[Federal Register Volume 71, Number 141 (Monday, July 24, 2006)]
[Proposed Rules]
[Pages 41973-41976]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-6280]


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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 327

RIN 3064-AD02


Deposit Insurance Assessments--Designated Reserve Ratio

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Notice of Proposed Rulemaking with Request for Comment.

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SUMMARY: Under the Federal Deposit Insurance Reform Act of 2005, the 
FDIC must by regulation set the Designated Reserve Ratio (DRR) for the 
Deposit Insurance Fund (DIF) within a range of 1.15 percent to 1.50 
percent of estimated insured deposits. In this rulemaking, the FDIC 
seeks comment on the proposal to establish the DRR for the DIF at 1.25 
percent of estimated insured deposits.

DATES: Comments must be submitted on or before September 22, 2006.

ADDRESSES: Interested parties are invited to submit written comments to 
the FDIC by any of the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Agency Web site: http://www.fdic.gov/regulations/laws/federal/propose.html. Follow the instructions for submitting comments 
on the FDIC Web site.
     E-mail: [email protected]. Include ``DRR'' in the subject 
line of the message.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th 
Street, NW., Washington, DC 20429.
     Hand Delivery/Courier: Comments may be hand-delivered to 
the guard station located at the rear of the FDIC's 17th Street 
building (accessible from F Street) on business days between 7 a.m. and 
5 p.m.
    Instructions: All submissions received must include the agency name 
and use the title ``Part 327--Designated Reserve Ratio.'' The FDIC may 
post comments on its Internet site at: http://www.fdic.gov/regulations/laws/federal/propose.html. Comments may be inspected and photocopied in 
the FDIC Public Information Center, 3501 N. Fairfax Dr., Arlington, 
Virginia, between 9 a.m. and 4:30 p.m. on business days.

FOR FURTHER INFORMATION CONTACT: Munsell St. Clair, Senior Policy 
Analyst, Division of Insurance and Research, (202) 898-8967; or 
Christopher Bellotto, Counsel, Legal Division, (202) 898-3801, Federal 
Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC 
20429.

SUPPLEMENTARY INFORMATION: The Federal Deposit Insurance Reform Act of 
2005 (the Reform Act) amends section 7(b)(3) of the Federal Deposit 
Insurance Act (the FDI Act) to eliminate the current fixed designated 
reserve ratio (DRR) of 1.25 percent.\1\ Section 2105 of the Reform Act 
directs the FDIC Board of Directors (Board) to set and publish annually 
a DRR for the Deposit Insurance Fund (DIF) within a range of 1.15 
percent to 1.50 percent of estimated insured deposits.\2\ 12 U.S.C. 
1817(b)(3)(B), (D). Under section 2109(a)(1) of the Reform Act, the 
Board must prescribe final regulations setting the DRR after notice and 
opportunity for comment not later than 270 days after enactment of the 
Reform Act. Thereafter, any change to the DRR must also be made by 
regulation after notice and opportunity for comment.
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    \1\ Section 2104 of the Reform Act, Public Law 109-171, 120 
Stat. 9.
    \2\ To be codified at 12 U.S.C. 1817(b)(3)(B), (D).
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    While the Reform Act requires the Board to set a DRR annually, it 
does not direct the Board how to use the DRR. There is no longer a 
requirement for the reserve ratio to meet the DRR within a particular 
timeframe. In effect, the Reform Act permits the Board to manage the 
reserve ratio within a range. In contrast to the prior law, the Reform 
Act does not establish a role for the DRR as a trigger, whether for 
assessment rate determination, recapitalization of the fund, assessment 
credit use, or dividends.
    The FDIC sets forth below background information, its analysis of 
the statutory factors that must be considered in setting the DRR and 
its proposal to set the initial DRR for the DIF at 1.25 percent, the 
current DRR.

I. Background

    In setting the DRR for any year, section 2105(a), amending section 
7(b)(3) of the FDI Act, directs the Board to consider the following 
factors:
    (1) The risk of losses to the DIF in the current and future years, 
including historic experience and potential and estimated losses from 
insured depository institutions.
    (2) Economic conditions generally affecting insured depository 
institutions. (In general, the Board should consider allowing the DRR 
to increase during more favorable economic conditions and decrease 
during less favorable conditions.)
    (3) That sharp swings in assessment rates for insured depository 
institutions should be prevented.
    (4) Other factors as the Board may deem appropriate, consistent 
with the requirements of the Reform Act.\3\
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    \3\ Section 2105 of the Reform Act (to be codified at 12 U.S.C. 
1817(b)(3)(C)) provides:
    (C) FACTORS--In designating a reserve ratio for any year, the 
Board of Directors shall--
    (i) Take into account the risk of losses to the Deposit 
Insurance Fund in such year and future years, including historic 
experience and potential and estimated losses from insured 
depository institutions;
    (ii) Take into account economic conditions generally affecting 
insured depository institutions so as to allow the designated 
reserve ratio to increase during more favorable economic conditions 
and to decrease during less favorable economic conditions, 
notwithstanding the increased risks of loss that may exist during 
such less favorable conditions, as determined to be appropriate by 
the Board of Directors;
    (iii) Seek to prevent sharp swings in the assessment rates for 
insured depository institutions; and
    (iv) Take into account such other factors as the Board of 
Directors may determine to be appropriate, consistent with the 
requirements of this subparagraph.
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    The DRR may not exceed 1.50 percent of estimated insured deposits 
nor be less than 1.15 percent of estimated insured deposits. Any future 
change to the DRR shall be made by regulation after notice and 
opportunity for comment. In soliciting comment on any proposed change 
in the DRR, the FDIC must include in the published proposal a thorough 
analysis of the data and projections on which the proposal is based.\4\
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    \4\ Section 2105 of the Reform Act (to be codified at 12 U.S.C. 
1817(b)(3)(D)).
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    The analysis of the statutory factors begins in part II. The manner 
in which the FDIC's Board evaluates the statutory factors may depend on 
its view of the role of the DRR, which may change over time. The FDIC 
has identified two potential general roles for the DRR: a signal of the 
reserve ratio that the Board would like the fund to achieve; and a 
signal of the Board's expectation of the change in the reserve ratio 
under the assessment rate schedule adopted by the Board.

1. Signaling a Goal for the Reserve Ratio

    One role for the DRR would be to serve as a signal of the reserve 
ratio that the Board would like the fund to achieve. Using the DRR in 
this manner could convey useful information to insured institutions and 
others about future deposit insurance assessment rates. Suppose, for 
example, the Board sets the DRR at 1.25 percent, intending it to be a 
target for the reserve ratio. If

[[Page 41974]]

the actual reserve ratio was 1.30 percent, the industry and the public 
could reasonably infer that the Board would be less likely to raise 
assessment rates in the near term than either to leave them unchanged 
or lower them.
    A key consideration in using the DRR to signal a goal for the 
reserve ratio is the amount of time that the Board would allow to 
achieve the desired ratio. As noted earlier, by eliminating the current 
fixed DRR and certain assessment rules triggered by the fixed DRR, the 
Reform Act permits the Board to manage the reserve ratio within a 
range. There is no statutorily required timeframe for a reserve ratio 
to achieve a specific DRR.\5\ Nonetheless, a DRR viewed as a reserve 
ratio target to achieve over time would convey to the public that the 
Board would generally want to avoid a sustained, significant deviation 
of the reserve ratio from the DRR.
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    \5\ However, the Board must adopt a restoration plan when the 
fund falls below 1.15 percent. Section 2108 of the Reform Act (to be 
codified at 12 U.S.C. 1817(b)(3)(E)).
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    The staff's best estimate is that the reserve ratio is likely to be 
less than 1.25 percent at year-end 2006 primarily due to strong insured 
deposit growth. If the Board considers the DRR to be a goal for the 
reserve ratio and adopts the proposal to set the DRR at 1.25 percent, 
it would need to determine how soon the reserve ratio should return to 
1.25 percent. The use of one-time credits required by the Reform Act 
will limit assessment revenue initially.\6\ Therefore, if the Board 
chooses to raise the reserve ratio to the DRR quickly and insured 
deposit growth is expected to remain strong, then a substantial 
increase in assessment rates might be required. The magnitude of the 
necessary assessment rate increase would likely diminish the more time 
that the Board allows the reserve ratio to climb back to its target.
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    \6\ Section 7(e)(3) of the Federal Deposit Insurance Act, as 
amended by the Reform Act, requires that the Board provide by 
regulation an initial, one-time assessment credit to each 
``eligible'' insured depository institution (or its successor) based 
on the assessment base of the institution as of December 31, 1996, 
as compared to the combined aggregate assessment base of all 
eligible institutions as of that date, taking into account such 
other factors the Board may determine to be appropriate. The 
aggregate amount of one-time credits is to equal the amount that the 
FDIC could have collected if it had imposed an assessment of 10.5 
basis points on the combined assessment base of the Bank Insurance 
Fund and Savings Association Insurance Fund as of December 31, 2001. 
12 U.S.C. 1817(e)(3).
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2. Anticipating Changes in the Reserve Ratio

    Another role for the DRR would be to signal the Board's expectation 
of the change in the reserve ratio under the assessment rate schedule 
adopted by the Board.
    For example, the Board may use the DRR to anticipate how the 
reserve ratio may move in response to changing economic conditions 
given the premium rate schedule adopted. Should deteriorating economic 
conditions precipitate an increase in bank failures that reduces the 
fund balance under the assessment rate schedule in effect, the Board 
could lower the DRR as the reserve ratio falls. Should improving 
economic conditions lead to a reduction in the fund's contingent loss 
reserve (estimated liability for anticipated failures), the Board could 
raise the DRR in recognition of the boost to the fund balance. In these 
two instances, using the DRR to signal expected changes in the reserve 
ratio is consistent with a statutory factor (discussed below) under 
which the Board would consider increasing the DRR during more favorable 
economic conditions and decreasing during less favorable ones.\7\
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    \7\ The reserve ratio may not necessarily rise (fall) under more 
(less) favorable economic and industry conditions. For example, the 
current economic outlook is generally good and industry conditions 
remain strong. Because of strong insured deposit growth and a low 
contingent loss reserve with little room for further reduction, 
there have been several onsecutive quarterly declines in the reserve 
ratio.
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    Assuming that insured deposit growth remains strong while 
institutions use their one-time assessment credits, the Board could 
adopt an assessment rate schedule under which the reserve ratio would 
likely decline temporarily. In recognition of the anticipated decline 
in the reserve ratio, the Board could lower the DRR for one or more 
years. As the depletion of the credits results in greater revenue and 
an increase in the reserve ratio, the Board could then raise the DRR.
    Setting the DRR to anticipate the actual direction of change in the 
reserve ratio under a given assessment rate schedule would, however, 
convey little information about future changes in assessment rates. The 
Reform Act requires regulatory action for any further change in the DRR 
(subsequent to the initial determination under this rulemaking), with 
notice and opportunity for comment. Furthermore, in soliciting comment 
on any proposed change in the DRR, the FDIC must include in the 
published proposal a thorough analysis of the data and projections on 
which the proposal is based. While the FDIC can meet these requirements 
for changing the DRR in order to reflect expected near-term changes in 
the reserve ratio, the notice-and-comment process and accompanying 
analysis may be more useful in the context of changes to a DRR that 
serves as a longer term target for the reserve ratio.

II. Proposed Designated Reserve Ratio

    The FDIC must set the DRR in accordance with its analysis of the 
statutory factors listed above: risk of losses to the DIF; economic 
conditions generally affecting insured institutions; preventing sharp 
swings in assessment rates; and any other factors that the Board may 
determine to be appropriate and consistent with these three factors.
    The analysis that follows considers each statutory factor, 
including several ``other factors.''

Risk of Losses to the DIF

    The FDIC has estimated that potential loss provisions in 2006 
related to future failures will range from $1 million to $241 million, 
with a best estimate of $93 million.\8\ (The bounds of this range do 
not represent ``best case'' and ``worst case'' scenarios, and larger or 
smaller losses could occur.) These estimates suggest that near-term 
losses to the insurance fund would not significantly alter the reserve 
ratio.
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    \8\ The FDIC has estimated a likely of insurance losses based on 
projected changes in the contingent loss reserve during 2006. These 
projections are influenced by several factors, including: (1) The 
shifting of problem banks among different risk categories within the 
reserve; (2) the reduction in problem banks due to improved 
financial conditions, mergers, or failures; and (3) the addition of 
new problem banks. To capture the effects of these changes, the FDIC 
uses a migration approach, which estimates the probabilities of 
banks entering into or leaving the group of banks included in the 
contingent loss reserve as well as the probability of banks moving 
between loss reserve risk categories. These probabilities are based 
on the recent history of changes to the reserve. Other factors 
driving changes in the contingent loss reserve are changes in 
expected failure rates and changes in rates of loss in the event of 
failure; however, for purposes of projecting changes to the 
contingent loss reserve, the FDIC assumes that failure and loss 
rates remain constant.
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    The FDIC also considered economic stress events and their potential 
implications for losses to the insurance fund by running several two-
year stress event simulations, affecting institutions specializing in 
residential mortgages, subprime loans, commercial real estate 
mortgages, commercial and industrial loans, and consumer loans. The 
results of each simulation, which were derived from historical stress 
events, demonstrate that banks are well positioned to withstand a 
significant degree of financial adversity. In no case did the stress 
simulation results raise any significant concerns.

Economic Conditions Affecting FDIC-Insured Institutions

    The performance of the economy and banking industry remains strong. 
The

[[Page 41975]]

consensus expectation is that real economic growth will run near its 
long-run average of 3.0 to 3.5 percent in 2006, but will ease 
moderately in 2007 as higher interest rates continue to weigh on 
economic activity, especially the housing sector. A slower pace of home 
price appreciation may impede growth in consumer spending, but it is 
unclear by how much. Corporate balance sheets remain strong and real 
nonresidential investment is forecast to grow by 9 percent in 2006.\9\
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    \9\ Growth forecast from Macroeconomic Advisers. Although the 
economy should stay in strong shape over the medium term, a number 
of downside risks exist, including further energy price spikes, an 
abrupt decline in U.S. financial or housing markets, or an abrupt 
decline in the foreign-exchange value of the dollar.
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    In the banking industry, earnings have set five consecutive annual 
records, capital is at historically high levels, and asset quality 
remains solid. For 2005, aggregate return on assets (ROA) remained high 
at 1.30 percent, marking the fourth successive year where ROA was over 
1.28 percent. The aggregate equity-to-asset ratio of 10.38 percent at 
year-end 2005 was the highest since 1939. No insured institutions have 
failed in two years, extending the longest period without a failure 
since the creation of the FDIC in 1933. Therefore, banks in general 
appear to be well positioned to withstand the financial stress that may 
arise from potential economic shocks in the next few years.

Prevent Sharp Swings in Assessment Rates

    The Reform Act directs the FDIC's Board to consider preventing 
sharp swings in the assessment rates for insured depository 
institutions.
    In the current environment, maintaining a DRR of 1.25 percent is 
more likely to be consistent with relative premium stability if the 
Board also allows a period of a few years for the reserve ratio to meet 
the DRR. As discussed above, the reserve ratio is expected to be below 
1.25 percent at the end of 2006. The use of assessment credits will 
temporarily limit future assessment income. Therefore, there may be 
further downward pressure on the reserve ratio if recent robust insured 
deposit growth continues. The downward pressure is expected to reverse 
itself once institutions begin to use up their assessment credits. 
Raising the reserve ratio to a DRR of 1.25 percent quickly could 
require (depending on insured deposit growth) a substantial increase in 
assessment rates that would exhaust most of the credits rapidly. Once 
the DRR is achieved, there could be a substantial reduction in rates. 
Increasing the reserve ratio more gradually toward the DRR could result 
in less substantial increases (followed by less substantial reductions) 
in rates, consistent with this statutory factor.

Other Factors

    The FDIC has identified certain ``other factors'' that the Board 
may choose to consider in setting the DRR. In the FDIC's view, these 
factors favor maintaining the DRR at 1.25 percent.
1. Transition to a New Assessment System
    The assessment system is about to undergo significant change. Once 
proposed risk-based assessment regulations are finalized and become 
effective, all insured institutions will pay deposit insurance 
assessments regardless of the level of the reserve ratio. These 
proposed regulations also will change how the FDIC differentiates among 
insured institutions for risk in assigning assessment rates.
    Furthermore, to provide institutions a transition to the new 
system, one-time assessment credits will be available to those 
institutions that contributed in earlier years to the build-up of the 
insurance funds. The application of these credits to assessments will 
limit assessment revenue in the near term. If insured deposit growth 
remains strong, this may place temporary downward pressure on the 
reserve ratio, which is expected to reverse itself once banks begin to 
use up their credits.
    Finally, as described above, the FDIC will be changing to a system 
where the reserve ratio will be managed within a range from a system 
where a hard target for the reserve ratio applied.
    Therefore, the FDIC staff believes that the changes facing the FDIC 
and insured institutions as a new assessment system is implemented 
argue against altering the DRR from the current 1.25 percent.
2. Midpoint of the Normal Operating Range for the Reserve Ratio
    The Reform Act authorizes the Board to set the DRR at no less than 
1.15 percent and no greater than 1.50 percent. The FDIC must adopt a 
restoration plan when the reserve ratio falls below 1.15 percent. When 
the reserve ratio exceeds 1.35 percent, the Reform Act generally 
requires the FDIC to begin to pay dividends. Because there is no 
requirement to achieve a specific reserve ratio within a given 
timeframe, these provisions in effect establish a normal operating 
range for the reserve ratio of 1.15 percent to 1.35 percent within 
which the Board has considerable discretion to manage the size of the 
insurance fund.\10\ The current DRR of 1.25 percent is the midpoint of 
the normal operating range. The FDIC believes that at the commencement 
of the new assessment system, it would be reasonable to leave the DRR 
at the middle of this range.
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    \10\ Based on March 31, 2006 aggregate insured deposits of 
$4.002 trillion, a 20 basis point range for the reserve ratio would 
be equivalent to an $8 billion range for the fund balance.
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3. Historical Experience
    Historical experience with a DRR of 1.25 percent indicates that it 
has worked well under varying economic conditions in ensuring an 
adequate insurance fund and maintaining a sound deposit insurance 
system. The FDIC believes that more experience with managing the fund 
under the new framework established by the Reform Act will be of 
benefit in determining whether the DRR should be raised or lowered from 
1.25 percent.

Balancing the Statutory Factors

    In the FDIC's view, the best way to balance all of the statutory 
factors (including the ``other factors'' identified above that the 
Board may choose to consider) and to preserve the FDIC's new 
flexibility to manage the DIF is to maintain the DRR at 1.25 percent. 
The FDIC recognizes that the Reform Act directs its Board to consider 
allowing the DRR to increase in favorable economic conditions and that 
the present economic conditions are favorable. However, several other 
factors that the Board must (or may) consider--preventing sharp swings 
in assessment rates, the transitional nature of the assessment system, 
maintaining a DRR at the midpoint of the reserve ratio's normal 
operating range, the historical experience with a DRR of 1.25 percent, 
as well as the intent of the new legislation to provide the FDIC with 
flexibility to manage the reserve ratio within a range--all support or 
are consistent with maintaining the current DRR of 1.25 percent.

III. Request for Comment

    The Board invites comments on all aspects of the proposed rule 
setting the DRR at 1.25 percent of estimated insured deposits. 
Interested persons are invited to submit written comments during the 
60-day comment period.

IV. Paperwork Reduction Act

    The proposed rule will set the Designated Reserve Ratio for the 
Deposit Insurance Fund. It will not involve any new collections of 
information pursuant to the Paperwork Reduction Act (44

[[Page 41976]]

U.S.C. 3501 et seq.). Consequently, no information has been submitted 
to the Office of Management and Budget for review.

V. Regulatory Flexibility Act

    Pursuant to 5 U.S.C. 605(b) the FDIC certifies that the proposed 
rule would not have a significant economic impact on a substantial 
number of small businesses (i.e., insured depository institutions with 
$165 million or less in assets) within the meaning of the Regulatory 
Flexibility Act (5 U.S.C. 601, et seq.). The proposed rule, if 
finalized, will set the Designated Reserve Ratio (DRR) at 1.25 percent 
of estimated insured deposits, which is unchanged from the present 
Designated Reserve Ratio. Under the Federal Deposit Insurance Reform 
Act of 2005, the DRR provides no trigger for assessment determinations, 
recapitalization of the insurance fund, assessment credit use, or 
dividends. Consequently, retaining the DRR at 1.25 will not have a 
significant economic impact on a substantial number of small 
businesses.

VI. The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families

    The FDIC has determined that the proposed rule will not affect 
family well-being within the meaning of section 654 of the Treasury and 
General Government Appropriations Act, enacted as part of the Omnibus 
Consolidated and Emergency Supplemental Appropriations Act of 1999 
(Public Law 105-277, 112 Stat. 2681).

List of Subjects in 12 CFR Part 327

    Bank deposit insurance, Banks, banking, Savings associations.

    For the reasons stated in the preamble, the Board of Directors of 
the Federal Deposit Insurance Corporation proposes to further amend 
part 327 of Title 12 of the Code of Federal Regulations as proposed to 
be amended at 71 FR 28790 on May 18, 2006, as follows:

PART 327--DESIGNATED RESERVE RATIO

Subpart A--In General

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

    Authority: 12 U.S.C. 1441, 1441b, 1813, 1815, 1817-1819; Pub. L. 
104-208, 110 Stat. 3009-479 (12 U.S.C. 1821).

    2. Add paragraph (g) to Sec.  327.4 (as proposed at 71 FR 28790) to 
read as follows:


Sec.  327.4  Annual Assessment Rate.

* * * * *
    (g) Designated reserve ratio. The designated reserve ratio for the 
Deposit Insurance Fund is 1.25 percent.

    By order of the Board of Directors.

    Dated at Washington, DC this 11th day of July, 2006.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 06-6280 Filed 7-21-06; 8:45 am]
BILLING CODE 6714-01-P