Responses to Questions Relating to H.R. 3717, Federal Deposit	 
Insurance Reform Act of 2002 (16-APR-02, GAO-02-646R).		 
                                                                 
The Federal Deposit Insurance Reform Act of 2002 would change the
definition of the reserve ratio for the deposit insurance fund,  
and provide the Federal Deposit Insurance Corporation (FDIC) with
the flexibility to set the fund's designated reserve ratio within
a range. Current law requires FDIC to maintain the deposit	 
insurance fund balances at a designated reserve ratio of at least
1.25 percent of estimated insurance deposits. If the reserve	 
ratio falls below that level, FDIC's Board of Directors must set 
semiannual assessment rates that are sufficient to increase the  
reserve ratio to the designated reserve ratio within a year, or  
in accordance with a recapitalization schedule of 15 years or	 
less.								 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-646R					        
    ACCNO:   A03082						        
  TITLE:     Responses to Questions Relating to H.R. 3717, Federal    
Deposit Insurance Reform Act of 2002				 
     DATE:   04/16/2002 
  SUBJECT:   Deposit funds					 
	     Funds management					 
	     Proposed legislation				 

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GAO-02-646R
     
GAO- 02- 646R Federal Deposit Insurance Reform Act

United States General Accounting Office Washington, DC 20548

April 16, 2002 The Honorable Michael G. Oxley Chairman Committee on
Financial Services House of Representatives

Subject: Responses to Questions Relating to H. R. 3717, Federal Deposit
Insurance Reform Act of 2002

Dear Mr. Chairman: This letter responds to your April 12, 2002, request that
we answer questions relating to H. R. 3717, the Federal Deposit Insurance
Reform Act of 2002. Among other things, H. R. 3717 proposes changes to the
definition of the reserve ratio for the deposit insurance fund, as well as
provides the Federal Deposit Insurance Corporation (FDIC) with the
flexibility to set the fund?s designated reserve ratio within a range.

Current law requires FDIC to maintain the deposit insurance fund balances
(net worth) at a designated reserve ratio of at least 1.25 percent of
estimated insured deposits. If the reserve ratio falls below 1.25 percent of
estimated insured deposits, FDIC?s Board of Directors is required to set
semiannual assessment rates that are sufficient to increase the reserve
ratio to the designated reserve ratio not later than 1 year after such rates
are set, or in accordance with a recapitalization schedule of 15 years or
less.

Your questions, along with our responses, follow.

1. Would there be any impact on FDIC's GAAP prepared financial statements if
the numerator of the reserve ratio were legislatively changed to add back
any estimated liabilities for anticipated failures?

No. FDIC prepares its annual financial statements in accordance with U. S.
generally accepted accounting principles (GAAP). GAAP requires FDIC to
report the fund balance (difference between total assets and total
liabilities) including any estimated liabilities for anticipated failures in
its Statement of Financial Position. Fund balance and estimated liabilities
for anticipated failures are clearly identifiable line items in the
Statement of Financial Position. The reserve ratio is legislatively defined
and does not affect FDIC?s financial statements.

GAO- 02- 646R Federal Deposit Insurance Reform Act Page 2

2. Recognizing that redefining a legislatively defined ratio may not impact
FDIC?s use of GAAP or its provisioning for losses in its financial
statements, what is the effect of adding the estimated liabilities for
future failures to net worth in the numerator of the reserve ratio and how
would other provisions of the bill mitigate these effects?

To the extent that estimated liabilities for anticipated failures exist, the
redefined reserve ratio in H. R. 3717 would result in a higher reserve ratio
than under current law. Further, if estimated liabilities for future
failures exist, the redefined reserve ratio would not provide the best
representation available on the deposit insurance fund?s financial
condition.

Under the current law, the numerator of the reserve ratio is the fund
balance, which is a widely understood measure of net worth. By adding back
any estimated liability for anticipated failures to net worth in the
calculation of the reserve ratio, the numerator will no longer represent the
fund?s net worth, and the resulting reserve ratio may not be as readily
understood as the currently defined ratio.

In addition, under H. R. 3717, a scenario could occur where the reserve
ratio is at or exceeds 1.4 percent and FDIC has also recorded a large amount
of estimated liabilities for anticipated failures. FDIC would be required to
declare dividends and refund, in the form of dividends, the amount of excess
fund balance over the amount of the designated reserve ratio. In this
scenario, FDIC would be required to provide dividends even though it expects
the reserve ratio to decline in the upcoming year when the anticipated
failures are expected. This could result in FDIC refunding a portion of its
fund balance in the form of dividends at a time when funds are needed to
cover expected losses.

Similarly, under H. R. 3717, if the reserve ratio is at 1.35 percent and
there are also large amounts of estimated liabilities for anticipated
failures, FDIC would be required to declare dividends in an amount equal to
50 percent of the insurance premium income for that assessment period. In
this scenario, FDIC would be required to reduce its insurance premium
income, even when it expects the reserve ratio to decline in the upcoming
year when the anticipated failures actually occur. This could result in FDIC
refunding premiums in the form of dividends at a time when premium income is
needed by the insurance fund to cover expected losses.

In addition, the impact of adding back the estimated liabilities for future
failures to net worth in the calculation of the reserve ratio would have the
effect of delaying premiums in the case where the estimated liability figure
would have caused the reserve ratio to be below the designated reserve
ratio. Delaying premiums creates the potential for volatility in the payment
of premiums, possibly resulting in the banking industry paying high premiums
when both banks and the economy can least afford it.

FDIC may be able to mitigate the delaying of premiums described above
because under H. R. 3717, FDIC would have the flexibility to increase the
designated reserve ratio up to 1.4 percent. Therefore, FDIC?s decision on
setting the designated reserve ratio higher could result in not having
premium delays that otherwise would occur with a lower designated reserve
ratio.

GAO- 02- 646R Federal Deposit Insurance Reform Act Page 3 Lastly, under the
current proposal, it appears that a potentially anomalous scenario

could occur in the instance where FDIC sets the designated reserve ratio at
1.4 percent and the actual reserve ratio is between 1.35 and 1.4 percent. In
this case, it appears that FDIC would be required to declare dividends in
the amount of 50 percent of insurance premiums for that period, even though
the fund?s reserve ratio is still below the designated reserve ratio.

-- -- -- - Should you or your staff have any questions, please contact me at
(202) 512- 9406 or Lynda Downing, Assistant Director at (202) 512- 9168. We
can also be reached by email at franzelj@ gao. gov and downingl@ gao. gov.

Sincerely yours, Jeanette M. Franzel Acting Director

Financial Management and Assurance

(194128)
*** End of document. ***