenters who were satisfied with the proposed rate 
structure generally were pleased that they will enjoy the benefit of a 
very large decrease in assessments in the near future and expressed 
pride that the BIF will be recapitalized much earlier than expected and 
without taxpayer assistance. 

[[Page 42690]]

    Of the commenters who indicated that the proposed assessment 
schedule was too high, 115 (including 12 trade associations and 102 BIF 
members) stated specifically that the rate either for institutions with 
a 1A risk classification or for all institutions should be 0 basis 
points (the ABA position); 87 commenters (including 2 trade 
associations and 84 BIF members) asserted that the rate for 1A 
institutions should be decreased to 2 basis points (the IBAA position). 
Many cited the statements in the proposal indicating that it was likely 
that the BIF reserve ratio could be maintained at 1.25 percent in the 
second half of 1995 solely as a result of investment income as support 
for their position that the proposed rate schedule is too high, at 
least with respect to 1A institutions.
    In fact, the ABA argued that when the BIF does not need assessment 
income to remain at 1.25 percent, the FDIC may not assess any BIF 
members, i.e., assessing a zero rate on all such regardless of risk. 
The ABA's position is that the risk-based assessment spread is 
determined independently from the revenue needs of the fund; that 
spread is simply moved up or down in order to generate the required 
revenue to offset expenses, i.e., the rate schedule itself is solely a 
function of the amount of revenue needed to maintain the BIF at 1.25 
percent. Thus, where no income is needed, there is no need for the 
risk-based assessment system. However, the ABA argues that beneficial 
incentives for bank performance will still operate because riskier 
banks will not know in advance whether the revenue needs of the BIF 
will require imposition of an assessment, so unless they improve their 
performance, they will face the prospect of paying higher assessment 
rates than their peers. Moreover, they argue that a zero rate serves as 
an incentive to manage banks well.
    Some commenters also criticized the historical basis on which 
expected losses are forecast by the FDIC. Several commenters asserted 
that the statute requires the Board to set assessments based on the 
revenue needs of the BIF for the succeeding six month period, not on a 
historical basis. Finally, many commenters indicated that the use of 
the historical average fails to take into account the fundamental 
changes that have occurred since FDICIA, i.e., least-cost resolutions, 
prompt corrective action, cross-guaranty authority, and depositor 
preference statutes.
    On the other hand, some of the commenters argued that the BIF rates 
should not be decreased at all. Among these was the Center for Study of 
Responsive Law/Essential Information, which thought the loss 
projections were completely inadequate for the potential risks facing 
the industry. They interpreted the statutory DRR as a floor, and urged 
the FDIC to establish a higher range for the DRR with a target average 
of 1.63 percent using 1.25 percent as the floor and 2.0 percent as the 
ceiling.
    In view of the numerous comments on the propriety of the average 
rate implied by the proposal, the Board finds it appropriate to provide 
here a detailed summary of the analysis and reasoning that served as a 
basis for its decision to adopt the proposed rate schedule in the final 
rule. Accordingly, this section considers in depth the analysis 
supporting the approach adopted by the Board for satisfying the 
requirements to maintain the reserve ratio at 1.25 percent and to have 
a risk-based assessment system.

B. Review and Balancing of Statutory Factors

    As discussed in Section II, pursuant to the directive of section 
7(b)(1) to have a risk-based assessment system and the directive of 
section 7(b)(2)(A)(ii) to maintain the reserve ratio at the DRR, the 
Board is required to review and weigh the following factors when 
establishing an assessment schedule:
    (1) The probability and likely amount of loss to the fund;
    (2) Case resolution expenditures and income;
    (3) Expected operating expenses;
    (4) The effect of assessments on members' earnings and capital;
    (5) The revenue needs of the fund; and
    (6) Any other factors that the Board may deem appropriate.
1. Analytical Framework
    (a) Summary. In principle, the requirements to maintain the reserve 
ratio at the DRR and to have assessments for individual institutions 
based on risk to the fund complement and reinforce each other. 
Maintenance of a particular reserve ratio requires the FDIC to attempt 
to match fund revenue and expense over time. An important element of 
that requirement comes from a risk-based assessment system that equates 
revenue with ``expected cost'' over a long period. The estimation of 
expected insurance losses is thus important both in the structuring of 
risk-based assessments and maintaining a given reserve ratio over a 
period of time.
    The following subsections outline the FDIC's analysis and the use 
of that analysis for informing the decision of the Board regarding BIF 
assessment rates. Subsection (b) discusses in general terms the 
selection of a time period over which to estimate insurance losses, and 
the relation of this question to the statutory requirements to maintain 
the BIF at its target DRR and to have a system of risk-based 
assessments. Subsection (c) describes the increase in volatility of key 
economic variables characteristic of the post-1980 period and reviews 
the increase in banking-industry risk that also occurred during this 
period. The basic conclusion is that a return to the relative stability 
of the 1950-1980 period is unlikely and, thus, the FDIC is likely to 
experience continued volatility in insurance losses in the years ahead. 
Subsection (d) provides a brief discussion of the risks in banking 
today and a historical perspective on the risks associated with highly 
rated and well capitalized banks. The information presented indicates 
that a meaningful assessment of risks posed by insured institutions 
must look beyond the immediate timeframe. Subsection (e) discusses the 
average assessment rates that would have maintained the fund at a given 
reserve ratio at various times in the FDIC's history, and sets out how 
it would be destabilizing to the banking industry for the FDIC to 
attempt to maintain continuous equality of the BIF to its DRR by trying 
to equate revenues and expenses during every six-month period. The 
analysis indicates that an average effective assessment rate in the 
range of four to 13 basis points would have matched revenue and expense 
over most of the FDIC's history. It also indicates that recent changes 
in business conditions, including several statutory changes, strongly 
suggest that a rate at the low end of that range should be adopted. 
Subsection (f) discusses the implications of volatility in insured 
deposits for the rate-setting process.
    (b) The Planning Horizon for Rate Setting. An important part of the 
rate-setting process is the desire to equate revenues with expenses 
over a period of time. The answer to the question ``over what period of 
time?'' has important ramifications for the way the FDIC sets 
assessments and manages its reserve ratio, as well as for the banking 
industry. This matching of revenue and expense encompasses most of the 
statutory factors required to be considered by the Board in that it 
seeks to determine the revenue needs of the fund in light of the 
probability and likely amount of losses, expected case resolution 
expenses and income, and the amount of operating expenses.
    Purely for expositional purposes, it is useful to consider an 
extreme case where revenues and expenses are balanced over a very short 
horizon, say 

[[Page 42691]]
one day. One could imagine that each morning banks would be billed 
electronically for the cost of any bank failures expected to occur that 
day. In this extreme case, the BIF could be managed to within very 
close to its DRR on a virtually continuous basis (ignoring 
uncertainties about the level of insured deposits).
    In this example the FDIC's insurance function would be that of 
allocating current costs across banks through billings and collections 
on a pay-as-you-go basis. The word ``insurance'' is normally associated 
with the concept of spreading risk. This risk spreading can be over 
time, across the insured parties, or both, depending on the type of 
insurance. A pay-as-you-go system in which the cost of the insured 
event is borne entirely at the time the event occurs does not 
accomplish the spreading of risk over time.
    Whether the spreading of risk over time is important in banking is 
an empirical question that is discussed below in subsection (e) of this 
section. If the FDIC had operated on a yearly pay-as-you-go basis 
during the post-1980 period, for example, assessments would have been 
as high as 62 basis points in 1991. Rates at that level would have 
adversely affected the earnings and capital of the industry and the 
soundness of the FDIC insurance fund.
    In general, one can say that the shorter the planning horizon over 
which one tries to equate revenues and expenses, the more certainty 
there will be about loss estimates, and the easier it will be to manage 
the reserve ratio to any given level. On the other hand, the shorter 
this planning horizon, the less the FDIC's business would resemble the 
risk-spreading function of an insurer and the greater the risk that 
high and volatile insurance premiums would adversely affect the 
earnings and capital of the banking industry and the soundness of the 
insurance fund.
    Attempting to equate revenues and expenses over a longer period has 
the risk-spreading advantages classically associated with insurance. 
Assessments are collected when times are good to pay for problems when 
times are bad, and there can be some measure of stability to the 
assessment rates, thereby avoiding the adverse effects on bank earnings 
and capital discussed above. Under this regime, the intent would be to 
maintain the insurance fund at the DRR on average over the planning 
horizon, rather than continuously.
    The choice of a planning period for equating revenues and expenses 
is therefore a fundamental decision for the FDIC as manager and 
fiduciary of sound deposit insurance funds. Relevant to the judgment is 
whether it is consistent with the FDIC's mission that the entire cost 
of banking problems be paid by the banking industry during the 
assessment period in which they occur. As discussed below, the use of a 
pure pay-as-you-go approach is inconsistent with the FDIC's mandate to 
charge assessments that reflect the probability and like amount of loss 
to the insurance funds because this approach ignores the risks that 
exist beyond a six-month horizon. In addition, the pay-as-you-go 
approach, if adopted as a general rule, would result in adverse effects 
on bank earnings and capital during times of stress in banking.
    (c) Increased Economic Volatility and Bank Stability. The economic 
environment affecting banks began to change during the 1970s and the 
pace of change accelerated during the 1980s. The result is that banking 
is a riskier and more demanding business today than ever before. This 
subsection documents some major changes in the banking environment that 
have occurred during the last 15 to 20 years. Part (i) contains a 
discussion of the increased volatility of certain key macroeconomic 
variables that directly and indirectly affect banking risk. Part (ii) 
contains a more specific discussion of developments in the financial 
services industry and in the characteristics of insured banks.
    (i) Key economic variables. For about twenty years beginning in the 
early 1950s, the U.S. economy and the commercial banking industry 
enjoyed a period of relative stability. Key economic variables such as 
inflation, interest rates and exchange rates displayed remarkable 
stability, and in part as a result, bank failures were few. This period 
of stability began to end in the 1970s.
    An important change in the nature of economic volatility resulted 
from the movement to a floating exchange rate system from a fixed rate 
system that occurred in 1973. As international trade expanded in the 
post World War II era, the maintenance of fixed exchange rates required 
adjustments to trading relationships and domestic economic policies of 
trading nations that were not optimal. Thus, the change substituted 
volatility in interest rates and commodities prices for increased 
volatility in exchange rates. However, as explained below, subsequent 
events have tended to increase the volatility in other financial and 
economic variables beyond the levels experienced in the fixed exchange 
rate environment.
    With the Smithsonian Agreement (see Figure 1 for the German mark 
(DEM) and Japanese yen (JPY) in 1971 to 1973), exchange rates among all 
of the major currencies were realigned and permitted to float without 
upper and lower bounds. These developments predictably gave rise to 
considerably greater exchange rate volatility at a time when world 
trade was also expanding rapidly.

BILLING CODE 6714-01-P

[[Page 42692]]
[GRAPHIC][TIFF OMITTED]TR16AU95.001



BILLING CODE 6714-01-C

[[Page 42693]]

    Markets for forward and futures exchange rate contracts developed 
in order for firms to manage more effectively exchange rate risks and 
markets for combined currency and interest rate swaps have followed 
this trend. The Chicago Mercantile Exchanged formed the International 
Money Market (IMM) and began offering the first foreign exchange 
futures contract on major currencies in 1972.\23\ The volatility that 
gave rise to these contracts can be seen in Figure 2, comparing the 
volatility in the dollar exchange rate with the German mark and the 
Japanese yen.\24\

    \23\ These contracts were also the first financial futures 
contracts offered in the U.S.
    24 Volatility is measured in each period as the standard 
deviation of the monthly percentage change of each exchange rate. 
The standard deviation is measured using observations over the prior 
six months.
---------------------------------------------------------------------------

BILLING CODE 6714-01-P
      
      

[[Page 42694]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.002
    


BILLING CODE 6714-01-C

[[Page 42695]]

    Since 1970, there have been periods of relative calm in exchange 
rates (e.g., 1976-77) interspersed with periods of substantial 
volatility, some considerably extended, and periods with volatility 
varying among currencies. For example, the first oil embargo in 1973 
resulted in increased volatility for the mark, but a decrease for the 
yen. In the European Monetary System currency crisis in late summer and 
early fall of 1992, the yen actually showed a decline in volatility, 
but the mark, the most appreciated European currency at the time, 
showed a sharp increase in volatility. More recently, the change in 
monetary policy by the Federal Reserve in February 1994 resulted in a 
depreciation of the dollar relative to the mark, increased volatility 
in exchange rates, and sharp increases in foreign and domestic interest 
rates (see Figure 2 for exchange rate volatility from January to May 
1995). Without the well-developed markets for forwards and futures 
contracts for foreign exchange, such volatility would be less 
manageable and would significantly lessen foreign trade.
    A second source of volatility, not unrelated to the adoption of a 
floating exchange rate system, is in the levels and term structure of 
interest rates. Foreign exchange rates and interest rates among 
countries are related through arbitrage opportunities to borrow and 
lend in different currencies. Banks are active participants in foreign 
markets and international deposit and loan markets for their own 
account and those of their customers. Banks that are lending and 
borrowing abroad face risks of exchange rate changes that affect the 
dollar value of their loans and liabilities denominated in foreign 
currencies. The interest rates banks and other investors are willing to 
accept for loans and pay on borrowings are affected by their 
expectations of future exchange rates. The more uncertain and volatile 
are exchange rates, the greater the opportunities for losses and the 
greater the need for hedging assets and liabilities from exchange rate 
risk. The greater volatility experienced in exchange rates is 
translated into greater interest rate volatility as banks and other 
investors attempt to hedge positions in loan and deposit markets and 
arbitrage among interest rate differentials that arise among debts 
denominated in various currencies. An example of the relationship of 
the link between exchange rate volatility and interest rate volatility 
was during the period of adjustment in 1973 to the new exchange rate 
regime and the rise in U.S. interest rate volatility during this same 
period (see Figure 1 for the rapid appreciation of the DEM and JPY 
during this period and interest rate volatility in Figure 3).

BILLING CODE 6714-01-P

[[Page 42696]]
[GRAPHIC][TIFF OMITTED]TR16AU95.003



BILLING CODE 6714-01-C

[[Page 42697]]

    Volatility in the level of interest rates can be seen in Figure 3 
for the 3-month T-bill rate (the darker connected line). In this 
figure, the dark bars are periods of recession (peak to trough) as 
designated by the National Bureau of Economic Research. Volatility is 
presented in this figure as the computed likelihood of being in a high 
interest rate volatility regime (the light, spiked areas measured on 
the left axis); that is, a period where the standard deviation of daily 
interest rate changes is statistically expected to be higher than 
average. As can be seen, the period of the 1960s was relatively calm 
with the exception of the recession of 1969 to 1970. After this period, 
interest rates became more volatile, as did general economic activity. 
During the 1970s, several oil embargo shocks in 1973 and 1978 resulted 
in accelerating inflation and contributed considerably to interest rate 
volatility. The Federal Reserve dramatically changed monetary policy in 
October 1979 by switching from an interest rate target to a monetary 
aggregates target, such as nonborrowed reserves, with the objective of 
reducing inflation. The result of this policy was a highly volatile 
interest rate period from October 1979 until late 1982.25 
Correspondingly, it was about this time when the volume of interest 
rate futures contracts was beginning to grow on the Chicago Mercantile 
Exchange and the Chicago Board of Trade.26 Soon afterwards, over-
the-counter interest rate forwards and swaps were introduced on a 
meaningful scale and their growth accelerated by 1986, coinciding only 
incidentally with the period of the collapse in world oil prices.

    \25\ The stock market crash in October 1987 is also clearly 
evident in Figure 3 with a period of high volatility occurring at 
this time. What is also interesting is that a period of high 
interest rate volatility occurred in early 1987 coinciding with an 
apparent change in monetary policy. It is important to note that 
changes in monetary policy tend to evoke periods of greater interest 
rate volatility and possible adverse effects on bank earnings.
    \26\ The development of interest rate futures contracts was 
given a boost in 1974 with the creation of the Commodity Futures 
Trading Commission. The CFTC was given exclusive responsibility over 
futures markets. As a by-product of this legislation, cash 
settlement of futures contracts was permitted. The provision of 
federal law superseded state laws that prohibited contracts settled 
in cash because they were considered wagers and were treated as 
illegal gambling.
---------------------------------------------------------------------------

    Another source of volatility is in the term structure of interest 
rates. The importance of the volatility in the term structure stems 
from the need to have accurate estimates of future short-term interest 
rates. Expected future short-term interest rates form the basis for the 
valuation of interest rate swaps, forward, futures, and options on 
future interest rates, and options on futures contracts. Volatility in 
the term structure can also give rise to volatility of bank earnings to 
the extent that banks face gaps between interest sensitive assets and 
interest sensitive liabilities. The causes of this volatility in 
interest rates have been linked to expectations of changes in future 
short-term interest rates fed by the volatility in the rate of 
inflation and inflation expectations. Figure 4 shows the 3-month T-bill 
rate and the difference between the 10-year T-bond rate and the 1-year 
T-bond rate as a proxy for the steepness in the yield curve. It is 
clear that the yield curve has been volatile and at times has become 
inverted (periods such as 1972 through late 1974, and early 1978 
through 1982 when the 1-year T-bond yield was higher than the 10-year 
yield), requiring considerable caution in funding long positions in 
long-term assets or fixed rate assets with short-term, variable rate 
liabilities. In periods of substantial volatility in the term 
structure, simple methods of interest rate risk management, such as 
duration gap management, become incomplete methods of managing interest 
rate risk.

BILLING CODE 6714-01-P

[[Page 42698]]
[GRAPHIC][TIFF OMITTED]TR16AU95.004



BILLING CODE 6714-01-C

[[Page 42699]]

    A final source of increased volatility is that arising from general 
economic activity. To a considerable extent, the volatility in general 
economic activity can be traced to real shocks, such as the oil 
embargoes of the 1970s, wars, dissolution of the Soviet Union, and the 
fiscal and monetary policies of the major industrialized nations. These 
shocks have caused considerable volatility in commodity prices and real 
output. The record inflation of the 1970s was followed by a period of 
slower inflation, but greater commodity price volatility. Figure 5 
presents commodity prices (CRB Raw Materials Spot Prices) compared with 
the Consumer Price Index (All Urban Areas). Although the oil shocks of 
the 1970s resulted in considerable inflation in commodities and 
consumer prices, the volatility that also resulted in commodity prices 
has not abated during the 1980s or early 1990s.

BILLING CODE 6714-01-P
      

[[Page 42700]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.005
    


BILLING CODE 6714-01-C
      

[[Page 42701]]

    The volatility of prices and general economic activity can have a 
substantial impact on banking performance, as the experience of the 
1980s makes clear. The sectoral inflation and subsequent deflation of 
agricultural prices in the late 1970s and early- to mid-1980s was a 
major contributor to the failure of hundreds of agricultural banks. 
Similarly, the boom and subsequent collapse of oil prices caused 
significant problems for banks in states whose economies had important 
energy sectors. The real-estate problems of the 1980s and early 1990s 
caused major problems for many banks. These problems can be traced in 
part to unanticipated changes in regional economic conditions, as the 
behavior of real estate prices departed sharply from past patterns 
(Figure 6).

BILLING CODE 6714-01-P
      

[[Page 42702]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.006
    


BILLING CODE 6714-01-C

[[Page 42703]]

    (ii) Trends in the banking industry since 1980. Since 1980, the 
business of banking has changed considerably. As noted above, risks 
have increased as interest rates, exchange rates and commodity prices 
have become more volatile and as economic shocks have been transmitted 
more widely via the globalization of markets. Meanwhile, competition in 
the financial marketplace has greatly intensified. The traditional 
intermediation function of banks has assumed a smaller role in 
aggregate economic activity, largely because financial and 
technological innovations have increased the funding options for firms 
that formerly were restricted to bank loans. Banks have been forced to 
seek new sources of income and to implement untested business 
strategies, and such experimentation carries inherent risks.
    The major trends affecting the banking industry since 1980 are 
summarized in an accompanying series of charts. The charts emphasize 
the substantial increase in banking risk as compared to earlier 
periods, and the role of competition and innovation as forces driving 
this development.
    Dramatic evidence that banking has become riskier is observable in 
the annual rates of bank failure (Figure 7). While annual bank failures 
exceeded single digits only rarely between 1940 and 1980, failure rates 
rose rapidly thereafter to a record high of 200 in 1988 (221 including 
assistance transactions). A similar picture emerges from the data on 
FDIC insurance losses relative to insured deposits (Figure 8). Annual 
insurance losses were extremely low on average prior to 1980, less than 
half a basis point of insured deposits, and were quite stable; losses 
for the 1980-94 period exceeded 14 basis points on average and were 
highly variable.

BILLING CODE 6714-01-P

[[Page 42704]]
[GRAPHIC][TIFF OMITTED]TR16AU95.007



[[Page 42705]]
[GRAPHIC][TIFF OMITTED]TR16AU95.008



BILLING CODE 6714-01-C

[[Page 42706]]

    Net loan charge-offs as a percent of average total loans have 
trended upward since the early 1970s, accelerating rapidly beginning in 
1980 and reaching a peak of 1.57 percent in 1991 (Figure 9). Over the 
same period, bank stocks substantially underperformed the S&P 500 
(Figure 10).

BILLING CODE 6714-01-P
      

[[Page 42707]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.009
    


[[Page 42708]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.010
    


BILLING CODE 6714-01-C

[[Page 42709]]

    The effects of increased competition and innovation are 
inextricably intertwined. Both have played a role in the banking 
industry's declining share of financial-sector assets since 1980 
(Figure 11). Innovation has transformed the commercial paper market 
into a formidable competitor for banks. Figure 12 shows that the ratio 
of commercial paper outstanding to bank commercial and industrial loans 
(C&I loans) has increased four-fold since 1980. Meanwhile, the ratio of 
finance-company business loans to bank C&I loans has more than doubled 
over the same period, and most of this growth has occurred since 1982 
(Figure 13).

BILLING CODE 6714-01-P
      

[[Page 42710]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.011
    


[[Page 42711]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.012
    


[[Page 42712]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.013
    


BILLING CODE 6714-01-C

[[Page 42713]]

    The growth in securitization of loans represents another dimension 
of the competitive pressures faced by banks. By increasing the 
liquidity and efficiency of the credit markets, securitization produces 
a narrowing of the spreads available to traditional lenders such as 
banks and thrifts. The outstanding example of this process occurs in 
the mortgage market, where the proportion of consumer mortgages pooled 
for resale (or ``securitized'') has grown from about 10 percent in 1980 
to more than 40 percent as of year-end 1993 (Figure 14).

BILLING CODE 6714-01-P
      

[[Page 42714]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.014
    


BILLING CODE 6714-01-C

[[Page 42715]]

    On the liability side, banks have faced increasing competition from 
many nonbank financial institutions. Foremost among these have been the 
money-market mutual funds (MMMFs), which rose from obscurity in 1975 to 
prominence by 1981: the ratio of MMMF balances to comparable commercial 
bank deposits (small time and savings deposits) was virtually zero 
during the mid-1970s, but reached nearly 35 percent by 1981 (Figure 
15). After declining briefly to 25 percent in the early 1980s, this 
ratio grew steadily thereafter, exceeding 40 percent by the end of 
1993.

BILLING CODE 6714-01-P
      

[[Page 42716]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.015
    


BILLING CODE 6714-01-P

[[Page 42717]]

    These developments have forced changes in the business strategies 
of commercial bankers. Faced with diminished opportunities for C&I 
lending, banks have shifted into real-estate lending in recent years 
(Figure 16). This new portfolio composition has exacerbated the adverse 
effects on banks of downturns in regional real estate markets. 
Noninterest income also has become more important for bankers (Figure 
17), and off balance-sheet activities have grown substantially in 
recent years. The dollar amount of these activities was roughly 60 
percent of the comparable amount for on balance-sheet activities in 
1984, but this figure grew to 120 percent by the end of the decade. 
Taken together with the periodic, large-scale movements in and out of 
particular lending markets (LDC, HLT, commercial real-estate 
development, and the like), these portfolio shifts suggest that many 
banks have embarked on a widening search for new profit opportunities 
in response to the competitive pressures undermining their traditional 
niche in the financial marketplace.

BILLING CODE 6714-01-P
      

[[Page 42718]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.016
    


[[Page 42719]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.017
    


BILLING CODE 6714-01-C

[[Page 42720]]

    Innovations in information systems technology have effectively 
integrated network development, telecommunication technology and 
computing into a tool for expansion in twenty-four hour global trading, 
market monitoring and sophisticated risk management. These developments 
have permitted a global markets presence for major banking companies 
and have expanded the opportunities for global market developments in 
exchange-traded products and dealing in over-the-counter bilateral 
contracts. Advances in telecommunications, in particular, have 
permitted the rapid and inexpensive transmission of market information 
and the globalization of markets. The result may be a banking 
environment that is more complex and less transparent than at any time 
since the 1920s.
    At present, there is no indication that the forces discussed above 
are abating. Nor are there reasons to expect that the degree of 
competition or the pace of innovation will reverse course in the 
foreseeable future. To the contrary, the relentless decline of 
information costs in recent years augurs, if anything, stronger 
competition for banks, occurring on new fronts and originating from new 
sources. In view of these realities, it is reasonable to assume that 
the FDIC will continue to experience a substantial amount of volatility 
in insurance losses in the coming years.
    (d) Risks in Banking Today. The banking industry at present is in 
good health, with high earnings, high capitalization, and few problem 
institutions. The risks that currently confront the industry do not 
pose an imminent threat, but several general concerns can be 
identified.
    Market participants continue to anticipate significant volatility 
in interest rates and exchange rates, as evidenced by the explosive 
growth of derivative instruments expressly designed to hedge against 
this volatility. Competition from nonbank sources remains intense and 
likely will increase for the reasons cited above, putting pressure on 
banks' interest-rate margins. The industry is restructuring through 
mergers and is adjusting to the changing rules with respect to 
interstate banking and branching. While these developments in general 
bode well for the deposit insurance funds, major structural changes in 
an industry usually are accompanied by some costly mistakes by 
individual firms. Finally, the possibility of an economic slowdown 
later in 1995 and 1996,27 reports of potential problems in the 
agricultural sector, and continuing economic weakness in California 
must be considered.

    \27\ The consensus forecast reported by Blue Chip Economic 
Indicators as of July 1995 was for slower GDP growth in late 1995 
and 1996 than prevailed in 1994.
    Some historical perspective is also useful for assessing current 
banking risks. Information problems are inherent in evaluating the 
condition of banking institutions, and the uncertainty is compounded in 
attempting to identify emerging problems. History shows that a 
substantial percentage of bank failures have been unanticipated as 
early as two years prior to failure. The FDIC examined 1,286 bank-
failure cases from 1982-1994 in order to determine the CAMEL ratings of 
the institutions prior to failure. Table 2 displays the relevant 
results. Two years prior to failure, almost 47 percent of the 
institutions had composite CAMEL ratings of 1 or 2.28 Of the 1,189 
cases for which CAMEL ratings could be obtained 3 years prior to 
failure, over 60 percent of the institutions (which accounted for 
almost 75 percent of failed-bank assets in the sample) were rated 1 or 
---------------------------------------------------------------------------
2.

    \28\ Not all institutions were examined precisely two years 
prior to failure. The results reflect the ratings in the examination 
database as of two years prior, but the date of examination varies 
across institutions. Nonetheless, these data represent the current 
rating of the institution as of two years prior to failure, based 
upon the latest examination.

BILLING CODE 6714-01-P

[[Page 42721]]
[GRAPHIC][TIFF OMITTED]TR16AU95.018



BILLING CODE 6714-01-C

[[Page 42722]]

    Similarly, Figure 18 indicates that the vast majority of banks that 
failed between 1987 and 1994 were well capitalized three years prior to 
failure. Moreover, 80 percent of failed-bank assets over this period 
originated from institutions that were well or adequately capitalized 
three years before failure.

BILLING CODE 6714-01-P
      

[[Page 42723]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.019
    


BILLING CODE 6714-01-C

[[Page 42724]]

    The track record of models developed to project bank failures 
illustrates the same issue: these models exhibit a high degree of 
imprecision. Table 3 presents annual forecast errors from two types of 
failure projection models employed by the FDIC. The ``actuarial'' model 
groups banks into 25 cells of a matrix based on current performance 
characteristics. Failures are projected for each cell according to the 
three-year historical failure experience of banks with characteristics 
matching the criteria for the cell. Projections for a one-year horizon 
are based on the one-year failure experience of banks that would have 
qualified for the cell at any time during the previous three years, 
those for a two-year horizon are based on the two-year historical 
experience, and so on. The one- and two-year projection errors for 
failed-bank assets from this model over the past 7 years have been 
large by any reasonable standard, regularly exceeding 50 percent and 
occasionally approaching 100 percent. The ``pro forma'' model has fared 
no better. This model assumes that an institution's current portfolio 
composition will be maintained in the future and that the recent 
relationship between nonperforming loans and subsequent charge-offs 
will prevail as well. The one-and two-year projection errors from this 
model have never been lower than 80 percent.

BILLING CODE 6714-01-P

[[Page 42725]]
[GRAPHIC][TIFF OMITTED]TR16AU95.020



BILLING CODE 6714-01-C

[[Page 42726]]

    Similar conclusions emerge from an analysis of the failure 
projections made by the FDIC's supervisory staff. These projections 
list, on an individual bank basis, the banks with over $100 million in 
assets that are deemed to have a greater than 50 percent probability of 
failing during each of the next eight quarters. Since 1992, assets in 
failing institutions have ranged from 18 percent to 80 percent of those 
listed as being likely to fail within one year under this approach. The 
forecast errors are substantially higher when a two-year horizon is 
used. This illustrates that predicting the identity and timing of the 
failures of specific institutions is even more difficult than 
predicting the total volume of assets in failed banks.
    In short, indicators such as CAMEL ratings, capital categories, and 
failure projections appear to be driven largely by the current 
condition of insured institutions and not by underlying risks that are 
difficult to identify and predict. The record shows that these risks 
cannot be ignored even for institutions that currently appear healthy. 
These findings serve to emphasize that any meaningful assessment of the 
risks posed to the deposit insurance funds by insured institutions must 
look beyond a six-month period.
    Another important point that emerges from Table 3 relates to the 
volatility of forecasting errors in predicting bank failures. While the 
total volume of assets in banks failing from 1988 through 1994 was just 
13.7 percent shy of the total amounts projected over that period using 
a one-year forecast horizon, the errors in any given year were much 
larger, ranging from an 86 percent overprediction for 1992 to a 59 
percent underprediction in 1987. Thus, while it may be possible to 
discern trends in bank failures over a reasonably long period, there is 
considerable uncertainty regarding the timing of these failures.
    (e) Rate Setting--Historical Context and Current Conditions. The 
considerations described in the subsection (c) suggest that financial 
services and banking experienced a fundamental increase in risk during 
the 1980s, and that the pressures that brought about this increase in 
risk have not abated. Banking today remains a highly competitive and 
demanding business. Opportunities for geographic expansion and 
diversification will most likely increase the safety-and-soundness of 
the banking system but, like other fundamental changes in the ``rules 
of the game'' governing depositories, could result in costly mistakes 
by some institutions.
    This section provides information on the FDIC's loss experience 
since 1935. Information on hypothetical ``breakeven assessments'' is 
provided for two scenarios: Pay-as-you-go versus a long-run average 
cost assessment structure. Information on the pay-as-you-go approach is 
used to evaluate the desirability of that approach, with the result 
being an unfavorable evaluation.
    Table 4 shows assessments that would have been needed to maintain 
the BIF at 1.25 percent of insured deposits on an annual basis since 
1949. These account for the effects of investment income, operating 
expenses and changes in the amount of insured deposits in the banking 
system. Figure 19 shows that these ``pay-as-you-go'' assessments are 
much more volatile than the actual assessments that were charged by the 
FDIC, because of the tendency of bank failures to be ``bunched'' as a 
function of economic shocks, rather than being evenly distributed over 
time.

                                                                        

[[Page 42727]]
           Table 4.--BIF Premium Rates and Ratios: Effective, Pay-As-You-Go, and Fixed Rate Scenarios           
----------------------------------------------------------------------------------------------------------------
                               Effective               Pay-as-you-go                 Fixed assessments          
                      ------------------------------------------------------------------------------------------
         Year           Assessment                Assessment                  4.5 bp                            
                           rate      BIF ratio       rate      BIF ratio      ratio      7 bp ratio  13 bp ratio
----------------------------------------------------------------------------------------------------------------
1994.................        23.60         1.15        -16.7         1.25        -0.42         1.42         1.16
1993.................        24.40         0.69        -37.3         1.25        -0.56         1.11         0.80
1992.................        23.00        -0.01        -10.8         1.25        -0.92         0.60         0.23
1991.................        21.25        -0.36         62.8         1.25        -0.93         0.44         0.04
1990.................        12.00         0.21         49.0         1.25        -0.05         1.20         0.76
1989.................         8.33         0.70         17.7         1.25         0.59         1.75         1.26
1988.................         8.33         0.80         32.3         1.25         0.78         1.89         1.33
1987.................         8.33         1.10          8.9         1.25         1.16         2.21         1.60
1986.................         8.33         1.12         16.9         1.25         1.23         2.18         1.54
1985.................         8.33         1.19          8.8         1.25         1.38         2.31         1.60
1984.................         8.00         1.19         10.2         1.25         1.44         2.32         1.56
1983.................         7.14         1.22          7.6         1.25         1.52         2.35         1.54
1982.................         7.69         1.21          9.8         1.25         1.57         2.38         1.49
1981.................         7.14         1.24         -1.4         1.25         1.65         2.45         1.46
1980.................         3.70         1.16          6.5         1.25         1.56         2.27         1.29
1979.................         3.33         1.21         -1.3         1.25         1.60         2.32         1.21
1978.................         3.85         1.16          3.3         1.25         1.52         2.19             
1977.................         3.70         1.15          4.1         1.25         1.51         2.16             
1976.................         3.70         1.16          5.8         1.25         1.52         2.15             
1975.................         3.57         1.18          3.3         1.25         1.54         2.17             
1974.................         4.35         1.18          6.2         1.25         1.54         2.14             
1973.................         3.85         1.21          5.5         1.25         1.57         2.17             
1972.................         3.33         1.23          6.4         1.25         1.60         2.19             
1971.................         3.45         1.27          2.4         1.25         1.65         2.24             
1970.................         3.57         1.25          5.5         1.25         1.63         2.19             
1969.................         3.33         1.29          0.3         1.25         1.66         2.22             
1968.................         3.33         1.26          7.5         1.25         1.60         2.12             
1967.................         3.33         1.33          6.1         1.25         1.68         2.20             
1966.................         3.23         1.39          6.0         1.25         1.73         2.24             
1965.................         3.23         1.45          4.7         1.25         1.79         2.30             
1964.................         3.23         1.48          3.7         1.25         1.81         2.31             
1963.................         3.13         1.50          0.7         1.25         1.82         2.30             
1962.................         3.13         1.47          2.4         1.25         1.77         2.21             
1961.................         3.23         1.47          3.3         1.25         1.75         2.16             
1960.................         3.70         1.48          1.6         1.25         1.75         2.14             
1959.................         3.70         1.47         -0.1         1.25         1.71         2.07             
1958.................         3.70         1.43          4.5         1.25         1.64         1.96             
1957.................         3.57         1.46          1.7         1.25         1.66         1.95             
1956.................         3.70         1.44          1.2         1.25         1.62         1.88             
1955.................         3.70         1.41          2.0         1.25         1.58         1.80             
1954.................         3.57         1.39          2.3         1.25         1.54         1.73             
1953.................         3.57         1.37          0.9         1.25         1.51         1.67             
1952.................         3.70         1.34          2.5         1.25         1.46         1.57             
1951.................         3.70         1.33          3.0         1.25         1.43         1.51             
1950.................         3.70         1.36         11.5         1.25         1.41         1.45             
1949.................         8.33         1.57          0.4         1.25         1.57         1.57             
----------------------------------------------------------------------------------------------------------------



BILLING CODE 6714-01-P

[[Page 42728]]
[GRAPHIC][TIFF OMITTED]TR16AU95.021



BILLING CODE 6714-01-C

[[Page 42729]]

    Pay-as-you-go assessments have the undesirable effect that the 
banking industry must pay the most for its insurance at precisely the 
time it can least afford it. For example, as indicated in Figure 20, in 
1988 through 1991, when the banking industry was experiencing its 
greatest difficulties since the 1930s, pay-as-you go assessments would 
have drastically reduced bank income. In 1988, median bank return-on-
assets (ROA) would have been reduced by 37 percent; in 1989 by 19 
percent; in 1990 by 57 percent; and in 1991 by 71 percent. These sharp 
reductions in income could have significantly impaired the recovery and 
recapitalization of the banking industry and increased the FDIC's costs 
from bank failures. Thus, the Board's obligation to consider the impact 
on bank earnings and capital of an assessment rate structure would 
virtually preclude it from adopting a rigid pay-as-you-go rate-setting 
approach.

BILLING CODE 6714-01-P
      

[[Page 42730]]
    [GRAPHIC][TIFF OMITTED]TR16AU95.022
    


BILLING CODE 6714-01-C

[[Page 42731]]

    For these reasons, there is likely to be considerable pressure 
brought to bear on the FDIC during periods when the banking industry is 
under stress not to charge assessments high enough to maintain the DRR. 
If the reserve ratio falls below the DRR, the FDIC is required by law 
to increase assessments to regain the DRR within one year. However, if 
the drop is such that the DRR cannot be attained after a year of 
increased assessments, the FDIC is mandated to impose assessments 
equivalent to a minimum average weighted rate of 23 basis points which 
would be in effect until the DRR is attained--potentially for up to 15 
years. While the requirement to charge an average rate of at least 23 
basis points is less onerous for the industry and the insurance fund 
than a strict pay-as-you-go rule, it may be cause for concern. Although 
BIF institutions absorbed the increase in effective annual assessment 
rates to 23 basis points as of 1992 with no known direct casualties, it 
is notable that a strong recovery was emerging in the banking industry 
at the same time, in part because of a more favorable interest rate 
environment. It is questionable whether such increases could have been 
absorbed without a discernable adverse impact during a downturn or at 
the trough of a banking cycle such as 1988-89.
    A strict pay-as-you-go approach results in substantial adverse 
effects on industry earnings and capital at the time the industry can 
least afford additional costs. It ignores the real risks that exist in 
banking beyond a six-month time horizon and, thus, appears to conflict 
with the Board's duty to consider fully the probability and likely 
amount of insurance losses and case resolution expenditures. Further, 
because such an approach would likely be abandoned during times of 
banking difficulties, it is likely to result in periodic episodes where 
the fund falls below its DRR and the FDIC is operating in 
``recapitalization mode,'' or in even more severe straits.29 For 
these reasons, the Board regards the pay-as-you-go approach as 
seriously flawed.

    \29\ For example, in 1991 the BIF reserve ratio reached a 
negative 0.36 percent of insured deposits.
---------------------------------------------------------------------------

    The alternative basis for setting BIF assessments, and the basis 
adopted by the Board, is to look beyond the immediate time frame in 
estimating the revenue needs of the fund. For illustrative purposes 
Table 4 shows the assessments that would have equated revenues to costs 
over certain periods in the FDIC's history. The analysis begins at 
year-end 1949, after the FDIC had retired its initial Treasury capital 
contribution. From 1950 through 1980, a period of relative stability in 
banking compared to more recent times, an assessment rate of roughly 
4.5 basis points would have balanced costs and revenues over the 
period. From 1980 through 1994 the required assessment rate would have 
been roughly 13 basis points, and for the entire 1950-1994 period the 
required rate would have been seven basis points. Under all these 
scenarios the reserve ratio of the fund would have fluctuated 
considerably and would have been ``maintained'' in a long-run average 
sense.
    The FDIC's historical loss experience thus suggests that an 
effective assessment in the range of 4.5 basis points to 13 basis 
points would be expected to balance revenues and expenses over a 
relatively long period of time. There are several factors that cause 
the Board to adopt an effective average assessment rate at the low end 
of the range suggested by historical experience.
    Recent developments suggest that the FDIC's expected cost resulting 
from a given level of banking risk may be smaller now than it was in 
the 1980s. Prompt corrective action has strengthened the regulators' 
hands in closing nonviable institutions promptly. The least-cost 
resolution process mandated by FDICIA has reduced the number of 
instances where the FDIC is permitted to protect uninsured depositors 
in bank failures. The nationwide depositor preference statute has 
placed the FDIC and the depositors ahead of all nondeposit creditors in 
receiverships of failing banks, although it remains to be seen whether, 
as the markets gain more experience with depositor preference, bank 
liabilities will shift as a bank approaches failure in ways that would 
reduce the FDIC's cost savings. Sectoral price inflation and the danger 
of subsequent deflation appear less of a concern now than in the 1980s. 
While underlying risks are still significant, the banking industry will 
face any new episode of problems with higher capital ratios than it 
enjoyed in the 1980s. Finally, the BIF balance and reserve ratio are 
much higher than they were during most of the 1980s, resulting in 
higher levels of investment income that will reduce the effective 
assessment rate needed to balance revenues and expenses.
    The net result of these changed conditions is that a purely 
historical analysis of long-term expected costs should be substantially 
tempered by a judgment about the effect of these changes on expected 
losses. Since we have not had a significant episode of bank failures 
since the imposition of these changes, there is little empirical basis 
for speculation about the magnitude of cost reductions likely to occur. 
Nevertheless, it is the judgment of the Board that an effective 
assessment rate for the banking industry at the lower end of the 4.5 to 
13 basis-point range suggested by historical experience is likely to 
cover expected losses to the BIF over a reasonable time horizon. The 
Board expects that this judgment will be revisited on a semiannual 
basis in light of changing conditions.
    (f) Rate Setting--Planning for Volatility in Insured Deposits. The 
FDIC sets assessment rates to be effective for a subsequent six-month 
period. An element of uncertainty about the reserve ratio that will 
result from a given rate schedule arises from the possibility for 
insured deposits to grow or shrink over the six-month period at rates 
different than originally expected.
    Figures 21 and 22 provide some perspective on this issue. Figure 21 
displays the frequency of various percentage changes in insured 
deposits at commercial banks occurring during six-month intervals, 
quarterly from 1984 through the first quarter of 1995. The impacts of 
these percentage changes on the BIF reserve ratio, applied to an 
assumed BIF ratio of 1.25 percent of BIF-insured deposits as of the 
first quarter of 1995, are displayed in Figure 22.

BILLING CODE 6714-01-P

[[Page 42732]]
[GRAPHIC][TIFF OMITTED]TR16AU95.023



[[Page 42733]]
[GRAPHIC][TIFF OMITTED]TR16AU95.024



BILLING CODE 6714-01-C

[[Page 42734]]

    The 1984-1985 period described in Figures 21 and 22 can be divided 
into two subperiods. From 1984 to mid-1991, there was healthy, 
sustained growth in insured deposits. Since mid- to late 1991, however, 
insured deposits have for all intents and purposes not grown at all. It 
is uncertain how much the dramatic reduction in assessments resulting 
from the new rate schedule in the final rule will stimulate growth in 
BIF-insured deposits.
    The experience of the 1984-1995 period indicates that changes in 
insured deposits can subject the BIF reserve ratio to considerable 
variation relative to the DRR. For example, during three six-month 
periods since 1984, insured deposits increased at rates that if applied 
today, would reduce the BIF reserve ratio by more than eight basis 
points, to less than 1.17 percent, other things constant.
    The import of these facts is that if the FDIC set assessment rates 
so that the BIF were expected to end the subsequent six-month period at 
the DRR, based on a modest expected growth in insured deposits, then 
actual growth in insured deposits could deviate sufficiently from 
expected growth that the FDIC could end the assessment period with a 
reserve ratio of considerably less than the DRR. This attests to the 
difficulty of precisely managing the reserve ratio and suggests 
maintenance of the DRR may require the FDIC to allow for the 
possibility of unexpected changes in insured deposits.
2. Summary of Application of Statutory Factors
    (a) Financial Factors: Probability and Likely Amount of Insurance 
Losses; Case Resolution Expenditures and Income; Operating Expenses; 
Revenue Needs of the Fund. As discussed in Section IV.B.1 above, the 
Board believes that its insurance responsibilities require it to look 
beyond the immediate timeframe in setting assessment rates. The 
probability and likely amount of losses and case resolution expenses 
are determined by risk factors that operate over a far longer horizon 
than six months. Accordingly, the Board's duty to assess risk-based 
assessments in accordance with these statutory factors require it to 
price the risk of adverse events that may occur beyond the immediate 
horizon.
    Projected income and expense for the second half of 1995 are 
presented in Table 5. Total income from assessments and investments of 
about $1.1 billion is expected to exceed total insurance losses and 
operating expenses in the range of $302 million to $352 million. The 
BIF reserve ratio is expected to be between 1.27 percent and 1.31 
percent at June 30, 1995, depending on the timing of the proposed 
refund of overpayments and the growth in insured deposits during the 
second quarter.

BILLING CODE 6714-01-P

[[Page 42735]]
[GRAPHIC][TIFF OMITTED]TR16AU95.025



BILLING CODE 6714-01-C
    The BIF reserve ratio as of December 31, 1995, will be dependent on 
a variety of factors, none of which can be predicted with certainty at 
this time. 

[[Page 42736]]
The Board considered a range of assumptions about these factors in an 
effort to estimate the BIF reserve ratio at year-end 1995 that would 
result from the new rate schedule. Insurance losses and increases in 
the reserve for future failures during the second half of 1995 were 
assumed to range from a negative $200 million to a positive $600 
million. This range reflects the possibility that institutions for 
which the FDIC has established a loss reserve would recover during the 
second half of 1995 or, alternatively, that currently unidentified 
institutions would develop problems during this period that would 
require the FDIC to establish a loss reserve. The range of variability 
considered for this factor is modest relative to the variations in the 
reserves that have occurred in recent years. BIF-insured deposits are 
assumed to grow at an annualized rate of between zero and six percent 
during the last three quarters of 1995. While six percent growth 
appears unlikely at this time, it is not outside the range of 
historical experience, as indicated in Figure 21. Under these 
assumptions, the BIF reserve ratio would be between 1.24 percent and 
1.36 percent at year-end 1995.
    The rule adopted by the Board thus is expected to result in an 
excess of revenue over expense for the second half of 1995. The Board 
based this decision on two general factors. First is the requirement to 
set assessment rates to account for the probability and likely amount 
of insurance losses. As just discussed, this requires the Board to 
consider the possibility of adverse events that may not occur during 
the immediate timeframe. The FDIC's experience during two very 
different times--the relatively stable period from 1950 to 1980, and 
the more volatile post-1980 period--suggests that an assessment in the 
range of 4 to 13 basis points would, on average, meet the revenue needs 
of the fund over a long period of time in light of the probability and 
amount of losses, case resolution expenditures, income, and operating 
expenses that have characterized the FDIC's past experience.
    The Board has considered other factors governing the probability 
and likely amount of losses and case resolution expenditures that are 
likely to occur in future years. As discussed in more detail in Section 
IV.B.1(e), these include recent statutory changes (prompt corrective 
action, least-cost resolution and depositor preference), the currently 
reduced likelihood of problems arising from sectoral inflations and 
subsequent deflations, and the high capital ratios generally prevailing 
in banking. These factors tend to reduce the probability and likely 
amount of losses and caused the Board to adopt an effective assessment 
rate at the low end of the historically suggested range.
    Another factor driving the selection of an assessment rate at the 
low end of the historical range was the investment income deriving from 
the current BIF balance. The investment income of the BIF will be 
substantially higher than it was during most of the last ten years. 
This reduces the need for assessment income to meet the revenue needs 
of the insurance fund. It is anticipated that the Board will revisit 
this issue on a semiannual basis by considering further adjustments in 
assessment rates if the BIF continues to grow in light of the Board's 
obligation to maintain the BIF at the target DRR.
    The second general factor governing the selection of the rates 
adopted by the Board is the need to allow for the possibility of 
unanticipated changes in insured deposits or loss reserves that may 
occur during a semiannual period. The BIF ratios projected to occur at 
midyear and year-end 1995, respectively, are projections based on a 
reasonable range of estimates of the growth in BIF insured deposits 
during 1995. It must be emphasized that the level of BIF-insured 
deposits for neither date are known at this time. As discussed in 
subsection (f) above, based on the historical variability in semiannual 
changes in insured deposits, it is conceivable that the BIF ratio might 
not reach the DRR at year-end even under the new rate schedule. As 
indicated in Figure 22, it is within the range of the historical 
experience of the past 10 years that insured deposits can change by 
enough in a six-month period to move the BIF reserve ratio by as much 
as eight basis points.
    Similarly, in evaluating the probability and likely amount of 
insurance losses, the Board considered the uncertainty inherent in 
predicting the level of the FDIC's reserve for future failures. This 
reserve is determined using a methodology agreed to by the U.S. General 
Accounting Office and is intended to estimate the cost of failures that 
can reasonably be anticipated over a subsequent 18-month period. The 
provision for insurance losses has displayed considerable volatility in 
recent years, ranging from a $15.4 billion addition to the reserve in 
1991 to a $7.7 billion reduction in the reserve in 1993.
    The net effect of variability in insured deposits and losses, and 
additions to the loss reserve, can be of considerable practical import 
in light of the Board's duty to maintain the DRR. For example, as 
indicated in Table 5, an annualized growth in BIF insured deposits of 
six percent over the last three quarters of 1995, in conjunction with 
insurance losses and additions to reserves of $600 million during the 
second half of 1995, would result in the BIF falling short of the DRR 
at year-end. The new rate schedule provides a level of comfort that 
unanticipated changes in insured deposits will not cause the BIF to 
fall below the DRR.
    (b) Impact on Earnings and Capital. In deciding against adopting a 
strict pay-as-you-go policy for setting assessments, the Board 
considered the adverse effects on banking industry earning and capital 
of such a policy. As discussed in subsection (e), such a policy has the 
undesirable effect of sharply increasing the assessment costs of 
insured institutions at a time when they can least afford such 
increases. Subsection (e) describes how a pay-as-you-go policy applied 
during the 1980s would have had a severe adverse impact on the earnings 
and capital of the banking industry during the years 1988-1991.
    The Board considered the near-term impact of adopting the 4 to 31 
basis point rate matrix. Because assessment rates for most BIF members 
will decline under the new assessment schedule, the impact on earnings 
and capital will be positive. Lower assessment costs will reduce 
expenses by approximately $4.4 billion per year. Based on the 
industry's year-end 1994 average tax rate of 33 percent, after-tax 
profits will increase by approximately $3 billion per year. BIF members 
may pass some portion of the cost savings on to their customers through 
lower borrowing rates, lower service fees, and higher deposit rates. 
Their ability to do so will be affected by factors such as the level of 
competition faced by banks. As discussed in Section III above, the 
potential adverse effect on weaker institutions resulting from the 
decreased assessment rate paid by their competitors is likely to be 
minimal in terms of the number of additional failures.
    (c) Other Factors the Board Deems Appropriate. When setting 
assessment rates to maintain the reserve ratio at the DRR, section 
7(b)(2)(A)(ii) authorizes the Board to consider ``any other factors 
that the Board of Directors may deem appropriate''. The statute does 
not limit the discretion of the Board to determine those factors which 
are appropriate to consider in the rate-setting process. Although the 
statute specifically lists other criteria, such as case resolution 
expenditures, which must be included in its determination, the Board is 
free to take into account economic and other data which it deems 
relevant. Accordingly, the Board has incorporated 

[[Page 42737]]
into its balancing process a review of variables particular to the 
financial services industry such as interest and exchange rate 
volatility and nonbank competition as well as projections for the 
economy in general.
    The proposal reviewed the propriety of including under this factor 
consideration of the competitive disparity arising from the 
differential in assessments for members of the BIF and SAIF. The Board 
is adopting without change the interpretation of ``other factors'' 
which was set forth in the proposal.
    The proposal discussed the interplay of the ``other factors'' 
provision with section 7(b)(2)(B), which requires the Board to set 
semiannual assessments for members of each fund ``independently'' from 
semiannual assessments for members of the other insurance fund. Read 
together, these provisions do not specifically prohibit Board 
consideration of the impact of BIF rates on SAIF members as long as the 
rates are set independently. However, the proposal indicated the 
potential conflict with section 7(b)(2)(A)(i) which requires the Board 
to set rates to maintain the BIF reserve ratio. If the Board were to 
take into consideration the impact on the SAIF when it set BIF rates 
(i.e., setting BIF rates higher than otherwise necessary to minimize 
the disparity between BIF and SAIF rates), and, as a result, the 
reserve ratio continued to increase in excess of the DRR, it might be 
considered a violation of the statute.
    Although a total of 591 commenters indicated that the Board should 
not take into account the impact on the SAIF and its members when 
setting the rates for BIF members, few of those comments provided any 
legal analysis. Those that did, (including the ABA, ABA State 
Association Division, IBAA, Citicorp, New York Clearing House, the 
California Bankers Association, GreenPoint Bank and Bank of Boston) 
concurred with the analysis set forth in the proposal. A number of 
these commenters indicated that ``other'' factors should be interpreted 
only to encompass factors that relate to the condition of the BIF.
    By contrast, the Savings Association Insurance Fund Industry 
Advisory Committee (SAIFIAC) indicated that the FDIC ``has an equal 
duty and responsibility to each Fund * * * [which] dictates that any 
proposal to lower BIF rates must be coupled formally with both a 
regulatory determination that the SAIF PROBLEM MUST BE DEALT WITH, and 
a proposal for a solution.'' (Emphasis in original.) SAIFIAC further 
indicated its belief that the proposal declined to take into account 
the impact on SAIF because that impact could not be quantified.
    The Board continues to believe that setting BIF rates higher than 
otherwise would be warranted would likely cause an increase in the BIF 
reserve ratio above in the DRR in violation of the statute. 
Accordingly, the Board is adopting the interpretation of ``other 
factors'' as proposed.
3. Conclusions
    The principal conclusion of the foregoing analysis is that the 
exercise of the FDIC's insurance responsibilities require it to look 
beyond the immediate period in pricing risk. A pure pay-as-you-go 
pricing system can expose the banking industry to unduly high and 
volatile insurance assessments that can adversely affect the soundness 
of the banking system and the BIF. Moreover, the FDIC's experience with 
bank failures makes it clear that a meaningful evaluation of the risk 
associated with even highly rated and well-capitalized institutions 
must look beyond a six-month period. Accordingly, the Board will 
undertake to look beyond the immediate period in determining the 
revenue needs of the BIF.
    The second principal conclusion is that the Board's duty to 
maintain the DRR as a target requires it to take account of the 
substantial variability of a number of factors influencing the revenue 
needs of the fund. Insured deposits display enough variability to cause 
the BIF reserve ratio to fluctuate considerably relative to the DRR. 
Insurance losses are extremely difficult to predict, and the FDIC's 
policy of establishing loss reserves for failures expected to occur as 
much as 18 months in the future magnifies the problem of prediction. 
This is because the prediction of the BIF's income in the second half 
of 1995 necessarily must allow for the possibility of changes in the 
reserve for future failures that may not occur until year-end, for 
failures anticipated to occur through mid-1997.
    In light of the imprecision inherent in the measurement of banking 
risk--whether through examination ratings, capital measures or models 
used to project bank failures--the Board does not intend to specify a 
time period over which the FDIC will attempt to estimate its expenses 
for the purpose of setting assessment rates. Instead, rate-setting will 
be undertaken as an evolving process in which historical analysis 
tempered by informed judgment about current conditions, including the 
investment income deriving from the balance in the BIF, is revisited on 
a semiannual basis.
    The historical analysis presented above suggests that an effective 
average assessment rate in the range of 4.5 to 13 basis points would be 
expected to meet the revenue needs of the fund over the very long term. 
The factors outlined above have convinced the Board that the lower end 
of the assessment range is reflective of the risks currently facing the 
BIF and, moreover, takes adequate account of the variability in insured 
deposits, losses, and additions to the reserve for future failures that 
may affect the adequacy of the BIF relative to the DRR over the second 
half of 1995. The Board is, accordingly, adopting the 4 to 31 basis 
point rate matrix as originally proposed.
    In adopting the 4 to 31 basis point rate schedule, the Board 
emphasizes its expectation that the rate-setting process going forward 
will evolve continuously. For example, even assuming no change in the 
FDIC's risk exposure to potential bank failures, the attempt to balance 
revenues and costs over a longer horizon is consistent with semiannual 
adjustments to reflect changes in the fund balance. Increases in the 
BIF balance, due either to shocks or to favorable industry conditions 
that persist beyond the period that could be expected, would increase 
investment income and make it less likely that the fund would fall 
short of the DRR over any given future horizon, other things equal. In 
response to this, and depending upon other relevant factors, the Board 
may deem it appropriate in subsequent semiannual periods to reduce 
assessments below the level that previously had been expected to be 
necessary to meet the revenue needs of the funds.
V. Application and Adjustment of New Assessment Schedule

    The Board is adopting the proposal to apply the new assessment rate 
schedule in the semiannual period during which the DRR is achieved, 
with refunds of any overpayments from the first day of the month 
following the month in which the DRR is achieved. Under the final rule, 
overpayments will be refunded with interest at a rate that corresponds 
to the rate of interest earned by the FDIC on the overpayments.
    In addition, the Board is adopting, with two clarifications, the 
proposed process for modifying the new assessment rate schedule by 
means of an adjustment factor of 5 basis points, as necessary to 
maintain the reserve ratio at 1.25 percent without the necessity of 
engaging in separate notice-and-comment rulemaking proceedings for each 
adjustment. 

[[Page 42738]]


A. Semiannual Period During Which DRR Is Achieved

    In the proposal, the Board interpreted the language and legislative 
history of section 7(b)(2)(E) of the FDI Act--that is, the requirement 
to assess a minimum average rate of 23 basis points--as prohibiting the 
Board from decreasing the assessment rates paid by BIF members until 
after the FDIC is able to confirm that the reserve ratio has, in fact, 
reached the DRR, regardless of projections for BIF recapitalization. If 
the Board were to decrease the rates based on projections for BIF 
recapitalization, the reserve ratio would ``remain'' below the DRR at 
the time of the Board's action and the minimum-assessments provision of 
section 7(b)(2)(E) would continue to apply. Accordingly, the Board 
proposed to decrease assessment rates once the FDIC has been able, 
based on a review of the relevant quarterly reports of condition (call 
reports) necessary to determine the amount of estimated insured 
deposits,30 that the DRR has in fact been achieved. The rate 
reduction would be effective on the first day of the month following 
the month in which the DRR is attained. The Board further proposed to 
refund, with interest from the date the new rates take effect, any 
overpayments of assessments under the new rate schedule resulting from 
the delay in confirming attainment of the DRR.

    \30\ The reserve ratio is the dollar amount of the BIF fund 
balance divided by the estimated insured deposits of BIF members. 
Although data for the fund balance is accounted for on a monthly 
basis, the amount of estimated insured deposits is based on data 
from the quarterly reports of condition (call reports). Because it 
appears that the BIF recapitalized in the second quarter, the amount 
of estimated insured deposits would be determined by the information 
on the June call reports which are due on July 30 (or for some 
institutions, August 14). Due to the customary time lag involved in 
verifying the information from the call reports, it is probable that 
the determination that the DRR has been achieved will not be made 
until mid-September. Moreover, because the fund balance is 
determined only on a monthly, rather than a daily basis, the date on 
which the Board ascertains that the DRR has been attained is the 
last day of the month.
---------------------------------------------------------------------------

    Of the 356 commenters addressing these elements of the proposal, 
343 expressed support for the process of implementing the new rates and 
refunding overpayments. Of these, 286 respondents expressly mentioned 
support for refunding the assessments with interest from the date the 
new rates become effective.
    One commenter thought that, for overpayments in the first 
semiannual assessment period of 1995, interest should be paid from the 
date the FDIC received the assessment in January, rather than from the 
date the new rates take effect. Eight commenters disapproved of the 
proposed process, believing rates should be dropped more quickly.
    Numerous commenters urged that the determination be made as quickly 
as possible. For example, the IBAA urged the FDIC to ``make the 
necessary determinations as soon as humanly possible so that banks will 
enjoy the benefits of premium reduction as early as possible.'' The ABA 
urged the FDIC to reduce assessments in the third quarter ``if the 
weight of the evidence shows that the BIF will have reached the DRR 
before June 30.'' The ABA's position is that waiting for confirmation 
of data from the June 30 call reports would merely unnecessarily 
complicate the whole process of changing rates.31

    \31\ The ABA reiterated this view in a May 19, 1995, meeting 
with FDIC staff members, which the ABA had requested to discuss the 
proposal. At the meeting, the ABA urged that the FDIC quickly act to 
reduce BIF rates to a level no higher than that necessary to bring 
the BIF to its DRR. FDIC staff stated the Board's position reflected 
in the proposal that the FDIC is precluded from reducing rates until 
it has been able to determine that the DRR has in fact been reached. 
A summary of the ABA meeting is included in the public comment file 
on the proposal, along with other oral and written comments 
submitted by the ABA and other respondents.
---------------------------------------------------------------------------

    The FDIC has carefully considered the comments addressing these 
issues. However, the Board continues to believe, given the statutory 
language of section 7(b)(2)(E) and the relevant legislative history, 
that the FDIC does not have authority to lower assessment rates until 
it is certain that the DRR has been attained. Accordingly, as proposed, 
the Board has decided not to apply the new rate schedule until the 
first day of the month after the month in which the DRR has actually 
been reached. In the event it is determined that the DRR has been 
reached before the September 30 assessment payment date, as is 
expected, the Board will promptly notify BIF members that the amount of 
the September 30 payment will be adjusted to reflect the new rate 
schedule. In order to avoid any additional overpayment or confusion, 
the final rule provides that the FDIC also may delay collection of the 
assessments that would otherwise be due on September 30 (or such later 
payment date that next follows the effective date of the new rate 
schedule). If this occurs, it is very likely that the FDIC would also 
delay for a brief period the date of the associated invoice, which is 
provided one month prior to the collection date (for example, the 
invoice date for a September 30 collection date is August 30).
    Because the new assessment rate schedule will apply from the first 
day of the month after the month in which the DRR was achieved, it is 
likely to be determined that many BIF members have overpaid their 
assessments. For example, if the DRR is determined to have been 
achieved on May 31 and the new assessment schedule becomes 
retroactively effective on June 1, it is likely that all institutions 
except those paying the highest rates will have overpaid their 
assessment for the first semiannual period of 1995. Similarly, most 
institutions will have overpaid their assessments paid on June 30, 
1995, for the July-September quarter of the second semiannual period.
    In such instances, the FDIC will refund the overpayment with 
interest from the effective date of the new assessment rate schedule, 
in the case of overpayments for the first semiannual period, and from 
the payment date, in the case of overpayments for the second semiannual 
period. The FDIC anticipates that it will provide such refunds 
electronically by means of credits sent through the Automated Clearing 
House (ACH) system, but may do so by check or in more than one payment. 
In the case of electronic refunds, it is anticipated that the same 
routing transit numbers and accounts used for direct-debit assessments 
collection will be used for the electronic credits.
    Under the proposal, the interest rate to be paid by the FDIC on 
overpayments resulting from a change in the BIF rate schedule would 
have been the rate normally applicable to assessment over- or 
underpayments in general. However, under the unique circumstances 
applicable here, the Board has decided to pay an interest rate that 
corresponds to the rate actually earned by the FDIC on the 
overpayments. Because the FDIC knew that it was highly likely that the 
June 30 collection of assessments at the existing rates would result in 
significant overpayments for all but the riskiest institutions, the 
Board believes that it is fair and appropriate to pay an interest rate 
that returns to the overpaying institutions the amount of interest 
actually earned by the FDIC on their overpayments. Accordingly, the 
final rule incorporates a special interest rate that is the arithmetic 
average of the overnight simple interest rate received by the FDIC on 
its U.S. Treasury investments during the relevant period (including 
weekends and holidays at the rate for the previous business day). For 
example, had the relevant period been June 1995, the applicable rate 
would have been 6 percent.
    The FDIC recognizes that, once the new assessment rate schedule 
becomes effective, insured institutions may have 

[[Page 42739]]
questions regarding the application of the new rate schedule and the 
mechanics of the refund process, including how and when refunds will be 
made. Accordingly, the FDIC will be providing additional, more specific 
information regarding these matters to insured institutions.

B. Semiannual Periods after the DRR is Achieved: the Adjustment Factor

    As to the semiannual assessment periods after the DRR is achieved 
and the new rate schedule has become effective, the Board is adopting 
the proposed adjustment factor, with two clarifications.
    Under the proposal, the new assessment rate schedule, once 
activated, would continue to apply to succeeding semiannual periods, 
with modification as necessary in future periods to maintain the 
reserve ratio at the target DRR by means of an adjustment factor of up 
to and including an aggregate of plus-or-minus 5 basis points or 
fraction thereof. The proposal limited to this 5 basis-point range the 
amount by which the Board could adjust the assessment rate schedule 
without engaging in a notice-and-comment rulemaking proceeding. Such 
adjustments would be applied to each cell in the rate schedule 
uniformly; they could not be applied only to selected risk 
classifications. For example, if the Board were to adjust the rate 
schedule by a reduction of 2 basis points, then the assessment rate 
applicable to each assessment risk classification would be reduced by 2 
basis points (from, say, 4 to 2 basis points, 7 to 5 basis points, 14 
to 12 basis points, and so on). Thus, the differences between the 
respective cells in the rate schedule would remain unchanged. 
Similarly, such adjustments would neither expand nor contract the 27-
basis point spread between the lowest- and highest-risk 
classifications.
    The 5 basis-point maximum would limit the extent to which the rate 
schedule could be adjusted over time without triggering a new notice-
and-comment rulemaking proceeding. Thus, for example, if the rate for 
1A banks were 4 basis points, no matter how many times the assessment 
schedule were adjusted up or down, the rate for 1A banks could not be 
increased over time to a rate higher than 9 basis points without a new 
notice-and-comment rulemaking proceeding. The same limitations would 
apply to rate reductions.
    Under the proposal, the adjustment factor for any particular 
semiannual period would be determined by (1) the amount of assessment 
income necessary to maintain the reserve ratio at 1.25 percent (taking 
into account operating expenses and expected losses and the statutory 
mandate for the risk-based assessment system) and (2) the particular 
risk-based assessment schedule that would generate that amount 
considering the risk composition of the industry at the time. The Board 
proposed to adjust the assessment rate schedule every six months by the 
amount, up to and including the maximum aggregate adjustment factor of 
5 basis points, necessary to maintain the reserve ratio at the DRR. 
Such adjustments would be adopted in a Board resolution that reflects 
consideration of the following statutory factors: (1) Expected 
operating expenses; (2) projected losses; (3) the effect on BIF 
members' earnings and capital; and (4) any other factors the Board 
determined to be relevant.
    The Board resolution would be adopted and announced at least 45 
days prior to the date the invoice is provided for the first quarter of 
the semiannual period for which the adjusted rate schedule would take 
effect. Thus, the rate schedule applicable to the November 30 invoice 
would be announced no later than October 16 and the schedule applicable 
to the May 30 invoice would be announced by April 15. If the amount of 
the adjustment under consideration by the FDIC would result in an 
adjusted schedule exceeding the 5 basis-point maximum, then the Board 
would initiate a notice-and-comment rulemaking proceeding to be 
completed prior to the invoice date.
    A total of 75 commenters addressed the issues of the proposed 
process to adjust the rates and the amount of the adjustment factor. Of 
the 61 comments in support of the process (including 8 trade 
associations and 47 BIF members), 41 indicated that the size of the 
adjustment factor (5 basis points) was appropriate. The ABA (as well as 
the ABA State Association Division) supported the process only so long 
as the purpose of the adjustment was to maintain the reserve ratio at 
the DRR. A number of commenters, including Signet Banking Corporation 
and Wells Fargo Bank, supported the proposed adjustment process but 
noted that it should be used both for rate increases and decreases. 
(The proposal intended that the adjustment process would be used both 
for increases and decreases.) NationsBank also supported the proposal 
but indicated any adjustments should be made not more frequently than 
annually.
    Other commenters expressed concern about the lack of opportunity 
for comment, particularly where an increase in rates could have a 
significant effect on BIF members. For example, the IBAA opposed the 
use of the proposed adjustment process for increases but not for 
decreases in the assessment schedule because of the lack of opportunity 
to comment on assumptions made by the FDIC concerning expected 
expenses, loss rates, investment income, and other factors. The IBAA 
indicated that this is particularly important in a case where the FDIC 
would raise the schedule by the full amount of the adjustment factor (5 
basis points) which would represent more than double the proposed 4 
basis-point rate for institutions in the 1A risk classification. 
Chemical Bank opposed both the process and the size of the adjustment 
factor for both increases and decreases in the rate, noting that an 
increase of 5 basis points would represent more than a doubling of the 
rate for most banks. The Bankers Roundtable also expressed concerns 
with permitting the FDIC to raise assessments without notice and 
comment where an increase could significantly increase costs to the 
banks. To provide the FDIC with some flexibility, it proposed an 
alternative process whereby the use of the adjustment factor at the 
FDIC's sole discretion would be limited to 2 basis-point changes; 
changes above 2 basis points but less than 5 basis points could be 
imposed after an abbreviated comment period (two-three weeks); changes 
above 5 basis points would go through the normal comment period.
    Banc One Corporation opposed the proposed adjustment process based 
on the erroneous belief that it would permit the Board to raise the 
assessment schedule by as much as 9 basis points from one semiannual 
period to another without the opportunity for notice and comment. 
Instead, Banc One favored limiting the adjustment factor to an increase 
or decrease of 1 basis point only. The New York Clearing House opposed 
the adjustment process, noting that an increase of 5 basis points would 
represent a 125 percent increase for banks with risk classification 1A. 
However, the Clearing House also misunderstood the proposed process, 
believing that the schedule could be increased sharply ``in only a few 
years without ever seeking public comment''.
    The Board has decided to adopt the proposed rate-adjustment 
process, with two clarifications. First, given the apparent confusion 
regarding the maximum extent to which the rate schedule could be 
adjusted without triggering a new rulemaking proceeding, 
Sec. 327.9(b)(1) of the final rule clarifies that the maximum 
adjustment level of plus-or-minus 5 basis points is intended to apply 
as an aggregate amount, over 

[[Page 42740]]
time, taking into account both increases and decreases, but that no one 
adjustment may constitute an increase or decrease of more than five 
basis points. This clarification reflects the Board's intent to seek 
public comment on, for example, a proposed increase of 3 basis points 
for a semiannual period following an earlier period for which the 
Board, by resolution, adjusted the rate schedule upward by 3 basis 
points, or a proposed decrease of 6 basis points after a previous 
increase of three basis points, but not to seek public comment on an 
increase of 5 basis points following an intervening decrease of 2 basis 
points.32 Similarly, language also has been added to this 
paragraph to expressly state the Board's intent, as indicated in the 
proposal, that any adjustment apply uniformly to each rate in the 
schedule.

    \32\ The following hypothetical examples illustrate this 
concept. Example 1. (a) On April 15, 1996, the Board adjusts the 
assessment rate schedule upward by 3 basis points to 7-to-34 basis 
points. Notice-and-comment rulemaking is not required because the 
increase does not exceed the 5 basis-point adjustment maximum. (b) 
On October 16, 1996, the Board again increases the adjusted schedule 
by 3 basis points, to 10-to-37 basis points. Such action requires 
notice-and-comment rulemaking because it would result in an 
aggregate increase of more than 5 basis points. Example 2. (a) On 
April 15, 1996, the Board increases the rate schedule by 3 basis 
points to 7-to-34 basis points. Notice and comment rulemaking is not 
required. (b) On October 16, 1996, the Board decreases the 
previously-adjusted schedule by 2 basis points to 5-to-32 basis 
points. Rulemaking is not required because the change, in the 
aggregate, does not result in an increase or decrease of more than 5 
basis points. (The change, in the aggregate, is a net increase of 
one basis point.) (3) On April 15, 1997, the Board adjusts rate 
schedule upward by 5 basis points. Such action requires notice-and-
comment rulemaking because it would result in an aggregate increase 
of more than 5 basis points, taking into consideration the previous 
adjustments. In addition, notice-and-comment rulemaking would be 
required for any single step in either of these examples which by 
itself, without aggregation, would constitute an increase or 
decrease of more than 5 basis points.
    Second, the final rule also expressly reflects the FDIC's intent 
promptly to make public the basis for any Board decision to adjust the 
rate schedule. Under Sec. 327.9(b)(2) of the final rule, with this 
clarification, the Board will announce the semiannual assessment 
schedule for the next semiannual period, with the amount and basis for 
any adjustment from the then-existing schedule, no later than 45 days 
before the invoice date for the first quarter of that next semiannual 
period (that is, by October 16 or April 15, as applicable).
    The Board fully understands concerns regarding the possibility of 
assessment rate increases without the benefit of full notice-and-
comment rulemaking. However, the Board notes that the adjustment 
applies to decreases as well as to increases and that, in the current 
economic environment, the former could be more common than the latter. 
Moreover, the Board's discretion in applying the adjustment factor is 
not unfettered. The maximum amount of the adjustments is limited to an 
increase or decrease of 5 basis points, either at any one time or over 
time, and in adopting an adjustment the Board must satisfy the criteria 
enumerated in Sec. 327.9(b) of the final rule, which reflect the 
statutory rate-setting factors referred to above. Moreover, as with any 
of its decisions, the Board may act only after due deliberation and in 
a reasonable manner. As previously indicated, the basis for any 
adjustment adopted by the Board will be made public promptly after the 
Board's decision.
    Furthermore, while the Board appreciates these concerns, it also 
recognizes that frequent rate adjustments may be necessary to maintain 
the reserve ratio at the DRR, and is mindful of the costs involved--
both to the industry and the FDIC--of engaging in a formal rulemaking 
proceeding each and every time even a minor adjustment in the 
assessment rate schedule is needed. The Board believes--as do 61 of the 
75 commenters addressing this issue--that an acceptable balance of the 
competing concerns is achieved by the approach taken in the final rule.
    The Board has noted the suggestion made by the Bankers Roundtable 
that the final rule include a modified adjustment procedure under which 
adjustments of between 2 and 5 basis points be subject to an 
abbreviated notice-and-comment period of 2 to 3 weeks. However, the 
Board is concerned that such a short period would not allow sufficient 
time for interested parties both to become aware of a proposed 
adjustment and still file timely comments. In addition, an abbreviated 
comment period involves the same costs as a non-abbreviated period, 
both to interested parties and to the FDIC.
    The adjustment factor is expected to provide the Board with the 
flexibility to raise a maximum additional $1.2-$1.4 billion in the near 
term without undertaking an additional rulemaking. The 5 basis-point 
maximum appears modest when viewed historically, as the loss-to-insured 
deposits ratio has been quite variable; the standard deviation was 8.5 
basis points for the 1934-94 period (Figure 8) and 11.9 basis points 
for 1980-94. In view of the currently favorable banking environment, 
however, a 5 basis-point adjustment factor should be sufficient to 
maintain the target DRR in the near term.

VI. Technical Amendments

    In addition to the amendments discussed above, the Board is further 
amending the assessments regulation to delete the BIF Recapitalization 
Schedule currently set forth in 12 CFR 327.9(d). Because the DRR has 
already been or soon will be reached, this schedule is no longer 
needed. Moreover, the schedule, which calls for BIF to reach the DRR in 
2002, is now obsolete.
    In addition, the final rule substitutes the term ``institution'' 
for the outdated term ``bank'' in Sec. 327.9(a).

VII. Paperwork Reduction Act

    No collections of information pursuant to section 3504(h) of the 
Paperwork Reduction Act (44 U.S.C. 3501 et seq.) are contained in this 
notice. Consequently, no information has been submitted to the Office 
of Management and Budget for review.

VIII. Regulatory Flexibility Act

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) does not 
apply to a rule of particular applicability relating to rates, wages, 
corporate or financial structures or reorganizations thereof. Id. at 
601(2). Accordingly, the statute does not apply to the proposed changes 
in the assessment rate schedule, the structure of that schedule and 
future adjustments thereto. In any event, to the extent an 
institution's assessment is based on the amount of its domestic 
deposits, the primary purpose of the Regulatory Flexibility Act, that 
agencies' rules do not impose disproportionate burdens on small 
businesses, is fulfilled.

IX. Riegle Community Development and Regulatory Improvement Act of 
1994

    Section 302(b) of the Riegle Community Development and Regulatory 
Improvement Act of 1994, Public Law 103-325, 108 Stat. 2160 (1994), 
requires that, in general, new and amended regulations that impose 
additional reporting, disclosure, or other new requirements on insured 
depository institutions shall take effect on the first day of a 
calendar quarter. This restriction is inapplicable to the final rule, 
which does not impose such additional or new requirements.

List of Subjects in 12 CFR Part 327

    Assessments, Bank deposit insurance, Banks, banking, Financing 
Corporation, Savings associations.

    For the reasons stated in the preamble, the Board is amending part 
327 of title 12 of the Code of Federal Regulations as follows: 

[[Page 42741]]


PART 327--ASSESSMENTS

    l. The authority citation for part 327 continues to read as 
follows:

    Authority: 12 U.S.C. 1441, 1441b, 1817-1819.

    2. Section 327.8 is amended by adding a new paragraph (i) to read 
as follows:


Sec. 327.8  Definitions.

* * * * *
    (i) As used in Sec. 327.9, the following terms have the following 
meanings:
    (1) Adjustment factor. The maximum number of basis points by which 
the Board may increase or decrease Rate Schedule 2 set forth in 
Sec. 327.9(a).
    (2) Assessment schedule. The set of rates based on the assessment 
risk classifications of Sec. 327.4(a) with a difference of 27 basis 
points between the minimum rate which applies to institutions 
classified as 1A and the maximum rate which applies to institutions 
classified as 3C.
    3. Section 327.9 is amended by revising paragraph (a), removing 
paragraph (b), redesignating paragraph (c) as paragraph (d), and adding 
new paragraphs (b) and (c) to read as follows:


Sec. 327.9  Assessment rate schedules.

    (a) BIF members. Subject to Sec. 327.4(c), the annual assessment 
rate for each BIF member other than an institution specified in 
Sec. 327.31(a) shall be the rate in the following Rate Schedules 
applicable to the assessment risk classification assigned by the 
Corporation under Sec. 327.4(a) to that BIF member. Until the BIF 
designated reserve ratio of 1.25 percent is achieved, the rates set 
forth in Rate Schedule 1 shall apply. After the BIF designated reserve 
ratio is achieved, the rates set forth in Rate Schedule 2 shall apply. 
The schedules utilize the group and subgroup designations specified in 
Sec. 327.4(a):

                             Rate Schedule 1                            
------------------------------------------------------------------------
                                                  Supervisory subgroup  
                Capital group                 --------------------------
                                                  A        B        C   
------------------------------------------------------------------------
1............................................       23       26       29
2............................................       26       29       30
3............................................       29       30       31
------------------------------------------------------------------------


                             Rate Schedule 2                            
------------------------------------------------------------------------
                                                  Supervisory subgroup  
                Capital group                 --------------------------
                                                  A        B        C   
------------------------------------------------------------------------
1............................................        4        7       21
2............................................        7       14       28
3............................................       14       28       31
------------------------------------------------------------------------

    (b) Rate adjustment; announcement--(1) Semiannual adjustment. The 
Board may increase or decrease Rate Schedule 2 set forth in paragraph 
(a) of this section up to a maximum increase of 5 basis points or a 
fraction thereof or a maximum decrease of 5 basis points or a fraction 
thereof (after aggregating increases and decreases), as the Board deems 
necessary to maintain the reserve ratio at the BIF designated reserve 
ratio. Any such adjustment shall apply uniformly to each rate in the 
schedule. In no case may such adjustments result in a negative 
assessment rate or in a rate schedule that, over time, is more than 5 
basis points above or below Rate Schedule 2, nor may any one such 
adjustment constitute an increase or decrease of more than 5 basis 
points. The adjustment factor for any semiannual period shall be 
determined by:
    (i) The amount of assessment revenue necessary to maintain the 
reserve ratio at the designated reserve ratio; and
    (ii) The assessment schedule that would generate the amount of 
revenue in paragraph (b)(1)(i) of this section considering the risk 
profile of BIF members.
    (2) In determining the amount of assessment revenue in paragraph 
(b)(1)(i) of this section, the Board shall take into consideration the 
following:
    (i) Expected operating expenses;
    (ii) Case resolution expenditures and income;
    (iii) The effect of assessments on BIF members' earnings and 
capital; and
    (iv) Any other factors the Board may deem appropriate.
    (3) Announcement. The Board shall:
    (i) Adopt the semiannual assessment schedule and any adjustment 
thereto by means of a resolution reflecting consideration of the 
factors specified in paragraph (c)(2)(i) through (iv) of this section; 
and
    (ii) Announce the semiannual assessment schedule and the amount and 
basis for any adjustment thereto not later than 45 days before the 
invoice date specified in Sec. 327.3(c) for the first quarter of the 
semiannual period for which the adjusted assessment schedule shall be 
effective.
    (c) Special provisions. The following provisions apply only with 
respect to the first time the BIF designated reserve ratio is achieved 
after 1994:
    (1) Notwithstanding the provisions of Sec. 327.3(c)(2) or 
Sec. 327.3(d)(2), the Corporation may modify the time of the direct 
debit of the assessment payment which next occurs after the Board 
determines that the designated reserve ratio has been achieved;
    (2) Notwithstanding the provisions of Sec. 327.7(a)(3), if, as a 
result of the new rate schedule having gone into effect, an institution 
has overpaid its assessment, the Corporation shall provide interest on 
any such overpayment, as follows:
    (i) For the first semiannual period of 1995, beginning on the date 
the new rate schedule goes into effect; and
    (ii) For the second semiannual period of 1995, beginning on the 
date of the overpayment; and
    (3) Notwithstanding the provisions of Sec. 327.7(b)(3), the 
interest rate applicable to overpayments described in paragraph (c)(2) 
of this section shall be the arithmetic average of the overnight simple 
interest rates received by the Corporation on its U.S. Treasury 
investments for the period during which the Corporation held the 
overpayment amount.
* * * * *
    By order of the Board of Directors.

    Dated at Washington, DC, this 8th day of August 1995.

    Federal Deposit Insurance Corporation.
Jerry L. Langley,
Executive Secretary.
[FR Doc. 95-20170 Filed 8-15-95; 8:45 am]
BILLING CODE 6714-01-P