[Senate Hearing 107-]
[From the U.S. Government Publishing Office]
S. Hrg. 107- 595
COMPREHENSIVE DEPOSIT INSURANCE
REFORM: RESPONSES TO THE
FDIC'S RECOMMENDATIONS FOR REFORM
=======================================================================
HEARING
before the
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
ON
THE FEDERAL DEPOSIT INSURANCE CORPORATION'S RECOMMENDATIONS FOR
IMPROVING THE DEPOSIT INSURANCE SYSTEM
__________
AUGUST 2, 2001
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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81-065 WASHINGTON : 2002
_____________________________________________________________________________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PAUL S. SARBANES, Maryland, Chairman
CHRISTOPHER J. DODD, Connecticut PHIL GRAMM, Texas
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii JOHN ENSIGN, Nevada
Steven B. Harris, Staff Director and Chief Counsel
Wayne A. Abernathy, Republican Staff Director
Martin J. Gruenberg, Senior Counsel
Sarah Dumont, Republican Professional Staff Member
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
______
Subcommittee on Financial Institutions
TIM JOHNSON, South Dakota, Chairman
ROBERT F. BENNETT, Utah, Ranking Member
ZELL MILLER, Georgia JOHN ENSIGN, Nevada
THOMAS R. CARPER, Delaware RICHARD C. SHELBY, Alabama
DEBBIE STABENOW, Michigan WAYNE ALLARD, Colorado
CHRISTOPHER J. DODD, Connecticut RICK SANTORUM, Pennsylvania
JACK REED, Rhode Island JIM BUNNING, Kentucky
EVAN BAYH, Indiana MIKE CRAPO, Idaho
JON S. CORZINE, New Jersey
Naomi Gendler Camper, Staff Director
Michael Nielson, Republican Professional Staff Member
(ii)
C O N T E N T S
----------
THURSDAY, AUGUST 2, 2001
Page
Opening statement of Senator Johnson............................. 1
Prepared statement........................................... 29
Opening statements, comments, or prepared statements of:
Senator Gramm................................................ 3
Senator Bunning.............................................. 4
Senator Sarbanes............................................. 5
Prepared statement....................................... 30
Senator Bennett.............................................. 12
Senator Reed................................................. 25
Prepared statement....................................... 30
Senator Miller............................................... 27
Senator Allard............................................... 31
WITNESSES
Robert I. Gulledge, Chairman, President & Chief Executive
Officer, Citizens Bank, Inc., Robertsdale, Alabama, Chairman of
the Independent Community Bankers of America, on behalf of the
Independent Community Bankers of America....................... 7
Prepared statement........................................... 31
Response to written questions of Senator Miller.............. 54
Jeff L. Plagge, President & Chief Executive Officer, First
National Bank of Waverly, Iowa, on behalf of the American
Bankers Association............................................ 9
Prepared statement........................................... 41
Response to written questions of Senator Miller.............. 64
Curtis L. Hage, Chairman, President & Chief Executive Officer,
Home Federal Bank, Sioux Falls, South Dakota, First Vice
Chairman, America's Community Bankers, on behalf of America's
Community Bankers.............................................. 10
Prepared statement........................................... 48
Response to written questions of Senator Miller.............. 71
Response to oral questions of Senator Johnson................ 74
(iii)
COMPREHENSIVE DEPOSIT INSURANCE
REFORM: RESPONSES TO THE
FDIC'S RECOMMENDATIONS FOR REFORM
----------
THURSDAY, AUGUST 2, 2001
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Subcommittee on Financial Institutions,
Washington, DC.
The Subcommittee met at 10:03 a.m., in room SD-538 of the
Dirksen Senate Office Building, Senator Tim Johnson (Chairman
of the Subcommittee) presiding.
OPENING STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. I would like to call the Subcommittee to
order.
Good morning. I am pleased to convene the first meeting of
the Financial Institutions Subcommittee of my Chairmanship on a
topic that has been of great interest to me for a great many
years. Federal deposit insurance is one of the cornerstones of
our banking and financial system. This insurance gives
depositors the confidence they need to fully utilize America's
financial institutions. Since I began service in Congress in
1987, we have seen some real ups and some real downs in the
banking industry, and it is a great privilege today to Chair a
hearing on a matter of such importance to our Nation's bankers,
and indeed, to our country as a whole.
I would first like to recognize Ranking Member Bennett, who
I am told has a hearing conflict right now and, hopefully, will
be able to join us later. I am pleased that Senator Gramm is
able to join us here this morning. But I do want to thank
Ranking Member Bennett in particular for working with me on a
great range of banking issues. He has a very distinguished
business background. I value his insights. Obviously, I
appreciate Chairman Sarbanes, who conducts all of his hearings
in a dignified and thoughtful manner and I aspire to live up to
the high standards that he has set for the Senate Banking
Committee.
As everyone in the room knows, or surely will find out in
short order, comprehensive deposit insurance reform is an
enormously complex issue. I will resist the opportunity today
to recite a history of banking reform, and steer clear of too
many statistics--at least until the question and answer period.
While the body of literature on deposit insurance is vast, I
would note that there appears to be more consensus than there
is disagreement on potential reforms.
At today's hearing, the financial services industry will
respond to the FDIC's recommendations for comprehensive reform
of the Federal Deposit Insurance System. The FDIC, in my view,
has identified some significant weaknesses in the current
system.
In particular, it is hard to argue with the FDIC's
observation that the current system is procyclical. That is, in
good times, when the funds are above the designated reserve
ratio of 1.25 percent, 92 percent of the industry pays nothing
for coverage. But in bad times, institutions could be hit with
potentially crushing premiums of up to 23 basis points. I think
that most industry members agree that this so-called ``hard
target'' presents a very real threat to their businesses.
Of course, this means that any movement in the funds down
toward 1.25 percent increases the anxiety level of bankers and
regulators alike, whether that movement comes from fast growth
of certain institutions, or from institutional failures like we
saw last Friday in the case of Superior Bank of Illinois. The
numbers are still preliminary, but cost estimates of the
failure start at around $500 million, which would reduce the
SAIF ratio by seven basis points. I say this not to be
alarmist, but I would urge caution against becoming simply
complacent in good times and resisting changes that make sense
over the long term and have the potential to enhance the
overall stability of our system.
I am particularly interested in hearing from the witnesses
about their positions on premiums. I would note that there is
unanimity among the Federal banking regulators that
institutions should pay regular deposit insurance premiums,
though not with respect to how we should determine those
premiums.
Now, I understand that 92 percent of the industry is free
from current premium payments, and it certainly presents an
interesting psychological and political challenge to persuade
folks to pay for something that they currently get for free. On
the other hand, I am not the first to note that very few things
in life are, in fact, free. If you are getting something of
value, eventually, you have to pay for it. The question is not
whether you will have to pay up; it is when and how much.
I am also interested in hearing comments about the erosion
in value of deposit insurance. I think my position is well
known. I believe that we need to increase, and index, coverage
levels. Over the last 20 years, coverage values have decreased
by more than half, and previous increases were unpredictable
both in terms of amount and timing. I expect to hear a spirited
debate on that topic, and I believe it should be included in
any discussion of comprehensive reform.
I would urge everyone involved in this debate to take a
step back and recognize that when we talk about deposit
insurance, we are talking about the foundation of our financial
system. I think it is simply irresponsible to take a short-term
approach, or to politicize these issues. And while I am open to
persuasion on just about every component of reform, I am firm
in my belief that we all share the common goal of a safe and
sound banking system.
As many of you know, I am committed to ensuring that our
small banks and thrifts--which play such an important role in
rural States such as mine, South Dakota--have the tools they
need to survive. I am also well aware of the value that our
larger banks, thrifts, and bank holding companies bring to this
country. I believe my strong support of financial modernization
speaks for itself, and would simply add that I am committed to
finding a reform package that considers the needs and interests
of all members of our financial services community.
Now some might argue that it will be impossible to craft
changes to our deposit insurance system that will bring all the
interested parties together, but I reject that argument. First,
every single bank and thrift in this country benefits from our
world-class deposit insurance system, and it is in everyone's
interest to find an acceptable set of changes. Second, I
believe that our witnesses will tell us that the industry is,
in fact, close together on many of the core reform issues.
Finally, the regulators themselves have said that they are
approaching consensus on a great many of these issues. I am
optimistic that we will be able to develop a sound and
comprehensive reform policy.
I am looking forward to hearing what my colleagues and our
witnesses have to say and I will now turn to my good friend and
colleague from Texas, Senator Gramm, for any opening statement
that he may have.
STATEMENT OF SENATOR PHIL GRAMM
Senator Gramm. Well, Mr. Chairman, first of all, I want to
thank you for this hearing. It has been my great pleasure to
work with you on banking issues now for several years. I have
appreciated your interest in small banks.
Let me say that, without question, I represent more small
banks and bankers than any other Senator, other than my
colleague, Senator Hutchison. And if there is a small banker in
Texas who does not support me, I do not know him.
So, I am very concerned about the health of small banks. I
am not one of these people who believes the future of America's
financial system is going to be dominated by large banks. There
are a lot of niches where small banks can be very successful,
and I think that people are finding these niches in my State.
I do believe we need a comprehensive reform of deposit
insurance, and I want to congratulate you for your interest and
leadership in this area. I want to pledge to you that I am
willing and eager to work with you to try to deal with the
problem we have.
We need to keep in mind that we have two different
insurance systems. We have two types of institutions with very
different charters and powers, that for all practical purposes
have the same deposit insurance. And this is something that
needs to be looked at very closely. Should we merge the funds,
and if we do, should we change charters so that all financial
institutions within the same insurance fund have the same
powers? I think these are the issues that ought to be looked
at.
I would say that my experience with the S&L crisis
convinces me that we should not raise the insurance limit.
I remember vividly from those terrible days of the S&L
crisis where institutions were broke, and it was obvious that,
at some point, they were going to be closed. But because of
deposit insurance, deposits would come into a failing
institution by the tens of millions of dollars and seize a
higher rate of return with absolute certainty that the taxpayer
was going to pick up the bill--if and when that institution
failed.
I believe that this created tremendous instability in the
system. I do not want to add to that by adding to these limits.
I think I am in good company with Alan Greenspan. I have
not yet talked to the new Secretary of the Treasury or the new
FDIC Chairman about this issue in any great detail, and I do
not remember whether the Comptroller of the Currency joined the
Secretary of the Treasury and Alan Greenspan in opposing last
year's proposals to raise deposit insurance limits.
There are a lot of issues here that we do have agreement
on, and I think this is an important area. I want to thank our
witnesses for their time today.
I have to go to a Budget Committee thing. We have some
people downstairs that want to take back the tax cut and they
need to be beaten into submission.
[Laughter.]
I want to thank you, Mr. Chairman, for holding this
hearing, and to pledge to you that I have an open mind on these
issues and I hope and believe we can work together.
Thank you.
Senator Johnson. Thank you, Senator Gramm.
Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman, for holding this
very important hearing and I would like to thank our witnesses
for testifying today.
It is good to have the industry represented here on the
topic of Federal deposit insurance reform. A little while back
we had the regulators here and we touched upon many of the same
issues that we will be talking about today. It will be very
helpful to have your take on these issues.
Last April, the FDIC issued its paper, ``Keeping The
Promise--Recommendations for Deposit Insurance Reform.'' There
are many ideas in that paper that I believe there were a great
deal of support for. Merging the BIF and the SAIF funds is an
idea that has been around a long time. In fact, it has been
around since I started in the House Banking Committee in 1987.
There is a great deal of support for merging the funds. But
it seems it has always been caught up in the bigger plans for
overall deposit insurance reform. Because of the desire for
reform, the funds have not been merged. I also believe there is
a consensus to adjust the reserve ratios. The current 1.25 hard
cap with 23 basis points under capitalization could very likely
be imposed in a time of great concern to the banking industry
when banks could least afford a readjustment.
By giving the FDIC some flexibility, we can prevent turning
hard times into crisis times. I also believe there is a lot of
consensus to price premiums on a risk basis. I do not believe,
however, there is a consensus on raising and indexing for
inflation the insurance levels. When the regulators were here
on June 20, Chairman Greenspan hesitated to speak for the Fed.
But in the past, he says he opposes raising the insurance
levels.
The OCC has also expressed concern about raising the
levels. The FDIC and the OTS have supported indexing the levels
for inflation. I also have concerns about raising the deposit
insurance levels. I am leery of putting the taxpayer on the
hook for higher levels of coverage.
I am also skeptical that raising the levels will lead to a
great deal of increased deposits for smaller banks. I believe
the deposits have shrunk in the smaller banks because those
deposits have been going to higher returning uninsured
vehicles. I do not believe those deposits would be put into
banks.
Mr. Chairman, once again, thank you for holding this
hearing and I look forward to our witnesses' testimony.
Thank you.
Senator Johnson. Thank you, Senator Bunning.
I am pleased that our Chairman, Senator Sarbanes, could
join us this morning at this initial hearing of our
Subcommittee.
And on very short notice, Chairman Sarbanes, do you have
any opening comments that you would like to share with us?
STATEMENT OF SENATOR PAUL S. SARBANES
Chairman Sarbanes. I would just like to make a few remarks,
Mr. Chairman.
First of all, I want to thank you as Chairman of the
Financial Institutions Subcommittee for holding this morning's
hearing on the very important subject of possible Federal
Deposit Insurance System reform. Obviously, any reform effort
will require thorough analysis of the issues and today's
hearing is an opening contribution to that effort.
As we are all of course aware, the FDIC in April published
a report on reforming the deposit insurance system, which
included, among other things, merging the two funds, charging
insurance premiums based on the institution's risk to the
insurance fund, so-called ``risk-based premiums,'' shifting
from a fixed reserve ratio of 1.25 percent of insured deposits
to a target range of reserve ratios, to avoid sharp swings in
insurance premiums and to counter the cyclical economic
movements.
At the moment, the way it works, it often ends up pushing
the cycle along rather than countering the cycle.
Rebating premiums based on an institution's historical
contributions to an insurance fund when the fund grows above a
target level. And indexing deposit insurance coverage levels to
the inflation rate.
Last week, the various Government agencies, in a hearing on
the other side, announced their views on the FDIC's various
recommendations, and they picked some and left others by the
wayside. Obviously, we need to review their positions very
carefully.
Let me say, I think today's hearing is particularly timely
in light of last Friday's failure of a major thrift, Superior
Bank of Illinois. It is the eleventh largest depository
institution to fail in our history. Reports suggests that it
may cost the SAIF as much as $500 million. Furthermore,
customers with uninsured deposits--in other words, amounts over
and above the $100,000 figure--may lose over $40 million.
I am very much concerned about this failure and have taken
steps to inquire into its causes. We have asked the GAO, under
the leadership of the Comptroller General, to examine the
situation, not as much the specific one, as a general
examination, because the specific one will be examined by the
Inspector General of the Treasury Department, which has
authority over the Office of Thrift Supervision, and by the
Inspector General of FDIC. And we have asked both of them to
submit their reports to us so that we may have an opportunity
to review them.
The statute actually requires the Inspector General at
Treasury to write a report when the deposit insurance fund
incurs a material loss. The statute also requires that the
report be made available to Congress upon request and it
requires the IG's report to review the agency's supervision of
the institution, including the agency's implementation of
prompt corrective action, to discuss why the institution's
problems resulted in a material loss to the deposit insurance
fund. And it also calls for recommendations for preventing such
losses in the future.
Pursuant to that statute, I have already requested of the
Inspector General that the report be made available to the
Congress upon its completion.
We look forward to receiving these two IG reports and the
study from the GAO as we examine this situation. And in a
sense, it is a timely reminder of the role of the insurance
fund. It is a timely reminder of the potential exposure
eventually to the taxpayer, if things really go amiss, as we
experienced in the savings and loan crisis when we ended up
footing a very large bill.
So, Mr. Chairman, I am pleased to join you and I am looking
forward to hearing from the witnesses.
Thank you very much.
Senator Johnson. Thank you, Chairman Sarbanes.
I am pleased that we are able to have a very distinguished
panel with us here this morning.
Mr. Robert Gulledge is here on behalf of the Independent
Community Bankers of America. He is Chairman of the ICBA. Mr.
Gulledge is Chairman, President, and CEO of Citizens Bank of
Robertsdale, Alabama.
Mr. Jeff Plagge is here on behalf of the American Bankers
Association. Mr. Plagge is President and CEO of the First
National Bank of Waverly, Iowa.
Mr. Curt Hage is here on behalf of America's Community
Bankers. Curt is the First Vice Chairman of the ACB. Curt is
Chairman, President, and CEO of Home Federal Bank in Sioux
Falls, South Dakota, and a good friend of mine. And I might
note that David Bochnowski, the Chair of the ACB, graciously
stepped aside and is allowing Curt to come before the
Subcommittee today. I know the Subcommittee is very well served
by Mr. Hage's testimony.
Welcome to the Subcommittee. Rather than using the
formality of the 5 minute clock because we have a relatively
small panel and just one panel, we will forego that.
I would invite panel members to summarize their statements
if they so wish. Their full statements will be placed into the
record.
With that, why don't we begin with Mr. Gulledge.
STATEMENT OF ROBERT I. GULLEDGE
CHAIRMAN, PRESIDENT & CHIEF EXECUTIVE OFFICER
CITIZENS BANK, INC., ROBERTSDALE, ALABAMA
CHAIRMAN OF THE INDEPENDENT COMMUNITY
BANKERS OF AMERICA
ON BEHALF OF THE
INDEPENDENT COMMUNITY BANKERS OF AMERICA
Mr. Gulledge. Good morning, Chairman Johnson, Senator
Sarbanes, and Senator Bunning. I am Bob Gulledge and I am
President of Citizens Bank, an $80 million asset community bank
in Robertsdale, Alabama. I am also the Chairman of the
Independent Community Bankers of America, on whose behalf I
appear today.
Mr. Chairman, I want to commend you for moving this
important issue forward. It has been 10 years since Congress
last took a systematic look at the deposit insurance program.
Now is the time, during a noncrisis atmosphere, to modernize
our very successful Federal Deposit Insurance System, by
adopting a package of interrelated reforms.
First, deposit insurance coverage levels have been badly
eroded by inflation and must be increased and indexed for
inflation. Today, in real dollars, deposit insurance is worth
less than half of what it was in 1980, and even less than what
it was worth in 1974, when coverage was raised to $40,000.
Higher coverage levels are critical to meet today's savings
and retirement needs. A recent Gallup poll showed that nearly
four out of five consumers think that deposit insurance should
keep pace with inflation. Higher coverage levels are critical
to support the local lending of community banks as they
increasingly face liquidity pressures in trying to meet loan
demand for our small business and agricultural customers.
Community banks' funding sources other than deposits are
scarce. Consumers and small businesses shouldn't have to spread
their money around to get coverage they deserve. They should be
able to support their local banks, and local economies, with
their deposits.
Meanwhile, the examiners and the U.S. Treasury are warning
against our growing reliance on Federal Home Loan Bank advances
and other noncore funding sources such as brokered deposits.
We do not have access to the capital markets like the large
banks do. In troubled times, we, unlike large banks, are many
times ``too small to save.''
A recent Grant Thornton survey revealed that nearly four
out of five community bank executives say higher coverage
levels will make it easier to attract and keep core deposits.
The growing concentration of deposits and of financial
assets in fewer and fewer organizations, not an increase in
coverage, presents the greatest systemic risk and ``moral
hazard'' in our financial system and to the loss exposure of
FDIC.
Chairman Johnson, ICBA strongly supports your legislation,
S. 128, which would substantially raise coverage levels and
index them in the future. This feature of deposit insurance
reform is essential for our support of legislation. The ICBA
also supports full FDIC coverage for municipal deposits and
higher coverage for IRA's and other retirement accounts.
Second, we must address the free-rider issue. Over the
course of last year or so, Merrill Lynch and Salomon Smith
Barney have moved around $100 billion into insured accounts
without paying a penny in insurance premiums, thereby reducing
the reserve ratio.
Further, by owning multiple banks, they offer their
customers higher coverage levels than we can. This is a double-
barreled inequity that we think must be addressed.
Third, a risk-based premium system must set pricing fairly.
Currently, 92 percent of banks pay no premiums. The FDIC says
that this is because the current system underprices risk.
The proposal to charge all banks premiums, even when the
fund is fully capitalized, faces controversy in our industry.
But we believe that as part of an integrated reform package,
which includes a substantial increase in the deposit insurance
limit, most community bankers would be willing to pay a small,
steady, fairly priced premium in exchange for increased
coverage levels and less volatility in the premiums. This is
also one way to make sure that the ``free-riders'' pay their
fair share, also.
Fourth, the 1.25 percent hard-target reserve ratio and the
requirement of a 23 percent premium when the fund is below
target should be eliminated. The U.S. Treasury and the
regulatory agencies recommend using a flexible range, with
surcharges as the ratio gets too low and rebates if the ratio
gets too high.
We believe that the current system is dangerously
procyclical with premiums the highest when banks and the
economy can least afford it. Using a more flexible target would
help to eliminate substantial fluctuations in premiums and
avoid intensifying an economic downturn by diverting lending
funds out of the banking industry.
We also strongly support the FDIC proposal to base rebates
on past contributions to the fund rather than on the current
assessment base. This would avoid unjustly rewarding those who
haven't paid their fair share into the fund.
Fifth, the FDIC proposes to merge the BIF and the SAIF. The
ICBA supports the merger only so long as it is a part of an
overall comprehensive reform package.
In conclusion, Mr. Chairman, now is the time to consider
these important FDIC reforms. Thousands of communities across
the country and millions of consumers and small businesses
depend on their local community banks. And without
substantially increased FDIC coverage levels, indexed for
inflation, community banks will find it increasingly difficult
to meet the credit needs of our communities and consumer,
agriculture, and small business customers.
The less that deposit insurance is really worth due to
inflation erosion, the less confident Americans will be about
their savings in banks. Thus, the soundness of our financial
system will then be diminished.
Congress must not let this happen and we urge Congress to
adopt an integrated reform package as soon as possible.
I thank you for the opportunity to comment and I will be
happy, Mr. Chairman, to answer questions.
Senator Johnson. Thank you, Mr. Gulledge.
We will turn next to Mr. Plagge.
STATEMENT OF JEFF L. PLAGGE
PRESIDENT & CHIEF EXECUTIVE OFFICER
FIRST NATIONAL BANK OF WAVERLY, IOWA
ON BEHALF OF THE
AMERICAN BANKERS ASSOCIATION
Mr. Plagge. I want to thank you, Mr. Chairman, for holding
this hearing. We certainly appreciate your long-term support of
a strong banking system and the financial system in general and
your leadership on this particular issue.
Assuring that the FDIC remains strong is of utmost
importance to the banking industry and the consumers
nationwide.
Over the past decade, the industry has gone to great
lengths to assure the insurance funds are strong. In fact, with
$42 billion in combined financial resources, the FDIC is
extraordinarily healthy. The outlook is also very good.
The banking industry is extremely well-capitalized,
profitable, and reserved for potential losses. Thus, now is a
great time to consider how we might improve an already-strong
system on a comprehensive basis.
A consensus is key to any bill being enacted. To fulfill
this goal, we have held extensive discussions with bankers,
Members of Congress and staffs, and the FDIC. And as you noted,
some differences remain between our three organizations, but in
most cases, our positions are very similar.
Our three associations have agreed that it is imperative to
discuss these issues together and work together with this
Committee to develop legislation that would have broad support.
Just this weekend, this issue was again brought before our
organization's bankers at the ABA summer meeting. This meeting
brings together our board of directors, government relations
council, and the leadership of all State banking associations
and others. My testimony today reflects the conclusions reached
during this meeting.
I must add, however, that while there is a willingness to
go forward, we do have deep concerns about legislation that
might increase bank costs or become a vehicle for extraneous
amendments. If that were to be the case, support amongst many
of our banks and bankers would quickly dissipate.
Indeed, the consensus at our summer meeting was more so
than ever that the ABA will oppose any FDIC reform legislation
that results in increased premiums when the insurance funds are
already above the 1.25 percent ratio as they are today.
Fortunately, we also believe, however, that by working
together, a consensus bill could be developed that would have
broad support.
In my testimony today, I would like to make several key
points that are also in the written testimony that was
submitted.
First, today's system is strong and effective, but some
improvements could be made. The current system of deposit
insurance has the confidence of depositors and banks. Strong
laws and regulations buttress this financial strength. Even
more important is that the bank industry has an unfailing
obligation to meet the financial needs of the insurance fund.
Second, as you have noted, a comprehensive approach is
required. Because insurance issues are interwoven, any changes
must consider the entire system. We are pleased that all the
issues are now on the table. We recognize that any final bill
might not cover all of these issues in full, but we certainly
appreciate the comprehensive process that the Congress and this
Committee is pursuing.
The issues that we feel should be considered include:
Number one, the impact inflation has on the $100,000 insurance
level and how it can be addressed in the long term; number two,
the fact that very fast growing institutions can dilute the
fund ratios without paying any premiums; number three, the
current counterproductive and procyclical premium requirement
when the fund falls below the 1.25 percent ratio; number four,
the need to cap the growth of the fund at some point and
provide rebates; number five, the possibility of basing rebates
on the history of bank payments into the fund; number six,
insurance levels on municipal deposits; and number seven,
merger of the insurance funds in general.
Our summer meeting participants emphasized that caps and
rebates need to be included in the deposit insurance
legislation.
My third and final point is that the changes should only be
adopted if they do not create new material costs or burdens to
the industry. The example used by the FDIC in its report would
result in unacceptable premium increases for many banks. The
current system is strong and we see no justification for such
increases when the insurance funds are above the required
reserve ratio.
Banks have paid for their insurance and, in fact, they have
prepaid and they continue to pay almost $800 million a year to
cover the FICO interest payments, even though the current
institutions that are paying these bills had nothing to do with
the S&L crisis.
We thank you, Mr. Chairman, for this opportunity to express
our views and we look forward to working with the Committee to
find workable and comprehensive solutions.
Senator Johnson. Thank you, Mr. Plagge.
Mr. Hage.
STATEMENT OF CURTIS L. HAGE
CHAIRMAN, PRESIDENT & CHIEF EXECUTIVE OFFICER
HOME FEDERAL BANK, SIOUX FALLS, SOUTH DAKOTA
FIRST VICE CHAIRMAN, AMERICA'S COMMUNITY BANKERS
ON BEHALF OF
AMERICA'S COMMUNITY BANKERS
Mr. Hage. Mr. Chairman and Members of the Subcommittee, I
am Curt Hage, Chairman, President, and CEO of Home Federal Bank
in Sioux Falls, South Dakota. I am representing America's
Community Bankers today in my capacity as First Vice Chairman.
We are pleased to have this opportunity to present our views on
deposit insurance reform.
America's Community Bankers welcomes your interest in
comprehensive reform. At the same time, we believe there are
serious potential problems facing the deposit insurance system
that Congress must act on immediately.
Last week's failure of Superior Bank and the failure of the
First National Bank of Keystone in 1999 should remind us of the
importance of strengthening the Federal Deposit Insurance
System. If the list of comprehensive reform proposals is too
long for Congress to pass this year, we ask that you set
priorities, enact what you can this year, and then return to
the rest of the issues next year.
America's Community Bankers urges Congress to enact three
major deposit insurance reform provisions this year:
First, merge the BIF and the SAIF into a single, stronger
deposit insurance fund.
Second, give the FDIC flexibility in recapitalizing the
deposit insurance fund if the fund falls below the 1.25 percent
reserve requirement. Current statute requires the FDIC to
impose a 23 basis point premium if a fund dips below the
required reserve ratio level for longer than a year.
The real dollar cost of this arbitrarily set premium would
be significant. For my bank alone, that premium would cost $1.4
million. For all banks in the State of South Dakota, that would
be $31 million-- enough capital to support over $300 million in
additional lending. In a rural State like South Dakota, $300
million would make a big difference in helping our State
continue to grow.
We recommend that Congress allow the FDIC to recapitalize
the fund using a laser-beam approach, not a sledgehammer.
Third, allow the FDIC to impose a special premium on
excessive deposit growth, if such growth would threaten the
health of the deposit insurance fund.
A few companies have shifted tens of billions of dollars
from outside the banking system into insured accounts at banks
that they control. While legal, this has diluted the deposit
insurance funds and reduced the reserve ratio of the BIF by
three to four basis points. It is time to give the FDIC
authority to counter this free-rider problem.
Fortunately, there is already legislation introduced in the
House to address these three priority issues. H.R. 1293, the
Deposit Insurance Stabilization Act, introduced by
Representatives Bob Ney and Stephanie Tubbs Jones. ACB asks
Congress to either pass this legislation immediately or to make
it the centerpiece of comprehensive reform legislation that can
be enacted this year. In any case, the provisions found in H.R.
1293 should be enacted before either the BIF or the SAIF falls
below the 1.25 percent reserve ratio level.
We agree with the incoming FDIC Chairman Don Powell that
Congress need not deal with all deposit insurance issues at
once. But ACB's strong support for addressing the most pressing
matters certainly does not rule out adding other provisions if
a consensus can be quickly developed.
In the area of coverage, ACB strongly believes that
Congress should focus on increasing protection for retirement
savings and also urges substantially increasing coverage for
retirement savings plans, such as IRA's and 401(k) accounts.
With respect to general increases in deposit insurance
coverage, ACB supports indexing coverage levels from 1974,
which, according to the FDIC, would bring the coverage limits
to approximately $135,000. This would help maintain the role of
deposit insurance in the Nation's financial system.
ACB also recommends that Congress set a ceiling on the
deposit insurance fund's designated reserve ratio, giving the
FDIC the ability to adjust that ceiling using well-defined
standards after following full notice and comment procedures.
In determining the actual ceiling level, Congress should
consult the FDIC. Once a ceiling has been set, reserves in the
fund that exceed the ceiling should be returned to insured
institutions based on their average asset base measured over a
reasonable period and based on premiums paid in the past. For
example, S. 2293, introduced by Senators Santorum and Edwards
in the 106th Congress, provides one approach that Congress
might take.
Finally, ACB strongly supports preserving the current
statutory language preventing the FDIC from imposing premiums
on well-capitalized and well-run institutions when reserves are
above the required levels. These institutions have already paid
dearly for their coverage.
Mr. Chairman, let me sum up by reiterating ACB's strong
belief that Congress should address the most pressing needs of
the deposit insurance system immediately--acting quickly to
give the FDIC the flexibility it needs to deal with the strains
imposed by the free-rider problem.
If a consensus can develop around other deposit insurance
reform measures, we welcome their consideration and inclusion.
Deposit insurance is an essential part of our banking
system. While a variety of opinions exist on the issues,
general consensus exists that any reform should leave the FDIC
stronger. It should continue and strengthen the original
mission of the FDIC to protect depositors.
America's Community Bankers is committed to working with
you and your Committee, and others in the industry, to help
forge a bill that can move expeditiously through Congress.
Again, Mr. Chairman, thank you for this opportunity to
testify on behalf of America's Community Bankers. I welcome any
questions that you or any Member of the Subcommittee might
have.
Senator Johnson. Thank you, Mr. Hage.
My able colleague and friend, Senator Bennett, is able to
join us now. And what I would suggest is that Senator Bennett
share with us some opening thoughts, and then with the
permission of the remainder of the Subcommittee, we would move
directly on to questioning at that point.
Senator Bennett.
COMMENTS OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you very much, Mr. Chairman. I
appreciate your holding this hearing.
When I first joined this Committee as a very freshman
Member and sat at the end of the table on the other side, I had
no idea what BIF and SAIF were. I would go home filled with the
excitement of a new Senate election and my appointment to the
Banking Committee and have bankers sit me down and say, where
are you on the issue of BIF and SAIF? And I said, well, I am in
favor of SAIF. Everybody likes to be safe.
[Laughter.]
What is BIF? That sounds like a statement on a Saturday
morning cartoon.
So, I now have been immersed in BIF and SAIF issues for
nearly 8 years and had thought they had gone away. I thought
that the problems had all been solved. But as you hold this
hearing, I realize that I was wrong. The problems have not all
been solved. They have simply changed. We are no longer dealing
with the issue of bailing out savings and loans. We are now
dealing with the issue of prosperity and too much money in BIF
and SAIF.
I am grateful to you, Mr. Chairman, for highlighting the
issue again and bringing it back up in the next context so that
we do not simply ignore it.
I think that is a salutary thing for you to be doing. I
appreciate the witnesses and the information they have shared
with us here today. And I hope that, maybe with your
leadership, Mr. Chairman, we finally can get to the point where
we can forget it and let it go on. But life being what it is
around this town, I am not sure we will ever do that.
Thank you.
Senator Johnson. Thank you, Senator Bennett.
If it is all right with Senators Allard and Reed, we will
proceed on with questioning. But certainly, your statements
will be placed into the record.
In the process of trying to find how much consensus is
possible on FDIC reform, we had an opportunity to seek out the
opinions of a wide range of authorities, not the least of all
the panel before us here today.
We also looked to the viewpoints of the FDIC itself, the
Fed, the Treasury, the OCC, and the OTS. And I thought it might
be useful to display a chart, which we have on the stand here,
which demonstrates a great many of the key components of FDIC
reform. There actually is a great deal of consensus,
admittedly, a bit less consensus on the indexation issue.
Certainly on the other issues, there is a great deal of general
consensus among these agencies.
I would ask Mr. Plagge and Mr. Hage that, with the FDIC,
the Fed, the Treasury, the OCC and OTS in unanimous position,
recommending that banks and thrifts, in fact, pay annual
premiums for deposit insurance coverage, it is my take on their
perspective that they are suggesting that a steady premium
system would not necessarily require banks and thrifts to pay
more. They would pay a steady amount each year rather than 23
basis points into the hard target, and that variability in
premiums would be reduced, not increased. Their attitude
appears to be making an assumption that these institutions will
never have to pay premiums because we will never break 1.25
percent, which may not be a realistic position to take.
I wonder if you would share again with me a bit of
deliberation about why your organization is right and these
institutions are wrong on the issue of premiums.
Mr. Plagge.
Mr. Plagge. Okay. I will start that. It is an interesting
discussion. And having served on the ABA board level and then
also on the Government Relations Council at the ABA, as well as
at the State level, what we find with our bankers that have
been brought into the discussion is they become almost more
emphatic about the fact that we have prepaid into the fund.
The combined funds today are extremely strong--1.37
percent, I believe is the ratio when you look at them combined.
In fact, congratulations to Congress for designing a system
that has worked.
We put the fund together. We have been far above the 1.25
percent, and we continue to pay $800 million a year toward the
$12 billion obligation for the FICO interest. So, we look at it
as, we have paid. We want to continue to make sure that the
fund is extremely strong. And at this point, it just seems to
us that the system in that regard is working.
Every dollar that comes out of our institutions, and I am
in a small, $140 million institution in rural Iowa, is money
that we cannot loan back into the economy, cannot do the kinds
of things that we are doing. And as one banker told me, we
already bought this car. It is paid for. The system is working
in that regard. Let's not continue to put more money into that
fund.
Last, our bankers tell us, and I agree, that right now, the
fund is building at approximately $1.5 billion more each year
just based on the excess earnings in the fund over and above
the operating cost to the FDIC. So in fact, the fund will
continue to grow as it stands today over and above the FICO
premiums and so forth that are being paid.
Senator Johnson. Mr. Hage.
Mr. Hage. Thank you, Senator Johnson.
I think we need to put a couple of pieces into perspective
to make this puzzle look like a whole picture.
I do not know of any of our members who are suggesting that
we shouldn't pay any premium for deposit insurance.
Historically, we have paid for those premiums and have paid for
that coverage and I think it has been appropriate.
The situation we are in today is that we have overpaid or
prepaid for the present insurance level required. And so, our
members are concerned about the equity of getting that
prepayment back where it belongs.
Normal conditions without the aberrations of huge inflows
of free-rider deposits probably wouldn't raise the issue to the
level it is today. But they are linked.
We have a number of beneficiaries who are not paying for
any coverage, yet getting full coverage at the expense of those
of us who have prepaid. And I think that is unfair and wrong.
So an important ingredient of getting back to paying a correct
premium is to rebalance who should pay and how much should they
pay.
Second, there seems to be a growing notion, as I get
reports of conversations around Capitol Hill and perhaps around
the country, that somehow this is a free system that we are
living off of.
It is not free at all. We have paid for this deposit
premium. We have accumulated those balances. My company alone
since 1991 has paid over $10.4 million in premiums. I have
gotten value for that. But a lot of that is prepaid and I would
like it back. And let those who are now putting uninsured money
into the system pay their fair share like the rest of us have.
That is really the key ingredient, to get it rebalanced and
get it fairly structured so all participants are paying
appropriately for participation in the deposit insurance fund.
Senator Johnson. Thank you, Mr. Hage.
I am going to suggest that Members of the Subcommittee
abide by the 5 minute clock, so that everybody gets a fair
opportunity. And having my time expire here, I will try and
behave myself and set a good example. So, I would turn next to
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
This is for any of the panelists. Do you believe that
deposits are down in smaller banks because insurance reform has
not kept up with inflation or because depositors are putting
their money in other uninsured vehicles that have the potential
for higher returns? Anyone who would like to speak on that
would be fine.
Mr. Gulledge. I do believe that deposits are down in the
smaller banks. I think that customers are in many instances
following the rates that they are getting for other nonbank
products. But also, there are quite a number of people who are
leaving community banks to take their funds simply because we
are not in a day when $100,000 coverage is indicative of a
person being rich.
Some of these people who are taking their retirement
accounts, their life event funds are being taken to other banks
and other products simply because we do not have the insurance
coverage to give them the protection that they are seeking and
that they expect from the FDIC coverage.
Mr. Hage. Senator Bunning, I think we saw in the last 5 to
6 years, maybe longer, a huge disintermediation or shift from
commercial bank deposits, thrift and community bank deposits,
because of higher rates of return and a high confidence level
in equity markets and mutual fund markets. I think that it had
relatively little to do with the deposit insurance coverage
limit itself as a stand-alone concept.
Today, with the lack of confidence given the recent market
readjustment, we have seen new inflows of deposits back into
community banks. Whether that will stay or not, I do not know.
I do know that people have and are accumulating higher
balances on an individual basis, particularly in their
retirement funds. And I think as we see the baby boomers reach
retirement age, their appetite for risk is going to decrease.
They are going to pay more attention to how much insurance
coverage they can get to assure return of their principle
rather than return on their principle.
Senator Bunning. During the Chairman of the FDIC's
testimony, she addressed the FDIC's concerns regarding the
issue of rapid deposit growth and its impact on the rest of the
industry. Do you see a trade-off between reform in this area
versus stifling the very initiative of practices that Gramm-
Leach-Bliley was intended to encourage?
Mr. Hage. Senator Bunning, I would draw a distinction and
definition of rapid deposit growth that I think is important.
If we are talking about deposit growth----
Senator Bunning. Those are her words, not mine.
Mr. Hage. I understand. But just to clarify the issue, if
we are talking about deposit growth, meaning one bank gives up
its deposits by competitive forces to another bank, that is
deposit growth for the bank, but it has no change on the fund
itself because both sides of that transaction were insured. So
bank-to-bank deposit growth has no effect, effectively, on the
insurance funds.
Funds like we see today that are in money market funds that
were not previously insured now moving into the deposit
insurance system through banks and thrifts that have been
properly chartered, that has an impact. It may well be a one-
time impact given the environment we have come from and the
environment we are into today. But it nevertheless is a very
significant impact today.
Over $50 billion have moved into the insured deposit funds
with no premium attached. That is significant.
Senator Bunning. How does the ABA feel?
Mr. Plagge. I would echo that. In fact, from a personal
example standpoint, we started a new bank in a close-by
community. Literally, all the money that has come into the
growth of that bank has come from other banks within the
system. And so, the impact is basically a neutral impact to the
FDIC.
The funds that are flowing in from the money market funds
and so forth, obviously have had an impact. As my counterpart
mentioned, it looks like it may be coming to an end as far as
the amount of that impact. Most of that money that would flow
in in the large amounts has. But it certainly can move the
percentages a lot greater than anything that happens within the
industry itself, the banking industry.
Senator Bunning. In meeting with the community bankers in
my area, Kentucky and most of the area that surrounds the
greater Cincinnati area, I have not heard one complaint, not
one, from any of them about merging the funds or charging too
much or increasing the amount of insured deposits. Not one of
them have ever come to me and said, this is something that we
really think is strongly needed.
So unless we can really see a great improvement, it is
going to take a lot of momentum to get this done. And I have a
personal banker who is a community banker and they are so
happy, it is unbelievable how happy they are. They are making a
lot of money.
Mr. Hage. Senator, I think that you have issued a challenge
for all three of our industry trade groups to awaken the issues
to your bankers.
Chairman Sarbanes. Well, I am sure that you will be hearing
from them now.
[Laughter.]
Senator Bunning. All right.
[Laughter.]
Senator Johnson. Thank you, Senator Bunning.
Senator Sarbanes.
Chairman Sarbanes. Examination of this issue actually
raises a lot of, in a sense, basic questions, and I would like
to ask a couple of those on the way to sort of gaining an
analytical framework. What do you think the deposit coverage
should be and what is the rationale for it?
And in answering that question, I would like you to abandon
the rationale that simply takes an old figure and then adjusts
it for inflation because that assumes that the old figure was
correct, or under changing circumstances, even today,
represents an appropriate base off of which to work. I do not
know whether that is the case or not.
What should the figure be and what is the rationale for
that figure? Should there be no limit? And if the answer to
that is no, why should there be a limit? If there should be a
limit, at what level? Why? What is the underlying rationale for
arriving at that figure?
Mr. Hage. Senator, I would offer that I do not know that
there is a clear, single number answer to your question. The
foundation of the question I think reflects the real heart of
the issue here. What is it that we as a society should protect
in terms of individual's wealth accumulation? What was magical
about $5,000 coverage at the beginning, going to $15,000, to
$20,000? I do not really know.
The related facts are that through incentives in the
currently passed tax act, we have encouraged individuals to
accumulate more wealth for retirement. We have a generation of
baby boomers coming into retirement that will be unprecedented
in the numbers of people. We know there is a strain on Social
Security.
So, I think there is a connection between how much deposit
insurance coverage we should provide and how much at-risk
wealth accumulation we should permit.
More than getting to a very specific number I think is an
active process which I think has been and can continue to be
actively administered through FDIC. Giving them some more
flexibility to continually look at the insurance coverage ratio
limit would be a strength. Giving them some flexibility in
setting the premiums that would be necessary to maintain
various ratio coverages that might be determined based on the
risk profile of our public depository institutions I think
would be a very healthy start. But I do not know that I could
give you a specific number that would be any more legitimate
than the numbers we have today.
Chairman Sarbanes. Should it be part of the rationale to
look at what percentage of the American people may, in fact,
have savings at a certain level, where we would say, well, for
ordinary people, we want to provide them the safety net. But we
are not going to provide a safety net without limit. And for
people of greater wealth, they presumably have their own
investment strategies and they are used to putting their money
at risk and so forth. Therefore, we are not going to cover
everything for everybody. Is that a reasonable factor to
include in the evaluation?
Mr. Hage. I would agree with that, Senator. I do not think
it is important that we provide 100 percent coverage. I think
there is some healthiness to having segments of wealth at risk.
I think it is a balance for public policy.
As you as an elected body make policies that may put our
Nation in positions of debt or not, the balance of how much
risk that puts on deposit accumulation and protection I think
is an integral ingredient of that.
Chairman Sarbanes. Obviously, if we start examining the
whole range of this, we put in the statute of the 1.25 percent
figure that the FDIC is supposed to work off of. But I guess I
would have to start looking at what the rationale is for that
figure.
Actually, you point out, Mr. Plagge, in your statement:
``As a result of failure last week, the FDIC's SAIF will
reportedly lose $500 million, 5 percent of the total in the
fund. A loss that size would reduce the SAIF's reserve ratio
from 1.43 percent of insured deposits to 1.36 percent.'' Now
that means that just two more failures of this magnitude would
bring that deposit fund below the 1.25 percent, and would then
kick in a mandated 23 basis point premium on all institutions
in the fund.
People are seeking not to have that fall off the cliff, so
they do not want the automatic mandatory premium when you go
below 1.25 percent. And of course, one argument made for that
is you may well be going below the 1.25 percent because of
worsening economic circumstances.
So, you are imposing an additional burden that is
countercyclical--I mean, it is procyclical. The press is on not
to do that, to do--I think you say later, a laser effect. And I
think there is some argument for that. But it would seem to me
that would seem to carry with it the proposition that the
figure would have to be higher in good times in order to build
up the fund.
You, of course, have addressed the so-called free-rider,
people that are sweeping in the deposits, and I think that is a
reasonable issue to be looked at, and I am appreciative of
that.
But again, what is the magic of the 1.25 percent? Maybe
that is not an adequate figure, particularly if we are going to
raise the amount of coverage.
This thing can erode very quickly. And those of us who went
through the S&L's are still scarred by the experience. We ran
out of the fund. It was all gone. In the end, there was, what,
$160 billion? I forget the figure. The figure was so enormous,
I have forgotten how much it was. What is the response on that
point?
Mr. Plagge. I might comment on that. I think, especially in
particular to the failure last week, there is a little bit of
an issue of what caused the failure and is it a bigger-picture
issue going on or is it more like a Keystone issue, where there
was particular issues with an institution?
Chairman Sarbanes. Well, we are going to look at that. And
of course, they were very heavy into high-risk lending and so
forth.
Mr. Plagge. I think the other thing is it is always
important to remember that both funds have the ability to set
aside another fund within the fund for reserves. And from what
I understand, approximately $250 million had already been
reserved in the subfund for that particular failure.
Time will tell us what the actual loss is. I think the
percent I have heard in the past over historical purposes is
approximately 13 percent is the average loss. Now if you get
into unusual situations like this one or Keystone where there
are other issues going on, obviously, that percent can change.
But the 1.25 percent, for whatever reason they came to that
number, whether it was historical discussion at that time or
long-term discussion, that is up for debate, obviously.
The fact remains that we are almost 1.37 percent today. So
even the 1.25 percent, which was considered the right number
back in previous discussions, we have exceeded that now and it
appears that, based on past failures, for instance, the
Keystone case, the numbers were large as a percentage as well.
But, again, it was an individual situation and there hasn't
been a lot of follow-up behind it. We hope that is the case in
this S&L failure as well.
Chairman Sarbanes. Mr. Chairman, I see my time is up. I
would just close with this observation.
If you increase the amount of coverage, you obviously
increase the extent to which you are placed at risk, ultimately
the taxpayer. It seems to me that then raises the question of
what is a proper figure for the fund, particularly if we are
going to move in the direction of not replenishing the fund
quickly if it drops below whatever the established level is.
So if you do not replenish it on the downside--or replenish
it more slowly, I guess--it raises a question of whether you
have to boost it more to have more of a margin to absorb these
losses.
Now, we have been through a pretty good period in terms of
failures and so forth. And so that tends to shape your
thinking. But the system is not in a sense there for the good
times. The system is there for the bad times. Therefore, we
have to be thinking in those terms.
Mr. Chairman, thank you and I want to thank the panel.
Senator Johnson. Thank you, Chairman Sarbanes.
Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman.
Let me do what you are not supposed to do--ask a question
to which I do not know the answer.
What happens to the extra money? Are we setting up another
Social Security trust fund here where the money is beyond the
1.25 percent level or whenever it gets invested and earns
interest, the money that is not needed to run the FDIC? Does it
just go into the Treasury Department? Does anybody know?
Mr. Hage. It stays in the insurance fund, Senator.
Senator Bennett. What is it invested in?
Mr. Hage. I do not know the investment portfolio. But that,
I believe, is under the administration of FDIC.
Senator Bennett. I understand that it stays in the
portfolio. But what is it invested in? Is it invested in
Government bonds?
Mr. Hage. We believe, yes.
Senator Bennett. So from a cashflow standpoint, just like
Social Security, if you have a big run on the fund and people
present those bonds for payment, the Government has to come up
with the cash from some place else to pay off those bonds.
Mr. Hage. Those bonds would have to be sold in a
marketplace environment. They would not be called by the FDIC
against the Government.
Senator Bennett. I understand that.
Mr. Plagge. I guess I might add that it actually gets kind
of to the heart of some of the concerns of our bank members. It
is really the question of what doesn't happen to it? Do we keep
building the fund up over and above and it takes money out of
my institution in Iowa, it takes money out of other banks
around the country, especially in rural areas where liquidity
is already tight and loan to deposit ratios are high? How much
do we keep putting into a fund that appears to be, by all
accounts, very safe and sound and meeting the needs of the
insurance fund itself ?
Senator Bennett. If it becomes too tempting because the
Government gets the revenue by selling the bonds, it becomes
almost a form of taxation to fund other governmental programs.
And we love that around here. But we are not sure that is the
thing that ought to be.
Mr. Plagge, institutions get rated as 1-A and therefore,
they do not have to pay anything into this fund. So in a very
real sense, that rating is worth something financially.
Mr. Plagge. Yes.
Senator Bennett. And you are at the mercy of the bank
examiner as to whether you get rated or not rated. So that just
raises the question of how objective is the bank examiner? Do
you feel good about the process that says, okay, this bank
doesn't have to pay and this bank does? Or do you have some
problems with it?
Mr. Plagge. Well, we have concerns, as you look at some of
the recommendations in the FDIC proposal of changing the
assessment system and changing the rating system. We are a
national bank. Both of our banks are national banks, so I
strictly deal with OCC. But I have been in a State bank before
where I have had FDIC and State regulators.
I like the system the way we have it. I think, again,
congratulations to the designers. It has worked. It has put 92
percent of the banks in the top category. I look at that as a
good thing.
The incentive has been to be in the top-rated, well-
capitalized category, which is exactly where you want banks in
any economic downturn. It puts more capital behind the whole
system, let alone the $42 billion that is sitting in the fund.
You have the $600 plus billion that is sitting behind it in
bank capital. I think the more you try to break that down, when
I see the assessment, the proposal where it is 1-A plus, 1-A,
1-A minus, 1-B, 1-C, and then going down the ladder into the
other categories, the subjectivity of that is somewhat
dazzling.
Bank regulators, and we have always had a good relationship
with our bank regulators, but they do have a lot of discretion.
There is a lot of subjectivity in that system, whether it is on
the overall rating or the individual ratings that make that up.
I guess I have not seen anything broke with the current
system that would dictate to me or suggest to me that we need
to keep breaking that down even further.
So, I think it trends into areas that would put, quite
honestly, a lot more pressure on the individual field
examiners, let alone the systems themselves. Again, I do not
see that the system has broken down in any fashion that would
suggest we need to go that route.
Senator Bennett. I see. Thank you. One final question.
You all talked about the free-riders, and nobody likes a
free-rider. But at the same time, the institutions that pay no
premiums, pay no premiums because they fall into the safest
risk category. And you just talked about the process by which a
bank gets into the safest-risk category. Should we change the
category in order to pick up the free-riders? Or are you saying
that there should be an entry fee to get into this business
regardless of how safe you are?
Free-rider is almost a pejorative--it is a pejorative term.
And it may very well be an earned pejorative term. But when you
look at it from the standpoint of, well, the safest banks now
do not pay anything, how do you specifically propose that these
institutions coming in that are very, very safe should pay
something? What should the ticket to the dance be, or how
should it be structured in your view, any of you?
Mr. Hage. Senator Bennett, I would suggest to you that
free-rider, as we would define it in our terminology, means
those institutions that have paid no premium in the past, yet
are dumping huge sums of deposit money into the insurance fund.
Senator Bennett. I understand that. But they come in
dumping this into the fund, as you say, and they have very,
very safe capitalization.
Mr. Hage. Yes. And what I was about to say is that, going
forward, I do not think any of us are proposing that there
would be a category of membership or participation in the fund
that would pay no premium, but that there would appropriately
be categories or grades of premium paid based on the risk
profile of individual institutions. That risk profile or
grading would be determined by FDIC as a result of their
examination process.
What is happened today in banking that is relatively new is
that balance sheets can today be constructed with different
risk profiles more in a broader range of business plans that
have perhaps historically been true.
You asked about the impact of regulation and examination. I
think regulators have grown in their sophistication of being
able to understand these instruments as have managements of
banks.
It is really critical that management in a bank understand
the risk profile that they are taking on into a balance sheet.
That risk profile is the investments and the loans that a bank
makes. That is where the risks come from, not the deposit.
When we talk about deposit insurance, we have to be careful
that we understand that difference. By and of itself, the
amount of a deposit in a bank has meaning only as the basis for
what we are insuring. But it is separated from the risk profile
of the bank, which is driven by the assets it has. So it is
really important that we measure the risk of the use of the
deposits and have a premium that reflects that risk on an
ongoing basis.
That underscores what we are talking about in terms of the
need for flexibility. Over time, as, cumulatively, bank balance
sheets would change, the FDIC should have some flexibility to
determine whether 1.25 percent or some other number is the
right minimum threshold for coverage. And if we gave that
flexibility, theoretically, any way, there would be an
opportunity to adjust premiums that would be less dramatic than
the all-or-nothing base that we have today, all of 23 basis
points or zero.
That is really the hard-core, not-working part of the
premium structure today. It is the all-or-nothing idea.
But the notion of having the ability over time to adjust
the appropriate level of reserve ratio to be able to accelerate
that in reasonable time frames, to be able to have a mix of
premium assessments based on risk profiles of institutional
members makes for a much healthier, stronger system.
Senator Bennett. Thank you.
Chairman Sarbanes. The FDIC, as I understand it, at least
is proposing indirectly to address this issue by providing
rebates that would be based on what you had paid into the fund.
So that at least if you are an institution, over time, the very
point you were making earlier, as I understood it, which had
paid into the fund, you would get a rebate, and if you were an
institution that had not paid into the fund, you would not get
a rebate.
Now that is addressing it at the other end, so to speak.
But I think it did reflect some sensitivity on their part.
Mr. Chairman, can I ask one question?
Senator Johnson. Yes, Chairman Sarbanes.
Chairman Sarbanes. I am interested in the fact that 92
percent of the institutions are well-capitalized. Now, if you
heard about a teacher who was giving 92 percent of the students
in her class an A, presumably, you would say, I do not know
about that marking system. I am not sure exactly what standard
the teacher is using.
Senator Bennett. Pretty smart class.
Chairman Sarbanes. Yes. She needs to make more
differentiations. I take it that is what the FDIC is perhaps
searching to do on this risk-based approach. So that you
wouldn't have all but 8 percent that passed the post, so to
speak, and were in the same risk category.
Mr. Plagge. I understand that as well. The incentive has
been placed where the regulation wants banks to be, and that is
in the well-capitalized area.
Breaking that down to the level that is being discussed,
where I looked at one chart where the potential premium charge
for, I think it was a 1-C bank, which is still in the well-
capitalized area, would essentially be the same as the premium
requirement for one that was in the low category. It would be
the 3-A category.
It seems to me that the risk to the system is certainly
much better protected when you still have that well-capitalized
bank.
Again, to try to break that down and micromanage that at
the kind of levels that are being discussed to me, becomes
very, very subjective. And I think we should look at the
positive side of that and the fact again that the system was
designed in a fashion that has moved banks to be exactly where
regulators hoped they would be in the well-capitalized
category.
Especially as we look at times like today, especially in
agriculture and so forth, in the part of the country where we
live.
It is good that banks are in that category. It does give
them the ability to stand the risk of a downturn and so forth,
long before the insurance fund would ever be tapped.
Chairman Sarbanes. Mr. Chairman, thank you again for the
hearing. This has been a very thoughtful panel and we
appreciate their testimony very much.
I am not sure how far the statement that the system is
working gets us because you are talking about making changes in
the system. Therefore, we have to consider what the
consequences of those changes should be. Again, I repeat the
fact that we are at the end of an extremely good economic
period. We haven't gone through the stress and strain that we
would experience in more difficult economic circumstances. And
that is what we have to evaluate because that is why all these
protections have been set up, to be able to carry us through
such a period.
But thank you very much and I very much appreciate the
thoughtfulness that is reflected in your statements and in your
responses at the table.
Senator Johnson. Thank you, Mr. Chairman.
It is my ongoing effort to try to find consensus wherever
we can find it. I have a couple of questions I want to ask.
Let me start by asking the entire panel, from what I
understand from your testimony today, you all appear to support
a significant increase in coverage for retirement accounts,
which, as you note, are likely to exceed $100,000 in fairly
short order and fairly commonly. Is it fair to say, at least on
this panel, that there is an industry consensus that we should
consider a significant increase on retirement accounts
independent of any disagreements that we might have about a
general coverage increase?
Mr. Plagge.
Mr. Plagge. We actually haven't centered in on that. The
one concern that seemed to be expressed about increasing
insurance in general is the fact that it would attract hot
money, and relating back to the comments that were made during
the S&L crisis.
I think the reason that bankers have talked about, well, at
least let's look at the retirement funding, is because it falls
out of that category of hot money. It is stable funding for
banks and so forth.
So as you look at the different areas where insurance could
be increased, whether it is municipal deposits or just
insurance in general, or IRA's and retirement funds, it seems
to be the one category that kind of deals directly with the hot
money, concern that resulted from the S&L crisis.
Senator Johnson. Mr. Hage.
Mr. Hage. Senator Johnson, I think that when you look at
the public policy directions that are articulated increasingly
today where citizens of this country are asked and encouraged
to be prepared to carry a larger amount of their retirement
well-being, increasing deposit insurance coverage to those
retirement accounts makes all the sense in the world. It
supports that philosophy.
The critical thing about when you reach the age of
retirement, I am told, although I am getting close, is that
your tolerance for risk, because you cannot replace funds lost,
goes down.
I think we need to recognize that in the nature of how we
encourage people to accumulate wealth and how we allow them to
protect its value. It makes a lot of sense to increase coverage
specifically for retirement type of instruments to encourage
people to add to that saving. That also provides a stable base
of funding for community banks to continue to play the
important role of providing growth through lending in our local
communities.
Senator Johnson. Mr. Gulledge, of course, ICBA supports a
generalized increase and catch-up with inflation. I would
assume that, obviously, a retirement component would be
something that you would support in the context of a larger
comprehensive increase.
Let me ask you, Mr. Gulledge, obviously, we do have a bit
less consensus on this issue than on some of the others in FDIC
reform. And we have heard some observe that increasing the
level from $100,000 to $200,000 would create the potential for
a moral hazard of the kind last seen in the banking system
during the savings and loan crisis of the 1980's.
The Fed and the Treasury, among others, have expressed to
this point adamant opposition to the concept of doubling
because of the risk issue. I wonder if you would share your
observations on that point.
Mr. Gulledge. Well, we do not agree that this would have a
great effect on the moral hazard issue. We feel that, for the
increase and the doubling of coverage under the provisions of
your bill for individual coverage, we think that consolidation
is bringing about, is creating more risk to the FDIC fund than
would be on an individual raising of the coverages.
Senator Johnson. I appreciate your observation on that, Mr.
Gulledge.
In the brief amount of time that I have left on the clock
for myself, let me ask Mr. Hage, because of your experience
with the Federal Home Loan Bank System, the Treasury has
suggested that Federal Home Loan Bank advances and other
secured capital be considered in the deposit insurance
assessment base. The FDIC's report said that a bank's reliance
on noncore funding, which may include these advances, should be
considered risky. How would you respond to those
recommendations?
Mr. Hage. I would oppose the inclusion of the Federal Home
Loan Bank advances as a part of the deposit insurance premium
base. Federal Home Loan Bank advances are an alternative source
of funding. They are fully collateralized by other collateral
that we offer to offset that. They provide no risk to a
consumer and there is no direct benefit to a consumer. To
include Federal Home Loan Bank deposits would increase the cost
of bank funding without any economic value whatsoever.
So, to me, there is no correlation at all to including the
Federal Home Loan Bank advances with the deposit premium.
Senator Johnson. There is agreement from the ABA, Mr.
Plagge.
Mr. Plagge. Yes. I can speak to a little different path on
that.
As you know, in your State, and at least in Iowa, community
banks are using the Federal Home Loan Bank System pretty
readily. With the new advances allowed for ag and small
business loans, it has become an important source of funding
for us.
We just went through a regulatory exam in the last 4 or 5
months. I think the thing to keep in mind on that is the
examiners already take that into account. As they look at our
liquidity, as they look at our balance sheet, as they look at
all the things that they look over when they do an exam, they
take that into account in how we are structuring our balance
sheet and how we are structuring our organization.
And so, I would hope and caution against that kind of stuff
being taken to equation because I think it really would have a
pretty exasperating impact on community banks.
Senator Johnson. Mr. Gulledge, are you in concurrence?
Mr. Gulledge. First of all, I would like to say that we
appreciate very much the expansion of the membership in the
Federal Home Loan Bank System because it has been very
meaningful to the community banks in our country. It has helped
in the liquidity problems that we do have. And it is also true
that the regulatory agencies are warning us about over-use of
advances from the Federal Home Loan Bank. And we understand
some of this warning because the rates are higher. It is
creating a shrinking of net interest margins.
But we feel that the cure for that and the need for using
these lines is increased coverage so that we will have the
liquidity that we need and we do not have to go to the Home
Loan Bank for these advances.
Senator Johnson. Thank you. My time is expired.
Senator Reed.
COMMENTS OF SENATOR JACK REED
Senator Reed. Thank you very much, Mr. Chairman.
Let me first commend you and the Ranking Member for holding
this hearing and beginning the careful deliberation about
deposit insurance reform. It has been an issue, as Senator
Bennett said, that has been with us for a long, long time. We
hope, with your leadership, that we can move forward and reach
some type of satisfactory conclusion.
Let me also thank the witnesses for their excellent
testimony.
I would just like to address initially a general question
to all the panelists. You have had the occasion to look at the
FDIC's proposals for reform. Is there any major element that
they have neglected to leave out that you would suggest in
terms of issues that should be considered in a comprehensive
reform package by the Senate?
Mr. Hage.
Mr. Hage. Senator Reed, as I have read that, I think it is
a very well-written report and reflects a lot of good, thorough
study on the part of the FDIC staff. I do not have anything
excluded that I would want to be included.
On behalf of ACB's position, I would remind you that we
think that the three points of our position of getting those
things done urgently and quickly are important, not as an
alternative of no additional reform, but simply get those done
first, they are right now urgent, continue the debate and the
dialogue on the rest of the proposal, and then enact it
appropriately.
Senator Reed. Again, without pinning you down to an hour
and a day, how fast do you feel that this should be done in
terms of the continued soundness and safety of the banking
system? And if you say yesterday, I will understand.
[Laughter.]
Mr. Hage. Well, since we all have a lot of money invested
in terms of prepaid premiums, yesterday would be a little
sooner----
Senator Reed. I have been listening to this discussion and
I am going to call my insurance agent because I believe I have
lots of prepaid premiums, also.
[Laughter.]
I have been behaving reasonably safely for years now.
[Laughter.]
But I appreciate your point.
Mr. Hage. Senator Reed, they are only charging you a year
in advance. This is a multiyear prepayment.
Senator Reed. All right.
[Laughter.]
Mr. Plagge.
Mr. Plagge. We agree as well. I think the FDIC has
presented a very good package. Obviously, we are not in
agreement on all elements of it, but we feel it is good to have
all those elements on the table.
The only thing that we think maybe has been left out is
giving more of an independent nature to the FDIC board going
back to the three independent seats to make sure that there is
continuity through transition of parties and so forth. But,
otherwise, we agree that they have done a comprehensive look at
things and hopefully, we can find those areas that we can agree
on.
Senator Reed. Thank you very much.
Mr. Gulledge.
Mr. Gulledge. We too feel that the FDIC proposals were
good. They were well thought-out, very thoroughly put together.
They established five areas or five points for consideration.
We believe that all of those are important.
Former FDIC Chairman Tanoue, I believe in her testimony
previously, has stated, and the report indicates that it is not
felt that there should be a separation or a segregation of any
of those points. For comprehensive coverage, all of those
should be taken into consideration.
Senator Reed. Thank you very much. The final point--related
to the size of the fund and the size of premiums is the
effectiveness of regulation. If we do not have effective
regulation, then we are going to need a lot of money in that
fund because we would be paying lots of failed institutions.
And so I would just ask for your comments with respect to
your sense of, at this juncture, the adequacy of the
regulation, the resources available for regulators, because I
think that is inextricably bound up in this whole discussion.
Mr. Hage. Senator Reed, I think you are on to a very
important point. Effective regulation certainly is the base
upon which any system like this would ever work.
Again, observing from our personal experience, I think that
the sophistication of the regulators in terms of being able to
model different financial instruments, getting more savvy about
management's preparedness and proactiveness in being able to
model the impact of different risk profiles that they might
take has improved significantly.
The system will never be 100 percent fail-safe. It is just
the nature of our economy and the instruments themselves. But I
think the process has gotten much better.
Senator Reed. Thank you.
Mr. Plagge.
Mr. Plagge. I agree with that as well. Again, we are a
national bank and we have gone through recent exams. In fact, I
would say the safety and soundness portion of the exams have
stepped up, which I consider positive. I think it is back to
the basics.
The other thing that I would point out is that the
regulators have so much more authority to take actions than
they used to have, which I think makes the fund safer by its
own nature. And so, I feel good about the exam process that we
currently have.
Senator Reed. Mr. Gulledge.
Mr. Gulledge. Well, I am examined by the FDIC and I think
the FDIC is doing a very adequate job of examination. I hear no
complaint of that. I have no complaint of their assessment
ratings, the CAMEL ratings of the bank.
They are, however, saying that the current system is such
that they have some difficulty. And this goes back I think to
the question earlier on the 92 percent of the banks that pay no
premiums.
I believe it was not because of the capital, it was because
of the CAMEL ratings that exists. So that speaks to the
strength of the industry.
As relates to the capital, however, there is a requirement
under FDICIA that banks remain at certain capital levels, and I
think that speaks to those levels that we have today.
Senator Reed. Thank you very much.
Thank you, Mr. Chairman.
Senator Johnson. Thank you, Senator Reed.
Senator Miller.
COMMENTS OF SENATOR ZEL MILLER
Senator Miller. First, I apologize for not being here at
the beginning of this hearing. I was presiding in the Senate.
And I also apologize if I am asking you something which you
have already covered.
I am curious about how you feel about this. Mr. Powell
indicated that perhaps all the FDIC-proposed reforms did not
have to be all in one package. I would like to know what any of
you think would be a must-have in the bill if you were making
it up, and what needs to be done most immediately.
Mr. Plagge. If it is okay, I will start with that.
Senator Miller. All right.
Mr. Plagge. Actually one of our concerns is that if it is
not a comprehensive approach, maybe one or two things happen
and then the rest of it is never visited again. And so, we
really feel that it is the time. It is good public policy time.
The fund is strong. It is a great time to look at the whole
package.
Obviously, there is a lot of things in that package, in the
comprehensive bill, and we understand fully that something may
come out as a result of these discussions, that it probably
won't include everything. But we will have to look at that at
that particular time.
I guess we do caution that one or two things should not be
picked out of that and run through, with the rest of them set
aside for a later date, that unfortunately, may never come. We
want to see the comprehensive discussion, even if it goes on
longer and takes longer to reach consensus.
Senator Miller. Do you feel the same way, Mr. Gulledge?
Mr. Gulledge. I surely do. I think that the FDIC comes with
a very good report and our association and our membership is
very supportive of all the provisions of that report.
We think it is also important to look at the whole package
while this is being done at this time. Frankly, we hope that
Mr. Powell will get a better view of this after he has come on
board and has been at the helm of the corporation for a period
of time.
Senator Miller. Mr. Hage.
Mr. Hage. Senator Miller, ACB agrees with Mr. Powell, they
do not all have to be looked at at once. But I think,
eventually, they all should be looked at.
From my opening remarks, the first importance to us is the
merger of the BIF-SAIF funds. We think that ought to be done
immediately. Second, give the FDIC appropriate flexibility to
set the correct premium levels in balance with the coverage
ratio, so that can be corrected on a smooth basis rather than a
catastrophic, all-or-nothing basis. Third, allow for the
special premiums for the free-riders to rebalance and reset the
appropriate funding for the deposits that have come into the
system.
Senator Miller. Thank you very much.
Senator Johnson. Senator Bennett, anything further?
Senator Bennett. No, Senator.
Senator Johnson. Well, let me thank the panel again for
what I think has been excellent testimony. We have had good
participation on the part of the Subcommittee as well. I am
appreciative of Senators Gramm and Sarbanes joining us for
this, and obviously, Senator Bennett's good work with me on the
Subcommittee.
We want to continue to move this issue forward. And as was
noted in Senator Miller's last line of questioning, I
acknowledge that it may be that we cannot find consensus on
every single issue here. But, on the other hand, I think it is
important that we begin this debate as comprehensively as
possible and recognize that a balanced meal involves both the
spinach and the dessert, and that some of that is part of
reality.
We will see what components we can move ahead with. But I
do want to see us work in conjunction with Representative
Bachus on the House side, with whom I met yesterday. I would
like to see what we can do to find bicameral and bipartisan
consensus on these issues. I think that our panel has
contributed very significantly to our progress in that regard
and again, I thank you for your participation.
The Subcommittee hearing is adjourned.
[Whereupon, at 11:40 a.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR TIM JOHNSON
Good morning. I am pleased to convene the first meeting of the
Financial Institutions Subcommittee of my Chairmanship on a topic that
has been of great interest to me for many years. Federal deposit
insurance is one of the cornerstones of our banking and financial
system. This insurance helps give depositors the confidence they need
to participate in America's financial institutions. Since I began
service in Congress in 1987, we have seen some real ups and downs in
the banking industry, and it is a great privilege today to chair a
hearing on a matter of such importance to our Nation's bankers, and
indeed to our Nation as a whole.
I would first like to recognize Ranking Member Bennett, and thank
him for his participation at today's hearing. It is a great pleasure to
work with Senator Bennett on banking issues. He has a very
distinguished business background, and I value his insights. I would
also like to recognize Chairman Sarbanes, who conducts all his hearings
with such dignity and thought. I hope I can live up to the high
standards that he sets for the Senate Banking Committee.
As everyone in this room knows, or will surely find out in short
order, comprehensive deposit insurance reform is enormously complex. I
will resist the opportunity to recite a history of banking reform, and
steer clear of too many statistics--at least until the question and
answer period. While the body of literature on deposit insurance is
vast, I would note that there appears to be more consensus than
disagreement on potential reforms.
At today's hearing, industry will respond to the FDIC's
recommendations for comprehensive reform of the Federal Deposit
Insurance System. The FDIC, in my view, has identified some significant
weaknesses in the current system.
In particular, it is hard to argue with the FDIC's observation that
the current system is procyclical: that is, in good times, when the
funds are above the designated reserve ratio of 1.25 percent, 92
percent of the industry pays nothing for coverage; but in bad times,
institutions could be hit with potentially crushing premiums of up to
23 basis points. I think most industry members agree that this so-
called ``hard target'' presents a real threat to their businesses.
Of course, this means that any movement in the funds down toward
1.25 increases the anxiety level of bankers and regulators alike,
whether that movement comes from fast growth of certain institutions,
or from institutional failures like we saw last Friday in the case of
Superior Bank of Illinois. The numbers are still preliminary, but cost
estimates of the failure start at $500 million, which could reduce the
SAIF ration by seven basis points. I say this not to be alarmist. But I
would urge caution against becoming complacent in good times, and
resisting changes that simply make sense over the long term and have
the potential to enhance the stability of our system.
I am particularly interested in hearing from the witnesses about
their positions on premiums. I would note that there is unanimity among
the Federal banking regulators that institutions should pay regular
deposit insurance premiums, though not with respect to how we should
determine those premiums.
Now, I understand that 92 percent of the industry is free from
current premium payments, and it certainly presents an interesting
psychological and political challenge to persuade folks to pay for
something they currently get for free. On the other hand, I am not the
first to note that very few things in life are, in fact, free. If you
are getting something of value, eventually you have to pay for it. The
question is not whether you will have to pay up; it is when and how
much.
I am also interested in hearing comments about the erosion in value
of deposit insurance. My position is well known: I believe we need to
increase, and index, coverage levels. Over the last 20 years, coverage
values have decreased by more than half, and previous increases were
unpredictable both in terms of amount and timing. I expect to hear a
spirited debate on this topic, and believe it should be included in any
discussion of comprehensive reform.
I would urge everyone involved in this debate to take a step back
and recognize that when we talk about deposit insurance, we are talking
about the foundation of our financial system. It is simply
irresponsible to take a short-term approach, or to politicize the
issues. And while I am open to persuasion on just about any component
of reform, I am firm in my belief that we all share the common goal of
a safe and sound banking system.
As many of you know, I am committed to ensuring that our small
banks and thrifts--which play such an important role in States like
South Dakota--have the tools they need to survive. I am also well aware
of the value that our larger banks, thrifts and bank holding companies
bring to this country. I believe my strong support of financial
modernization speaks for itself, and would simply add that I am
committed to finding a reform package that considers the needs and
interests of all members of our financial services community.
Now some might argue that it will be impossible to craft changes to
our deposit insurance system that will bring all the interested parties
together. I reject this argument. First, every single bank and thrift
in this country benefits from our world-class deposit insurance system,
and it is in everyone's interest to find an acceptable set of changes.
Second, I believe that our witnesses will tell us that the industry is,
in fact, close together on many of the core reform issues. Finally, the
regulators themselves have said they are approaching consensus on many
issues. I am optimistic that we will be able to develop a sound
comprehensive reform policy.
I would like to hear what my colleagues and our witnesses have to
say, and would invite Ranking Member Bennett to make an opening
statement.
----------
PREPARED STATEMENT OF SENATOR PAUL S. SARBANES
I thank Senator Johnson, Chairman of the Financial Institutions
Subcommittee, for holding this morning's hearing on the important
subject of possible Federal Deposit Insurance System reform. Any reform
effort will demand a thorough analysis of the issues and today's
hearing contributes to that effort.
On April 5, 2001, the FDIC published a report on reforming the
deposit insurance system. The FDIC recommended:
Merging the Bank Insurance Fund (BIF) and Savings Association
Insurance Fund (SAIF) to reduce risk.
Charging insurance premiums based on an institution's risk to
its insurance fund, or ``risk-based premiums.''
Shifting from a fixed reserve ratio of 1.25 percent of insured
deposits to a target range of reserve ratios to give FDIC
flexibility and to eliminate sharp swings in insurance premiums.
Rebating premiums based on an institution's historical
contributions to an insurance fund when the fund grows above a
target level.
Indexing deposit insurance coverage levels by the amount of
inflation.
Last week, the Treasury Department, Federal Reserve Board,
Comptroller of the Currency, and the Office of Thrift Supervision
announced their views on the FDIC's recommendations. They all supported
merging the funds. They also supported the concept of giving the FDIC
greater flexibility to allow a range of reserve ratios. The Treasury
Department, Fed, and Comptroller did not support raising the amount of
Federal deposit insurance coverage.
Today's hearing is particularly timely in light of last Friday's
failure of a major thrift, Superior Bank, FSB, of Illinois. The failed
institution is projected to be the 11th most costly loss to the
insurance fund in U.S. history. Reports suggest that the failure may
cost the SAIF $500 million. In addition, customers with uninsured
deposits may lose over $40 million.
I am very concerned about this failure and have taken steps to
inquire into its causes. I have sent letters to the Comptroller General
of the United States, Inspector General of the Treasury Department,
which has authority over the Office of Thrift Supervision, and the
Inspector General of the FDIC and asked them to report on the reasons
for the failure with recommendations for preventing future losses. I
look forward to their responses.
I look forward to hearing the testimony from representatives of the
banking and the thrift industries on their views of the deposit
insurance system and the FDIC's recommendations.
----------
PREPARED STATEMENT OF SENATOR JACK REED
First of all, I want to commend Senator Johnson for holding this
hearing. This is a very timely issue now, particularly with the House
Financial Services Committee already holding several hearings on the
subject. I am pleased that the Senate Banking Committee, within the
appropriate Subcommittee, now has an opportunity to discuss the issue
from our own perspective. I also understand from Senator Johnson that
he intends to hold several hearings on this topic once Congress has
returned from the August recess.
Second, I want to thank all of the witnesses who are appearing
before us this morning. I know that this is an important issue to all
of you, and for those that you represent, so we are appreciative of
your time and work in this effort, in order to better explain your
positions to us at this time.
Third, I want to just briefly speak of my feelings toward deposit
insurance reform, and the importance I believe it holds in the context
of this Committee's attention, and possible future action.
The FDIC's Options Paper that it produced in April provides much
sound advice on how Congress should proceed with reforming our deposit
insurance system. Most importantly I think, it needs to be done sooner
rather than later, and I certainly commend former FDIC Chairwoman Donna
Tanoue for having the foresight to work on this issue and produce such
a worthy product for discussion.
It has been said many times before by others, including the
distinguished Chairman of the Subcommittee, that the current system is
procyclical and will harm the banks it seeks to assist by charging
higher premiums during more difficult economic times. Therefore, it
seems to behoove us to work together to enact a system that will have
the opposite effect. In other words, we should change the system now
during strong and healthy economic times, by potentially charging
minimal premiums to institutions, based on their risk of course, and
lessening the burden in the leaner years.
Obviously, there are many complicated issues inherent in taking on
a matter as complex as our deposit insurance system, and there are many
different sides to the issue as well. That is why I am pleased that we
are able to hear today from the major banking trade associations, and
that we will hear from other interested parties in the weeks to come. I
also look forward to working with Senator Johnson and others on the
Committee on deposit insurance reform legislation in the near future.
We have a long road and task ahead of us, but I am confident that we
will produce thoughtful and comprehensive legislation at the end of the
day.
Thank you, Mr. Chairman.
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PREPARED STATEMENT OF SENATOR WAYNE ALLARD
I want to thank Subcommittee Chairman Tim Johnson for holding this
important hearing. I am a cosponsor of his legislation to index deposit
insurance and I look forward to working on this and on the broader
issue of deposit insurance reform. I think we have some excellent
witnesses here today and I am looking forward to their testimony.
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PREPARED STATEMENT OF ROBERT I. GULLEDGE
Chairman, President & Chief Executive Officer
Citizens Bank, Inc., Robertsdale, Alabama
Chairman of the Independent Community Bankers of America
on behalf of the
Independent Community Bankers of America
August 2, 2001
Good morning, Chairman Johnson, Ranking Member Bennett, and Members
of the Subcommittee. My name is Robert I. Gulledge, and I am Chairman,
President, and CEO of Citizens Bank, a community bank with $75 million
in assets, located in Robertsdale, Alabama. I also serve as Chairman of
the Independent Community Bankers of America (ICBA) \1\ on whose behalf
I appear today. Thank you for this opportunity to testify on the very
important issue of deposit insurance reform.
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\1\ ICBA is the primary voice for the Nation's community banks,
representing 5,000 institutions at nearly 17,000 locations nationwide.
Community banks are independently owned and operated and are
characterized by attention to customer service, lower fees and small
business, agricultural and consumer lending. ICBA's members hold more
than $486 billion in insured deposits, $592 billion in assets and more
than $355 billion in loans for consumers, small businesses, and farms.
They employ nearly 239,000 citizens in the communities they serve. For
more information, visit www.icba.org.
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I want to commend you, Chairman Johnson, for scheduling this
hearing and giving this matter priority attention. Deposit insurance is
of enormous importance to community banks and their customers--and to
the safety and the soundness of our financial system.
Few would dispute that Federal deposit insurance has been an
enormously successful program, enhancing financial and macroeconomic
stability by providing the foundation for public confidence in our
banking and financial system. It has done what it was established to
do--it has prevented bank runs and panics, and reduced the number of
bank failures. Even at the height of the S&L crisis, there was no panic
or loss of confidence in our financial system. The financial system and
our economy are stronger and less volatile because of Federal deposit
insurance.
But it has now been more than 10 years since the last systematic
Congressional review of our deposit insurance system, and it should be
modernized and strengthened. In the past two decades since deposit
insurance levels were last increased, inflation has ravaged the value
of this coverage. Inflation has eroded the real level of deposit
insurance coverage to less than half what it was in 1980. The less
deposit insurance is really worth due to inflation erosion, the less
confidence Americans will have in the protection of their money, and
the soundness of the financial system will be diminished. Rejecting an
inflation adjustment to deposit insurance levels, as the Federal
Reserve and Treasury Department did in testimony last week before a
Subcommittee of the House Financial Services Committee, is a
prescription for weakening a vital and successful U.S. Government
program.
The deposit insurance system currently remains strong, the industry
is strong and the overwhelming majority of institutions are healthy,
but as the FDIC states in its report ``Keeping the Promise:
Recommendations for Deposit Insurance Reform'' (FDIC Report), there are
emerging problems and room for improvement.
Now while we can do it in a noncrisis atmosphere, is the time to
consider comprehensive improvements to enhance the safety and the
soundness of our Federal Deposit Insurance System and ensure that the
effectiveness of this key element of the safety net is not undermined.
Emerging Issues
The major deposit insurance reform issues that have emerged and
should be addressed in a comprehensive legislative package include:
Preserving the value of FDIC protection and coverage for the
future by substantially increasing coverage levels and indexing
these new base levels for inflation.
Establishing a pricing structure so that rapidly growing
``free-riders'' pay their fair share into the deposit insurance
funds (these free-riders like Merrill Lynch and Salomon Smith
Barney have also used multiple charters to offer coverage levels
well beyond the reach of community banks).
Smoothing out premiums to avoid wild swings caused by the hard
target reserve ratio (so banks do not pay unreasonably high
premiums when they and the economy can least afford it).
Providing appropriate rebates of excess fund reserves.
These issues, plus others addressed in the FDIC Report, are
discussed below.
Deposit Insurance Coverage Has Been Eroded By Inflation and Should
Be Increased and Indexed for Inflation to Maintain Its Real Value
For community bankers, the issue of increased deposit insurance
coverage has been front and center in the deposit insurance reform
debate. More coverage would benefit their communities, and their
consumer and small business customers. It would help address the
funding challenges and competitive inequities faced by community banks
and ensure that they have lendable funds to support credit needs and
economic development in their communities. For community bankers, any
reform package will fall far short if it does not include a substantial
increase in coverage levels and indexation.
The ICBA strongly supports legislation introduced by Chairman
Johnson and Representative Joel Hefley (R-CO) to raise Federal deposit
insurance coverage levels. Both bills (S. 128 and H.R. 746) would
increase FDIC coverage levels to around $200,000 and provide for
automatic inflation adjustments (based on an IRS index) every 3 years
rounded up to the nearest thousand dollars. Both bills have garnered
substantial bipartisan support. Thirteen Senators are on the Johnson
bill, 7 Democrats and 6 Republicans. Sixty-six Representatives have
signed onto the Hefley bill, including 28 Democrats, 37 Republicans,
and one Independent.
Coverage Levels Ravaged By Inflation
The general level of income, prices, and wealth in the United
States has been steadily increasing for decades. As a consequence,
inflation is severely eroding the value of FDIC protection. The current
deposit insurance limit is economically inadequate and unacceptable for
today's savings needs, particularly growing retirement savings needs as
the baby-boomer generation reaches retirement age.
The real value of $100,000 coverage is only about half what it was
in 1980 when it was last increased. Chart 1, which is attached, shows
that simply adjusting for inflation, the $100,000 limit set in 1980
represents only $46,564 in coverage today. Worse yet, as Table 1 shows,
today's deposit insurance limit in real terms is worth $20,000 less
than it was in 1974 when the deposit insurance limit was doubled to
$40,000.
Looked at another way, in 1934, when Federal deposit insurance was
established, the coverage level was 10 times per capita annual income.
Today, it is only four times per capita income. During the last two
decades, while deposit insurance levels remained unchanged, financial
asset holdings of American households have quadrupled, from $6.6
trillion in 1980 to $30 trillion in 1999.
Deposit insurance coverage levels have been increased six times
since the program was created in 1934. But the increases have been made
on an ad hoc basis with no predictability either on timing or the size
of the increase. We need to first adjust coverage levels not touched in
20 years and move away from ad hoc increases to a system that is
predictable and grows automatically with inflation.
The ICBA strongly supports the FDIC proposal to increase coverage
levels to make up for inflation's devaluing effects by automatically
adjusting the levels based on the Consumer Price Index. Using 1980 as
the base year would raise coverage levels to nearly $200,000 (see Chart
2 attached); using 1974 as the base year--the year coverage levels were
raised to $40,000 --and would boost coverage to around $137,000 today.
Gallup Poll Shows Consumers Want Increase
A recent survey conducted by The Gallup Organization \2\ on behalf
of the FDIC revealed that Federal deposit insurance coverage is a
``significant factor'' in investment decisions, especially to more
risk-averse consumers and those making decisions in older and less
affluent households. Fifty-seven percent of respondents said deposit
insurance is ``very important'' in determining where to invest.
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\2\ The Gallup Organization conducted telephone interviews with a
randomly selected, representative sample of 1,658 adults who identified
themselves as the people most knowledgeable about household finances
age 18 or older, living in households with telephone service in the
continental United States. The interview period ran from November 20 to
December 23, 2000. The margin of error is plus or minus 3 percent.
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Six in ten respondents said they would be likely to put more of
their household's money into insured bank deposits if the coverage
level of deposit insurance were raised. Six in ten said they would move
their money into insured accounts as they neared retirement age or
during a recession. The survey also showed that one in eight households
keep more than $100,000 in the bank, and about one-third of all
households reported having more than $100,000 in the bank at one time
or another.
Importantly, the Gallup survey indicated that nearly four out of
five (77 percent) respondents thought deposit insurance coverage should
keep pace with inflation.
Small Business Customers Support Increase
Small businesses are key customers of the community banks, which in
turn are premier providers of credit to these businesses. A recent
study commissioned by the American Bankers Association (ABA) \3\ found
that half of small business owners think the current level of deposit
insurance coverage is too low. When asked what actions they would take
if coverage were doubled, 42 percent said they would consolidate
accounts now held in more than one bank; 25 percent would move money to
smaller banks; and 27 percent would move money from other investments
into banks.
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\3\ ``Increasing Deposit Insurance Coverage: Implications for the
Federal Insurance Funds and for Bank Deposit Balances,'' Mark J.
Flannery, December 2000 (study was commissioned by the ABA).
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Consumers and small businesses should not be forced to spread their
money around to many banks to get the coverage they deserve. As more
and more institutions base pricing on the entire customer relationship,
consolidating accounts enables customers to reap the benefits of
pricing and convenience when holding more of their financial ``wallet''
at one institution. For small businesses, especially, aggregating their
business with one bank can enhance their banking relationship. And
equally important, customers should be able to support their local
banks, and local economies, with their deposits.
Increased Deposit Insurance Will Help Support Local Lending
An adequate level of deposit insurance coverage is vital to
community banks' ability to attract core deposits, the funding source
for their community lending activities. Many community banks face
growing liquidity problems and funding pressures. It is hard to keep up
with loan demand as community banks lose deposits to mutual funds,
brokerage accounts, the equities markets, and ``too-big-to-fail''
banks.
Deposit gathering is critical to community banks' ability to lend
because alternative funding sources are scarce. Due to their small
size, unlike large banks, community banks have limited access to the
capital markets for alternative sources of funding. As a consequence,
community banks must rely more heavily on core deposit funding than
large banks. To illustrate, at year end 1998, core deposits represented
72 percent of assets for banks of less than $1 billion in size, and
only 43 percent of assets for banks over $1 billion.
The Federal Reserve's recent observation that small banks have
enjoyed higher rates of asset growth and uninsured deposit growth than
large banks misses the point. Since 1992, deposit growth has lagged the
growth in bank loans by about half--hence small banks are finding it
harder to meet loan demand that supports economic growth. Average loan-
to-deposit ratios are at historical highs and the ratio of core
deposits to assets is declining as community banks fund a growing share
of their assets with noncore liabilities such as Federal Home Loan Bank
advances and other more volatile, less stable sources of funds such as
brokered deposits. Federal Home Loan Bank advances are not a substitute
for deposits. Bankers must pay higher rates for advances and other
nontraditional funding than they do for deposits, putting pressure on
net interest margins. Examiners are warning community banks against
over-reliance on FHLB advances and other noncore funding sources.
Some banks have seen a surge in deposit activity during the last
two reported quarters. The instability of the stock market has caused
some weary investors to pull out of the equities market and return to
the safety and stability of banks. But most observers believe this is
an aberration that may not continue when the market turns back up.
Moreover, this phenomenon provides deposits to banks in a down economy
when loan demand is weakened; it does not help address the need for
funding when loan demand is strong.
Large complex banking organizations (LCBO's) are acknowledged as
presenting greater systemic risk to our financial system.\4\ The
systemic risk exception to the least cost resolution requirement in
FDICIA has never been tested. It is our belief, based on the historical
record that LCBO's will never be allowed to fail because of this
systemic risk factor. Government policy has fostered the establishment
of ever-larger financial institutions further concentrating our
financial system. Uninsured depositors in such institutions benefit
from too-big-to-fail.\5\
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\4\ In a speech before the National Bureau of Economic Research
Conference on January 14, 2000, Federal Reserve Board Governor Laurence
H. Meyer said, ``. . . the growing scale and complexity of our largest
banking organizations . . . raises as never before the potential for
systemic risk from a significant disruption in, let alone failure of,
one of these institutions.''
\5\ Thomas M. Hoenig, President of the Federal Reserve Bank of
Kansas City, noted in a speech on March 25, 1999, ``To the extent that
very large banks are perceived to receive governmental protection not
available to other banks, they will have an advantage in attracting
depositors, other customers and investors. This advantage could
threaten the viability of smaller banks and distort the allocation of
credit.''
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The Federal Reserve spokesmen reject the notion that any bank is
too-big-to-fail. The historical record, however, is to the contrary.
Notably, the Secretary of the Treasury--not the Federal Reserve--has
authority under FDICIA to make systemic risk determinations (after
consultation with the President).
In our judgment, the issue is not that FDICIA does not require that
uninsured depositors and other creditors be made whole, as the Federal
Reserve testified last week, but rather that the determination of
systemic risk does permit all uninsured depositors to be made whole--as
they have been made whole during previous banking crises.
Increasing deposit insurance coverage would help level the playing
field for community banks with large banks and large securities firms
offering FDIC-insured products, while protecting the funding needs of
Main Street America.
According to Grant Thornton's ``Eighth Annual Survey of Community
Bank Executives,'' \6\ 77 percent of community bankers favor raising
the insurance coverage from its current level of $100,000 in order to
make it easier to attract and retain core deposits.
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\6\ ``The Changing Community of Banking,'' 2000 Seventh Annual
Survey of Community Bank Executives, published by Grant Thornton LLP,
March 2001.
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Full Coverage for Public Deposits
The ICBA also supports full deposit insurance coverage for public
deposits. Most States require banks to collateralize public deposits by
pledging low-risk securities to protect the portion of public deposits
not insured by the FDIC. This makes it harder for community banks to
compete for these deposits with larger banks. Many community banks are
so loaned-up that they do not have the available securities to use as
collateral. And those that do have to tie up assets in lower yielding
securities which could affect their profitability and their ability to
compete. In addition, collateralizing public deposits takes valuable
resources away from other community development and lending activities.
As the FDIC noted in its report, ``Raising the coverage level on
public deposits could provide banks with more latitude to invest in
other assets, including loans. Higher coverage levels might also help
community banks compete for public deposits and reduce administrative
costs associated with securing these deposits.''
Providing 100 percent coverage for public deposits would free up
the investment securities used as collateral, enable community banks to
offer a more competitive rate of interest in order to attract public
deposits, and enable local governmental units to keep deposits in their
local banks as a valuable source of funding that can be used for
community lending purposes.
ICBA strongly supports legislation, S. 227 and H.R. 1899,
introduced by Senator Robert Torricelli (D-NJ) and Representative Paul
Gillmor (R-OH) respectively, to provide 100 percent coverage of public
deposits.
Full Coverage for IRA's and Retirement Accounts
Today's retirement savings needs require a deposit insurance limit
higher than $100,000. Retirement accounts are long-term investments
that over time can reach relatively large balances that exceed the FDIC
coverage limit. Today, accumulating $100,000 in savings for education,
retirement, or long-term care needs is not a benchmark of the wealthy.
With the graying of the population, safe savings opportunities are
needed more than ever and an insured savings option is becoming even
more crucial now that budget surpluses are reducing the supply of
Treasury securities. Thus, raising the coverage level on IRA's and
other long-term savings accounts could encourage depositors to invest
more of these savings in insured bank deposits.
FDICIA Reforms Minimize Taxpayer Exposure
Critics of proposals to substantially increase and index coverage
levels contend that the 1980 increase to $100,000 was unjustified and
increased the resolution costs of the S&L crisis. Overlooked, perhaps,
is the fact that the Federal Reserve Board advocated this increase at
the very time its monetary policies were driving the prime rate over 20
percent to wring inflation out of the economy and Congress passed
legislation deregulating interest paid on deposits. Also overlooked is
the fact that the new $100,000 coverage limit helped stem depositor
panic as thousands of the thrifts holding long-term, fixed-rate loans
failed from the resulting severe asset liability mismatch.
Higher coverage limits will not necessarily increase exposure to
the FDIC or taxpayers as some fear. A variety of factors serve to
minimize any increase in exposure to the FDIC or taxpayers from bank
failure losses due to an increase in deposit insurance coverage levels.
The reforms in bank failure resolutions instituted by the Federal
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)--
including prompt corrective action, least cost resolution, depositor
preference, and a special assessment when a systemic risk determination
is made--are designed to reduce losses to the FDIC.
Prompt corrective action helps ensure that swift regulatory action
when a bank becomes critically undercapitalized so that losses do not
increase while the bank's condition further deteriorates. Least cost
resolution requires that--except in the case where the systemic risk
exception is invoked--the FDIC uses the least costly method when a bank
fails to meet its obligations to pay insured depositors only. And
depositor preference minimizes the FDIC's losses by requiring that
assets of the failed institution are first used to pay depositors,
including the FDIC standing in the shoes of insured depositors, before
other unsecured creditors are paid. And when a systemic risk
determination is made, the FDIC must charge all banks an emergency
special assessment to repay the agency's costs for the rescue.
It is ironic indeed to hear policymakers talk about the moral
hazard of increasing deposit insurance coverage to account for
inflation when the trend of greater and greater deposit concentration
in fewer and fewer banks that are likely too-big-to-fail because of
systemic risk continues.\7\ The moral hazard, if any, created by
inflation-indexing coverage pales in comparison to that presented by
the increased number of LCBO's whose failure could have serious adverse
effects and thus trigger the systemic risk exception of FDICIA.
Systemic risk presents much greater loss exposure to the FDIC, and
ultimately taxpayers, than does an increase in the coverage limit.
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\7\ In 1980, 14,000 banks with less than $500 million in assets
accounted for about 50 percent of total core deposits, and 11 banks
with more than $20 billion in assets accounted for 15 percent of core
deposits. By 1999, 7,800 banks with less than $500 million in assets
accounted for only 20 percent of core deposits and 46 banks with more
than $20 billion in assets accounted for 50 percent of core deposits.
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``Free Riders'' Must Pay Their Fair Share
Currently, the FDIC is restricted from charging premiums to well-
capitalized, highly rated banks so long as the reserve level remains
above the 1.25 percent designated reserve ratio. As a result, 92
percent of the industry currently does not pay premiums, rapidly
growing institutions do not pay their fair share for deposit insurance
coverage, and the more than 900 banks that were chartered within the
last 5 years have never paid premiums. According to the FDIC, this
system underprices risk and does not adequately differentiate among
banks according to risk.
By the end of the first quarter of 2001, Merrill Lynch and Salomon
Smith Barney had moved a total of $83 billion in deposits under the
FDIC-BIF umbrella through two banks that Merrill owns and six banks
affiliated with Salomon Smith Barney, without paying a penny in deposit
insurance premiums. This dilutes the FDIC-BIF's reserve ratio, which is
already lagging behind the FDIC-SAIF's, which doesn't face a similar
inflow problem. Every $100 billion of insured deposit inflows drops the
reserve ratio of the FDIC-BIF--which stood at 1.32 percent on March 31,
2001 (down from 1.35 percent on December 31, 2000)--about six basis
points.
Once the 1.25 percent reserve ratio is breached, FDIC is required
by law to assess all banks a minimum average of 23 cents in premiums
unless a lower premium would recapitalize the fund within 1 year. How
long it will be before the 1.25 percent designated reserve ratio is
breached and premiums are triggered for all banks is not known. But
today, past assessments on banks are subsidizing the insurance coverage
for Merrill Lynch and Salomon Smith Barney! This inequitable situation
must be remedied.
Because Merrill Lynch and Salomon Smith Barney own multiple banks,
they can offer their customers more than $100,000 in insurance
coverage. Merrill with two banks can offer $200,000 in FDIC coverage,
and Salomon Smith Barney is offering each of its customers $600,000 in
FDIC protection. This could have a significant negative impact on the
funding base of community banks. Most community banks cannot offer
their customers more than $100,000 in deposit insurance coverage in
this manner. Additionally, these huge institutions are too-big-to-fail,
giving them another advantage over community banks in gathering
deposits.
If the FDIC were able to charge premiums to all banks, even when
the reserve level is above 1.25 percent, it could collect premiums from
Merrill Lynch and Salomon Smith Barney as they move deposits under the
insurance umbrella. As it now stands, the FDIC is prohibited from
charging them anything. Furthermore, if rapidly growing banks grew at a
particularly fast rate, posing a greater risk, they could be charged
premiums at a higher rate.
Regular Premiums
The FDIC, Federal Reserve and Treasury have all recommended that
the current statutory restriction on the agency's ability to charge
risk-based premiums to all institutions be eliminated, and that the
FDIC be allowed to charge premiums, even when the fund is above the
1.25 percent designated reserve ratio.
The recommendation to charge premiums to all banks, even when the
fund is fully capitalized, faces controversy in the industry. However,
we believe that in a carefully constructed, integrated reform package
which includes substantial increases in deposit insurance coverage
levels, bankers would be willing to pay a small, steady premium in
exchange for increased coverage levels and less volatility in premiums.
With a small, steady premium, bankers will be better able to budget for
insurance premiums and avoid being hit with an unexpectedly high
premium assessment during a downturn in the business cycle. Also the
premium swings will be less volatile and more predictable. It is also
one way to extract some level of premiums from the free riders and
reduce the dilution of the reserve ratio.
Risk-Based Premium System Should Set Pricing Fairly
The current method of determining a bank's risk category for
premiums looks at two criteria--capital levels and supervisory ratings.
The FDIC argues that this risk-weighting system is inadequate since it
allows 92 percent of all banks to escape paying premiums when the fund
is fully capitalized. The FDIC says that it cannot price risk
appropriately under this method.
The FDIC has proposed a sample ``scorecard'' to charge premiums
based on a bank's risk profile. The FDIC is quick to point out that
this example is not etched in stone, and the factors to be used to
stratify banks by risk deserves more analysis and discussion. But the
model can be used as a starting point.
The FDIC proposes to disaggregate the highest-rated category of
banks that currently do not pay insurance premiums (92 percent) into
three separate risk categories based on a scorecard using examination
ratings, financial ratios and, for large banks, possibly certain market
signals as inputs to assess risk.
Under this system, three premium subgroups would be created-- 42.7
percent of the currently highest-rated institutions would pay a 1 cent
premium, 26.5 percent would pay 3 cents, while another 23 percent would
pay a 6 cent premium. The 8 percent of institutions that are currently
charged premiums under the current system would fall into higher-risk
categories and pay premiums ranging from 12 to 40 cents, as contrasted
to the 3 to 27 cents they pay now. Under this example, the FDIC would
collect $1.4 billion in annual premiums for an industry average of 3.5
cents.
The Treasury Department and the OCC have cautioned against making
the risk-based premium structure unduly complex at this time, both in
terms of assigning banks to risk categories and in setting premium
rates for the various categories.
The ICBA and community bankers generally support a risk-based
premium system. However, we believe more study is needed to determine
the appropriate risk factors, risk weighting, and complexity to be used
in the matrix. Reaching consensus on the factors to be used to stratify
banks into risk categories and the premiums to be charged in the
various categories will take more thought and discussion.
We are concerned that under the FDIC proposal, nearly 50 percent of
banks that do not pay insurance premiums now would be paying either a 3
or 6 cent premium (before rebates) during good times. We are also
concerned about charging unduly punitive premiums against weak
institutions. We are concerned as well that this system could create a
reverse-moral hazard by encouraging banks to squeeze risk out of their
operations and in the process reduce the amount of lending they do in
their communities. Banking is not a risk-free enterprise.
We do recommend, however, that while it would be appropriate for
Congress to establish parameters or guidelines for the risk-based
premium structure, the details of the structure should be set by the
FDIC through the rulemaking process with notice and comment from the
public. The FDIC is in a better position to judge the relative health
of the insurance funds and the industry and can react more quickly to
make changes in the premium structure as necessary.
Assessment Base
The Treasury Department has recommended that deposit insurance
reform consider whether the existing assessment base, which is domestic
deposits, be modified to account for the effect of a bank's liability
structure on the FDIC's expected losses. The Treasury notes that in the
event of bank failure, secured liabilities including Federal Home Loan
Bank advances have a higher claim than domestic deposits on bank
assets, and may increase the FDIC's loss exposure.
If consideration is to be given to changing the assessment base at
this time, then Congress should look beyond assessing deposits and
secured liabilities, which discriminates against community banks, and
consider all liabilities (excluding capital and subordinated debt). For
years, community banks have paid assessments on close to 90 percent of
their liabilities, since domestic deposits are their primary funding
source, while the largest banks--the too-big-to-fail banks--pay on less
than 40 percent of liabilities since their funding comes in large part
from nondeposit liabilities. Experience has shown that all nonassessed
liabilities, not just deposits and secured liabilities, have funded
excess growth and troubled loans of banks that subsequently failed. If
the assessment base were to be expanded, it must be done so equitably.
Premiums Should Be Smoothed Out and Volatility Reduced
The current statutory requirement of managing the funds to the hard
1.25 percent DRR can lead to volatile premiums with wide swings in
assessments. As noted above, under the current system, well-capitalized
and well-run banks cannot be charged premiums so long as the reserve
ratio is above the DRR of 1.25 percent. However, when the reserve level
falls below 1.25 percent, the law requires the FDIC to charge an
average of 23 cents in premiums unless the fund can be recapitalized at
a lower premium in 1 year.
This means there could be substantial fluctuations in premium
assessments, depending on the extent of bank failure losses. The
current system is dangerously procyclical with premiums the highest
when banks and the economy can least afford it. Premiums could rise
rapidly to 23 cents when economic conditions deteriorate, potentially
exacerbating the economic downturn, precipitating additional bank
failures and reducing credit availability by removing lendable funds
from banks.
The FDIC, Federal Reserve, and Treasury Department all recommend
that the 1.25 percent hard target be eliminated, and the reserve ratio
be allowed to fluctuate within a given range. The FDIC argues that the
deposit insurance system should work to smooth economic cycles, not
exacerbate them. For example, maintaining the current DRR of 1.25
percent as a target, the reserve ratio could be allowed to fluctuate
between 1.15 percent and 1.35 percent. Regular risk-based premiums
would be charged so long as the ratio is within that range.
However, in years when the ratio is below 1.15 percent, the FDIC
suggests a ``surcharge,'' for example, equal to 30 percent of the
difference between the reserve ratio and 1.15 percent. Alternatively,
in years when the ratio is above 1.35 percent, there would be a rebate
equal to 30 percent of the difference between the reserve level and
1.35 percent. This would ensure that premiums rise and fall more
gradually than under the current system.
The ICBA supports eliminating the hard 1.25 percent DRR and
instituting a range within which the funds can fluctuate without
penalty or reward as part of a comprehensive reform package. Under the
current system, banks could be faced with steep deposit insurance
payments when earnings are already depressed. Such premiums would
divert billions of dollars from the banking system and raise the cost
of gathering deposits at a time when credit is already tight. This in
turn could cause a further cutback in credit, resulting in a further
slowdown of economic activity at precisely the wrong time in the
business cycle. The agency says it would be preferable for the fund to
absorb some losses and for premiums to adjust gradually, both up and
down, around a target range.
The FDIC also makes a strong case for maintaining 1.25 percent as
the mid-point of such a range. The FDIC report showed that under
various loss scenarios (no loss, moderate loss, and heavy loss), the
fund never drops below .80 percent and it never goes above 1.5 percent.
Gradual surcharges and gradual rebates help to keep the fund within
this range.
Rebates
Pricing and rebates go hand-in-hand. If premiums are charged to all
institutions regardless of the fund's size, rebates represent a
critical safety valve to prevent the fund from growing too large. The
FDIC notes that in the best years, the rebate could result in a bank
receiving a net payment from the FDIC. In an economy as relatively
strong as we have today, more than 40 percent of banks would receive a
net rebate.
Importantly, under the FDIC proposal, the rebates would be based on
past contributions to the insurance fund, and not on the current
assessment base. This would have two advantages. It would not create a
moral hazard that would encourage banks to grow just to get a higher
rebate. And it would not unjustly enrich companies like Merrill Lynch
and Salomon Smith Barney, which have transferred large deposits under
the insurance umbrella without paying any premiums.
We very strongly support this recommendation on rebates. It is only
fair to those institutions that have paid into the insurance fund for
years. And it would prevent free riders like Merrill Lynch and Salomon
Smith Barney from earning rebates on premiums they never paid.
Merge the BIF and SAIF As Part of the Comprehensive Reform Plan
Historically, banks and thrifts have had their own insurance funds.
The BIF and the SAIF offer identical products, but premiums are set
separately. Since the S&L crisis, when many banks acquired thrift
deposits, many institutions now hold both BIF- and SAIF-insured
deposits. More than 40 percent of SAIF-insured deposits are now held by
banks.
The FDIC, Federal Reserve, and Treasury Department all recommend
merging the BIF and the SAIF as part of a deposit insurance reform
package. They note that the lines between S&L's and banks have blurred
to the point where it is difficult to tell them apart. They argue that
merging the two funds would make the combined fund stronger, more
diversified, and better able to withstand industry downturns than two
separate reserve pools. The FDIC says costs also would go down since it
would not need to track separate funds.
The ICBA supports a merger of the BIF and the SAIF so long as it is
part of a comprehensive and integrated deposit insurance reform package
that includes an increase in coverage levels.
Conclusion
In summary, Mr. Chairman, the ICBA believes it is critical to
review the Federal Deposit Insurance System now in a noncrisis
atmosphere. An ongoing strong deposit insurance system is essential for
future public confidence in the banking system and to protect the
safety and soundness of our financial system. The effectiveness of this
key Government agency should not be permitted to be undermined or
eroded away by a failure to preserve the value of its protection.
Deposit insurance is critical to the thousands of communities
across America that depend on their local community bank for their
economic vitality. Without substantially increased deposit insurance
coverage levels indexed for inflation, community banks will find it
increasingly difficult to meet the credit needs of their communities
and compete fairly for funding against the too-big-to-fail institutions
and nonbank providers.
We believe that deposit insurance reform should be comprehensive.
The coverage levels should be raised and indexed for inflation. The
hard 1.25 percent designated reserve ratio should be scrapped in favor
of a flexible range. The statutory requirement that banks pay a 23 cent
premium when the fund drops below the DRR should be repealed. A pricing
structure that fairly evaluates the relative risks of individual banks
without undue complexity should be instituted. Full deposit insurance
coverage should be accorded to public deposits. And IRA's, education
savings and retirement accounts should be accorded higher coverage
levels. We urge Congress to adopt such an integrated reform package.
We commend you, Mr. Chairman, for moving the debate forward. The
ICBA pledges to work with you, the entire Committee, and our industry
partners, to craft a comprehensive and an integrated deposit insurance
reform bill that can work and can pass.
Thank you, Mr. Chairman, for the opportunity to express the views
of our Nation's community bankers.
PREPARED STATEMENT OF JEFF L. PLAGGE
President & Chief Executive Officer
First National Bank of Waverly, Iowa
on behalf of the
American Bankers Association
August 2, 2001
Mr. Chairman, I am Jeff L. Plagge, President and CEO of First
National Bank of Waverly, Waverly, Iowa, and a member of the Government
Relations Council of the American Bankers Association (ABA). I am
pleased to be here today on behalf of the ABA. ABA brings together all
elements of the banking community to best represent the interests of
this rapidly changing industry. Its membership--which includes
community, regional, and money center banks and holding companies, as
well as savings institutions, trust companies, and savings banks--makes
ABA the largest banking trade association in the country.
I would like to thank you, Mr. Chairman, for holding this hearing
to examine some key issues related to the Federal Deposit Insurance
Corporation (FDIC). We appreciate your long-held support of a strong
banking and financial system, and in particular, your concern for
community banks. We also greatly appreciate your leadership and your
openness to working with the banking industry to develop reforms that
enhance the deposit insurance system.
Assuring that the FDIC's deposit insurance funds remain strong is
of the utmost importance to the banking industry. Over the past decade,
commercial banks and savings associations have gone to extraordinary
lengths to rebuild the insurance funds, contributing $36.5 billion to
ensure that the insurance funds are well-capitalized. With the Bank
Insurance Fund (BIF) exceeding $31 billion and the Savings Association
Insurance Fund (SAIF) at nearly $11 billion as of March 2001--
representing over $42 billion in financial resources--it is safe to say
that FDIC is extraordinarily healthy.
The outlook is also excellent. There have been few failures, and
the interest income earned by BIF and SAIF (nearly $2.5 billion per
year) is roughly three times the FDIC's cost of operation. As the
current deposit growth rate moves back to the recent norm, as we expect
it will, this interest income will likely continue to move the reserve
ratio even further beyond the designated reserve ratio mandated by
Congress. Moreover, the banking industry is extremely well-capitalized,
adequately reserved for potential losses, and profitable.
With the deposit insurance funds so strong, now is an appropriate
time to consider how we might improve the overall system. To this end,
the ABA has held extensive discussions with commercial banks and
savings institutions, as well as with Members of Congress and their
staffs and the FDIC, in order to facilitate the development of an
approach that would both strengthen the system and be acceptable to a
broad range of parties.
Just this weekend, this issue was discussed in detail at ABA's
Summer Meeting, which brings together our Board, Government Relations
Council, the leadership of all the State Bankers Associations, and
others. This testimony reflects the conclusions reached during that
meeting.
The FDIC has done an excellent job developing an approach that
addresses many of the key issues. While we do not agree with everything
in the FDIC's April 2001 report--and are particularly concerned about
the possibility of increasing premiums--we believe it provides a basis
for serious discussion.
The ABA has stated for the past year and a half that a bill to
strengthen the FDIC is likely to be enacted only if an industry
consensus in support of such legislation can be developed. As you will
see, while some differences remain, the positions of the ABA, America's
Community Bankers, and The Independent Community Bankers of America are
very similar. Our three associations have agreed that we should discuss
the issues together on an ongoing basis and work together to develop
legislation that would have broad support.
I would add that while there is a general belief among most bankers
that we should work with Congress to strengthen the FDIC, there is also
deep concern that such legislation could evolve to increase banks'
costs or to become a vehicle for extraneous amendments. If that were to
be the case, we have no doubt that support would quickly dissipate and
turn to opposition. Indeed, our Summer Meeting discussion emphasized
that the ABA will have to oppose any FDIC reform legislation that
results in a increase in premiums when the insurance funds (or a merged
fund) are above the 1.25 percent designated reserve ratio, as they are
today. Fortunately, we also believe working together, we can see a
consensus bill develop that can have broad bipartisan support.
In my testimony today, I would like to make several key points:
Today's system is strong and effective, but some improvements
could be made. It is the position of the ABA that we have a
workable deposit insurance system that has the confidence of
depositors and banks. However, there are areas that can be
improved. Any reform should strengthen and improve the deposit
insurance system, enhance the safety and the soundness of the
banking system, and improve economic growth.
A comprehensive approach is required. Because deposit
insurance issues are intrinsically interwoven, any changes must
consider the overall system. We are pleased that all the issues we
believe should be considered are on the table now. We recognize
that any final bill may not cover in full all of the issues given
political realities, but the Congress is engaging in a thoughtful
comprehensive process, which we appreciate.
Changes should only be adopted if they do not create new costs
to the industry. The ABA will work to develop and support a
consensus position, but ABA will oppose deposit insurance
legislation that imposes new insurance costs or contains negative
add-on amendments not related to deposit insurance reform.
I would like to discuss these points more fully, and in the
process, discuss a few specific issues.
Today's System is Strong and Effective, But Improvements Could Be Made
For over 65 years, the deposit insurance system has assured
depositors that their money is safe in banks. The financial strength of
the FDIC funds is buttressed by strong laws and regulations including
prompt corrective action, least cost resolution, risk-based capital,
risk-based premiums, depositor preference, regular exams and audits,
enhanced enforcement powers and civil money penalties. Many of these
provisions were added in the Financial Institutions Reform, Recovery
and Enforcement Act of 1989 (FIRREA) and the FDIC Improvement Act of
1991 (FDICIA).\1\ Taken together, these provisions should reduce the
number of bank failures, lower the costs of those that do fail, and
ensure that the FDIC will be able to handle any contingency. Even more
important is that the banking industry has an unfailing obligation--to
meet the financial needs of the insurance fund.
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\1\ See Apprendix A for details of these significant safeguards
under current law that protect the FDIC funds.
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Simply put, the system we have today is strong, well-capitalized
and poised to handle any challenges that it may encounter for decades
to come. As with any system, there is room for improvement. We would
propose three litmus tests for any reform: (1) it should strengthen and
improve the deposit insurance system; (2) enhance the safety and
soundness of the banking system; and (3) improve economic growth.
A Comprehensive Approach is Required
The ABA firmly believes that any approach to reforming the FDIC
should be done in a comprehensive manner. Since last year, support for
a comprehensive approach has clearly grown. We are pleased that the
FDIC's proposal released in April 2001 is comprehensive and basically
has put most of the relevant issues on the table for discussion. In
this section of my testimony, I want to give you ABA's perspective on
what constitutes a comprehensive approach. Again, we recognize that any
final bill may not cover in full all of the issues discussed below, but
we respectfully suggest that all of them should be on the table.
Mutual Approach
The ABA believes consideration should be given to the concept of
including the current insurance program elements of a mutual approach
in which banks are provided with some type of ownership interest. Under
such an approach, dividends would be paid based on the ownership
interest. This approach will help address the issue of new and fast
growing institutions paying no premiums, since such institutions will
not have the same dividend stream. A great deal more work needs to be
done to develop a specific proposal. We believe, however, that when the
fund reaches a designated cap (discussed below), dividends should be
paid to banks and savings institutions based on a measure of their
historic payments to the FDIC. The FDIC says it can track such payments
and develop such a system. A dividend system based on previous
contributions is fair because it is the accumulated interest income on
those very contributions that boosted the fund beyond the cap. Thus,
this represents a return on the significant sacrifices that were made
to more than fully capitalize the insurance funds.
Deposit Insurance Limit
As ABA stated last year, the current $100,000 insurance limit--set
in 1980--has lost over half its value when adjusted for inflation. As a
consequence, it is more difficult, particularly for smaller
institutions, to raise sufficient amounts of funds to meet loan demand
in their communities. For many banks, a source of funding is the number
one issue. Recent increases in loan-to-deposit ratios demonstrate that
many community banks are searching for funds to support loan demand. In
discussing this issue, three items deserve consideration: (1) indexing
the insurance limit to account for inflation; (2) raising the insurance
limit above the current $100,000; and (3) providing additional coverage
to IRA's and other retirement accounts held at banks. Let me briefly
discuss each in turn.
Indexing
There is general, although not unanimous, support within the
banking industry for permanently indexing the level of deposit
insurance coverage. Under an indexing system, the insurance limit would
be automatically adjusted from time-to-time, based on changes in an
appropriate index. These changes should be in level increments--that
is, $5,000--to avoid consumer confusion. Without indexing, the
insurance level constantly falls behind inflation, as Congress cannot
be expected to regularly pass increases.
Base for Indexing
There has been a great deal of discussion within the banking
industry, as well as in the Congress and the regulatory agencies, about
the appropriate year to use as the base for beginning any inflation
adjustment. For example, as the FDIC has pointed out, if the base
chosen were 1980 (when the limit increased from $40,000 to $100,000),
the insurance level would be approximately $200,000 today to account
for inflation; if 1974 were chosen (when the limit was increased from
$20,000 to $40,000), the new limit would be approximately $140,000.
In discussions with bankers over the last year on this topic, two
questions have emerged about increasing the coverage level: (1) what
are the potential economic costs; and (2) how many new deposits might
flow into the banking system? To help answer these questions, ABA hired
Professor Mark Flannery of the University of Florida. Dr. Flannery's
study was extremely helpful in understanding the potential economic
benefits and costs of various increases in the deposit insurance level.
The study concluded--based on research conducted separately with
bankers, individuals, and small business owners--that doubling coverage
could result in net new deposits to the banking industry of between 4
percent and 13 percent of current domestic deposits, with the lower end
of the range more likely, in Flannery's opinion. Obviously, the amount
of any increase would vary among individual banks, depending on their
markets and business strategies. These hypothetical new deposits, plus
the added protection that existing deposits (between $100,000 and
$200,000) would receive, would lower the BIF-SAIF reserve ratio below
the required 1.25 percent. This would eliminate the $3.2 billion
cushion that exists today and would, under current law, require a 3-13
basis point assessment on all domestic deposits to return the ratio to
1.25 percent.\2\
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\2\ The full study is available at aba.com.
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This study--the first attempt to assign real numbers to a
complicated and theoretical concept--stimulated considerable discussion
in the banking industry. Several points of view emerged: First, there
are many bankers who strongly believe a significant increase to
$200,000 is important to improve their access to funding and that the
benefit would exceed the potential cost. Second, there are also many
bankers who are very concerned about the loss of the current buffer
above the 1.25 percent reserve ratio and the potential for premium
increases that would accompany a significant increase of the insurance
limit. Third, there are bankers who expressed concerns about the
acceptability of such an increase to Members of Congress, the Treasury,
the Federal Reserve, and others.
While there are differences of opinions in the industry, we believe
that Congress should consider an increase in the current limit to the
maximum possible that can be achieved without incurring significant
costs that would outweigh the value of the increase. We appreciate your
efforts, Mr. Chairman, to focus on this issue and the importance of
attracting additional deposits into the banking industry to meet the
credit needs of our communities. Of course, the bottom line is that we
need to develop a comprehensive bill that addresses the key issues
outlined in this statement that can also be enacted. We recognize that
this is a controversial issue and therefore want to work with you to
see what approach can be developed that can have the support necessary
to be enacted.
Retirement Savings
The ABA believes Congress should also consider the possibility of a
higher level of insurance for long-term savings vehicles, such as
IRA's, Keoghs, and any future private Social Security accounts if
enacted. These are long-term investments that tend to grow considerably
over time, frequently exceeding the current $100,000 limit. For
example, at an interest rate of 6 percent, even an annual deposit of
$2,000 in an IRA would grow with compounding to over $110,000 in 25
years. And because stock market volatility may be particularly
worrisome to retirees, the security of insured deposits is very
appealing. Moreover, these deposits represent a very important, stable
funding source for bank lending.
A differential for retirement savings accounts is not a new
concept. In fact, in 1978, the Congress passed the Financial
Institutions Regulatory and Interest Rate Act that provided IRA and
Keogh accounts coverage up to $100,000--two-and-a-half times the
$40,000 limit that was in place at that time. The Senate Banking
Committee Report on the Act supported the differential coverage in this
way: ``The Committee believes that an individual should not have to
fear for the safety of funds being saved for retirement purposes.''
Such a concern is as important today as it was then.
We also note that some of the concern, expressed by some Members of
Congress and others, about a general increase in the $100,000 limit is
based on the problem of ``hot money'' moving to weak institutions, as
occurred in the 1980's. However, this concern would not seem to apply
to retirement savings, which are very clearly more stable.
Capping the Insurance Fund and Expanding the Rebate Authority
The ABA has long advocated that the insurance fund should be capped
and the rebate authority expanded. Not only are the BIF and SAIF
currently fully capitalized, they are $3.2 billion over the 1.25
percent designated reserve ratio (DRR) set by Congress following the
difficulties in the 1980's. Moreover, with interest income exceeding
the FDIC's operating expense by $1.5 billion a year, it is highly
likely that the insurance funds will continue to grow, after deposit
growth rates return to their norm, as we expect. The compounding effect
will mean even greater rates of growth in the future. We believe the
FDIC's proposal on this point--which for the first time acknowledges
the importance of rebates as a check on excessive growth of the fund--
is a tremendous step forward. While in the past we have advocated
direct rebates, a dividend approach, based on historic payments into
the funds, accomplishes the same purpose and ABA supports that
approach. The Federal Reserve and Treasury Department, in testimony
before a House Financial Services Subcommittee last week, supported
such an approach.
The funds held in excess of the DRR are not necessary to ensure the
soundness of the deposit insurance system. As I mentioned above, the
FDIC has the authority to adjust premium levels and has significant
regulatory powers over depository institutions to ensure that the FDIC
can meet any funding contingency. Importantly, the FDIC also has the
authority to set aside a reserve to cover anticipated future losses.
The power of this reserve was clearly demonstrated in the early 1990's
when the FDIC reserved $16 billion for future losses, $13 billion of
which was never needed. Because this reserve is subtracted out of the
funds' balances, the reserve ratios were dramatically understated at
that time. This extra, and often overlooked, cushion provides an
important tool for managing the funds resources. Perhaps most
importantly, the banking industry is legally obligated to meet the
financial needs of the insurance fund. Simply put, limiting the size of
the fund and expanding the rebate or dividend authority will not affect
the FDIC's ability to meet any future obligations to insured
depositors.\3\
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\3\ See Appendix A for details of additional FDIC powers and
authorities.
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The cost of FDIC holding excess reserves is very high. It
represents a significant loss of lendable funds for banks in the
communities they serve. I can tell you as a banker that I certainly can
put rebates to good use in my community providing loans and services to
my customers. This will have a far greater positive impact on economic
conditions in Waverly, Iowa, than if that money sits in the
Government's coffers in Washington.
As noted above, we believe that viewing the FDIC more as a mutual
insurer will naturally lend itself to a rebate system, through the
payment of dividends. While the details of a cap and dividend system
need to be worked out, we believe the 1.40 percent cap proposed in S.
2293 (as introduced in the last Congress) and H.R. 4082 is a reasonable
point at which to cap the funds. We thank Senator Santorum for his
leadership on this issue.
There is a precedent for this type of system. The National Credit
Union Administration has provided over $500 million over the last 5
years in dividends to credit unions. The dividend payment is designed
to keep the National Credit Union Share Insurance Fund at 1.30 percent
of insured deposits.
Premiums From Fast Growing Institutions
Bankers believe there is an inherent unfairness in the current
system that allows fast growing institutions to pay no premiums, even
though their growth materially dilutes the coverage reserve ratio of
the insurance funds. For many bankers this has become a top priority in
FDIC reform. The problem of fast growing institutions can be addressed
through a combination of a dividend/rebate system under the mutual
approach and granting the authority to the FDIC to charge premiums in
cases where institutions are growing by a defined percentage over
average growth at banks.
Municipal Deposits
In a number of States municipal deposits are a significant source
of funding, particularly for community banks. However, collateral
requirements for municipal deposits often entail a costly
administrative burden and have a very large opportunity cost by tying
up funds in securities that could otherwise be used for additional
lending in the community. This situation varies by State. The ABA will
continue to work on suggestions for addressing collateral requirements.
A number of bankers advocate a 100 percent insurance on municipal
deposits, or at least on local municipal deposits. They point to the
huge administrative burden required to pledge bonds to collateralize
these deposits, as well as the lost opportunities from holding excess
bonds rather than making more loans. The ABA recognizes that 100
percent has raised economic and political concerns with some Members of
Congress due to ``moral hazard'' questions, and there is, frankly, no
consensus within the industry on this issue at this point. There is, it
is worth noting, precedent under current deposit insurance practices
for a differentiation between municipal and other deposits. Therefore,
we believe further work needs to be done on this issue. For example,
consideration could be given to providing broader coverage or perhaps
granting banks the option to purchase additional insurance for
municipal deposits. Any such additional insurance should be limited to
some definition of local deposits, and the cost of such additional
insurance should fully cover any additional risk to the insurance fund.
Too-Big-To-Fail
The ABA has long opposed the too-big-to-fail doctrine and worked
with the Congress and regulators to include the limits on its use
contained in FIRREA and FDICIA. Nevertheless, important aspects of this
doctrine continue to exist. Deposit insurance reform provides an
opportunity to revisit the too-big-to-fail doctrine, and hopefully,
eliminate it fully.
Merger of the Funds
In the context of comprehensive reform, a merger of the SAIF and
BIF would be appropriate.
Smoothing Out Premiums
The FDIC is recommending that the ``hard'' 1.25 percent
``Designated Reserve Ratio'' (DRR) trigger be softened so that the
industry would not be charged very high premiums all at once if the
fund falls significantly below the 1.25 percent level. The ABA believes
there is merit to smoothing premiums by eliminating the so-called ``23-
cent cliff '' as long as it does not result in additional net premium
payments over the long run. The current system is, in effect, a major
tax increase in a recession. It is procyclical and would undermine any
economic recovery.
We are, however, troubled by the suggestion in the FDIC's proposal
that a band around the 1.25 DRR be established under which no rebate
(if over-funded) or surcharge (if under-funded) would be provided. The
FDIC would still charge regular premiums within this band. If the goal
is always to return to the DRR level, then there should be no band
around that level. Since the majority of the time there are few
failures and losses, the fund will generally be above the upper level
of the band. In effect, the broad approach would set a new de facto
reserve level above 1.25 percent and would ignore the billions of
dollars in lost lending opportunities of over-funding the FDIC.
Independent FDIC Board
Consideration should be given to changing the FDIC Board to make
sure it is truly independent, as it is designed to be. The most direct
way to do that would be to have three independent board members. Since
the board was expanded to five members in FIRREA, more often than not,
there have been vacancies on the board. The vacancies tend to be the
``outside'' seats because the seats held by the Comptroller of the
Currency and the head of the Office of Thrift Supervision are always
filled (either by the Comptroller or the head of OTS or acting
directors of those organizations). Thus the Administration has
generally had half of the Directors. Such an imbalance threatens the
independence of the FDIC and could politicize decisions. Returning to a
three-member independent board--which served the FDIC for well over 50
years--should be considered as part of a comprehensive approach to
reform.
Changes Should Only Be Adopted If They Do Not Create
New Costs To The Industry
We must emphasize that we cannot support, and would oppose, any new
approach that results in additional premium costs to those banks which
are currently paying no premiums and which grow at normal rates. The
example of a new premium structure used by the FDIC in its report
would, for example, result in unacceptable premium increases for many
banks. We see no justification for such increases when the insurance
funds are above the required reserve ratio.
There are several arguments made for charging premiums to at least
some banks that now pay no premiums. First, it is argued that to charge
no premiums means these banks are not paying for their insurance. We
could not disagree more. Banks have paid for their insurance--they
prepaid it. The billions of dollars in the BIF and SAIF are the result
of premiums and interest on premiums. The fact that the FDIC is now
self-funded is an extraordinary achievement.
Moreover, banks are obligated to maintain the fund at 1.25 percent
of insured deposits. If the fund falls below this level, all
institutions pay to recapitalize the fund. This assures adequate
funding of the insurance fund. Even more important is that the banking
industry has an unfailing obligation--set in law--to meet the financial
needs of the insurance fund. This means that the entire capital of the
industry--over $600 billion--stands behind the FDIC funds.
It is also worth noting that the commercial banks and savings banks
are paying nearly $800 million each year to cover FICO and interest
payments; despite the fact that these institutions had nothing to do
with the crisis that led to the issuance of the FICO bonds. Therefore,
we have fully paid up our insurance and more. We must remind Congress
that the current premium system was a carefully negotiated compromise
with our industry in exchange for the picking up of the FICO interest
payments. We see no justification for Congresses' unilaterally
reworking that ``agreement'' with our industry when the funds remain
above the 1.25 percent reserve ratio.
A second argument is that there must be gradations of risk in the
upper category of banks. We are not at all persuaded that these
gradations are significant or that the FDIC or anyone else has a system
that can really make that differentiation with any degree of
confidence. Furthermore, we believe there is a sort of ``grade on the
curve'' implicit in this argument. The upper category is just that.
Banks have worked hard to become stronger institutions, with strong
capital; these banks are in the top category because they deserve to be
there, as would be clearly shown by an historical perspective. We see
no justification for changing the system now by arguing that there are
too many banks in that category, after they have done what it takes to
be strong, well-managed and well-capitalized.
Of utmost importance, bank premiums are funds that otherwise could
be lent and invested in local communities. Charging new premiums takes
that money out of communities, undermining economic growth.
Another potential cost that could severely impact bank lending
would be a change in the assessment base related to Federal Home Loan
Bank advances and other secured liabilities. This change was suggested
in testimony last week by the Treasury Department. We believe that such
actions are directly counter to the intent of Gramm-Leach-Bliley, which
recognized the need for additional sources of funding for community
banks, and the appropriate role that the Federal Home Loan Banks could
play in filling that need. To alter the assessment base to now include
Federal Home Loan Bank advances and other secured liabilities will
hamper the ability of banks to fund themselves and their communities.
We would also note that changing the risk-based premium system may
trigger other problems and costs. For example, the scoring system
suggested by the FDIC could impose additional regulatory burdens and
may conflict with examination ratings of the OCC, the Federal Reserve,
and State banking departments. The Federal Reserve, in testimony last
week before a House Financial Institutions Subcommittee, raised
questions about how this new system might work. The Treasury Department
noted in the same hearing that the approach was complicated and
suggested it not be included in this legislation.
Conclusion
Mr. Chairman, we greatly appreciate the speed with which you have
moved to hearings on this issue. We are prepared to work with you and
the Members of this Subcommittee to find the best solution to these
critical issues. We think this is an excellent time to begin that
process--with the industry and the FDIC in excellent health. We sense
there is a growing consensus on issues to be addressed and approaches
to these issues. We look forward to working with you to see if we can
develop and enact legislation to make the FDIC insurance system even
stronger.
Appendix A
Capping the insurance fund and providing rebates will not limit the
FDIC's ability to meet any contingency. The FDIC has great flexibility
to manage the funds to maximize effectiveness, and there are many
existing laws that help protect the funds. For example, consider:
Reserves for Future Losses: FDIC has great flexibility to adjust
reserves for future losses. This reserve fund is subtracted from the
fund balance when calculating whether the fund is fully capitalized--
for example, if the fund balance is at least 1.25 percent of insured
deposits. Obviously, the larger the reserve for future losses, the
smaller the fund balance. Once the fund balance falls below 1.25
percent of insured deposits, premiums must be charged by the FDIC to
fully capitalize the fund. Thus, if FDIC anticipates greater potential
losses, it can merely set aside reserves, potentially creating a
situation where banks would have to pay premiums to maintain the
capitalization level of the fund. The FDIC has suggested that this
``hard'' target of 1.25 percent be ``softened'' allowing a slower
recapitalization than possible under current law. It is important to
note that even with such a change, the FDIC still would be able to set
aside reserves for future losses, thereby affecting the level of the
fund relative to the 1.25 percent level.
Authority to Raise the Designated Reserve Ratio (DRR): The FDIC has
the authority to raise the DRR if it can document that it is justified
for that year ``by circumstances raising a significant risk of
substantial future losses to the fund.'' By raising the DRR, the FDIC
would likely be raising the assessments necessary to maintain that new
higher level. Thus, if the FDIC foresees problems, it has this
additional authority to easily deal with the situation.
Risk-Based Premiums: Risk-based premiums were authorized in 1991 by
the Congress and implemented in 1993. Several important points should
be made: First, the risk-based system provides an automatic self-
correcting mechanism. If industry conditions deteriorate and the banks'
capital falls or supervisory concerns arise, a higher risk-premium is
charged and more income is received in the fund. The FDIC has been
critical of the fact that nearly 92 percent of the industry falls in
the top-rated category and therefore pays no premiums. On the contrary,
the incentives are such that nearly all banks want to be in this top
category, and given the economic performance of the economy and the
banking industry over the last decade, it is no wonder that such a high
percentage enjoys the benefits of such a rating.
Second, the FDIC has made additional changes to the risk-based
system designed to identify patterns that signal future problems for
individual banks. This should serve to improve the sensitivity of the
risk-based system to changes, and build in the automatic adjustments
sooner than would otherwise have been the case.
Mandatory Recapitalization: If the reserve ratio falls below the
DRR, the banking industry must immediately rebuild the fund back to the
DRR. If the rebuilding is expected to take longer than one year, a
mandatory recapitalization plan at very high assessment rates (minimum
23 basis points of domestic deposits) must be established. Thus, if the
industry continues to grow, the practical impact is that the fund
balance will never fall below 1.25 percent of insured deposits for any
length of time. In dollar terms, the fund would therefore always be
over $35 billion. We agree with the FDIC that, in times of stress, the
high premiums that would be required to maintain the DRR may be
counterproductive. Moreover, a ``hard'' 1.25 percent level means that
the benefits of such a large fund cushioning the shock of bank failure
losses is lost. While maintaining a level of capitalization is
important to preserving depositor confidence, proposals that would
require a slower rebuilding would be beneficial to maintaining credit
availability during difficult economic times. Again, it is worth noting
that the reserves of future losses, mentioned above, provide a
cushioning effect and should mitigate large upward swings in premiums.
Additional Authorities That Protect FDIC
Beyond the flexibility to adjust the deposit insurance funds to
meet any contingency, there are other important laws and regulations
that have fundamentally changed the operating environment for FDIC.
Taken together, these provisions lower the probability of banks failing
and they reduce the cost to the FDIC from those that do fail.
Prompt Corrective Action: This established mandatory
regulatory actions as capital levels fall below the minimum
requirements.
Critically Undercapitalized Institutions: This requires
mandatory conservatorship or receivership of institutions with
capital less than 2 percent. Theoretically, if receivership takes
place, the FDIC should suffer no losses on the institution at all.
Holding Company Guarantees /Cross Guarantees: This requires
the holding company to guarantee compliance with recapitalization
plans of the bank and puts losses on sister banking institutions of
a holding company in the event that one bank subsidiary fails. By
expanding the obligation to cover losses, the FDIC effectively
reduces its loss exposure.
Depositor Preference: This law elevates the FDIC's claim above
general creditors (standing in place of the insured depositors that
it has made whole) in the receivership of any failed bank. This
superior claimant position will certainly lower resolution costs to
the FDIC.
Rules Restricting Too-Big-To-Fail: FDIC may not take any
action, directly or indirectly, that causes a loss to the insurance
fund by protecting depositors for more than the insured portion of
deposits or by protecting creditors other than depositors.\4\
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\4\ There is a ``systemic risk'' exception to advance funds if
needed to prevent a severe economic effect (upon a determination by the
Secretary of the Treasury, in consultation with the President and
written recommendation from the FDIC and the Fed). Any costs would be
an obligation of the banking industry on a broader base of assets minus
tangible capital and sub debt. Also, the Federal Reserve is restricted
from providing discount window lending to ``undercapitalized''
institutions or those with CAMEL 5 ratings. This has the effect of
preventing delays that would allow large, uninsured deposits to run
before the bank was closed. This provision also extends discount window
lending to other nonbank firms for emergencies.
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Emergency Special Assessment Authority: This authority
requires the industry to repay any borrowing by FDIC and for any
other purpose deemed necessary.
``Least-Cost Rule:'' This requires the FDIC to resolve
failures in the least costly manner of all alternatives.
Line of Credit Expanded: The 1989 law increased the FDIC's
line of credit to the Treasury from $5 billion to $30 billion and
made it mandatory for the industry to repay any borrowing.
Simply put, limits on the size of the insurance fund and expanding
the rebate authority poses no concern to the FDIC funds-- existing laws
and regulations provide the needed flexibility to meet any financial
obligation that may arise.
----------
PREPARED STATEMENT OF CURTIS L. HAGE
Chairman, President, & Chief Executive Officer
Home Federal Bank, Sioux Falls, South Dakota
First Vice Chairman, America's Community Bankers
on behalf of
America's Community Bankers
August 2, 2001
Chairman and Members of the Committee, I am Curtis Hage, Chairman,
President, and CEO of Home Federal Bank in Sioux Falls, South Dakota. I
am here today representing America's Community Bankers (ACB) \1\ as
their First Vice Chairman. ACB is pleased to have this opportunity to
discuss with the Committee reform of the deposit insurance system.
While the system is still healthy, rapid growth of insured deposits is
highlighting the problems caused by an overly rigid statute that could
result in damage to the banking system and the Nation's economy.
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\1\ ACB represents the Nation's community banks of all charter
types and sizes. ACB members pursue progressive, entrepreneurial, and
service-oriented strategies in providing financial services to benefit
their customers and communities.
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Rapid growth is diluting the insurance funds as they stretch to
cover more deposits. And inevitably, the FDIC must sometimes use those
funds to protect depositors. As a result of a failure last week, the
FDIC's Savings Association Insurance Fund (SAIF) will reportedly lose
$500 million--5 percent of the total in the fund. A loss that size
would reduce the SAIF's reserve ratio from 1.43 percent of insured
deposits to 1.36 percent. The Bank Insurance Fund (BIF) had already
fallen to 1.32 percent through a combination of rapid growth in insured
deposits and similar losses.
Both funds are still well above the statutory minimum of 1.25
percent of insured deposits. However, under a statutory requirement
imposed in 1989, if a fund falls below the 1.25 percent reserve
requirement, the FDIC must impose premiums. If a fund is projected to
take over a year to exceed 1.25 percent, the FDIC must impose a
statutorily mandated 23 basis point premium on all institutions in that
fund. For a community bank with $100 million in deposits, that equals
$230,000. This premium would be like a targeted tax increase,
threatening to drag the economy closer to recession, and inhibiting
community bankers' ability to help their customers.
Fortunately, there is a ready solution to this problem. The Deposit
Insurance Stabilization Act (H.R. 1293), introduced by Representatives
Bob Ney and Stephanie Tubbs Jones, would eliminate the arbitrary 23
basis-point requirement. Eliminating the 23 basis-point premium would
give the FDIC flexibility to recapitalize the fund under a more
reasonable schedule. The bill would also do what everyone agrees should
be done, merge BIF and SAIF. A merged fund is stronger and would be
less affected by either rapid growth or losses from failures. The bill
would also permit the FDIC to impose a special premium on excessive
deposit growth.
ACB strongly recommends that Congress act on the Deposit Insurance
Stabilization Act this fall, before either BIF or SAIF might fall below
1.25 percent. We agree with incoming FDIC Chairman Don Powell that
Congress need not deal with all deposit insurance issues at once. Our
position does not rule out adding additional provisions. If Congress
can quickly develop a consensus on other issues, such as capping the
fund, providing for rebates, and modestly indexing coverage, ACB would
endorse an expanded bill.
On the coverage issue, ACB believes that Congress should focus on
increasing protection for retirement savings. We strongly urge you to
provide substantially more coverage for retirement savings than for
other accounts, as was done before 1980. This is needed to provide
adequate coverage for the variety of tax-advantaged savings accounts
that have grown substantially over the years, as well as prepare for
any Social Security reform, including self-directed accounts should
Congress adopt that concept.
While ACB believes the FDIC should reform the risk-based premium
system, we strongly oppose the agency's proposal to impose a premium on
all insured institutions when the funds are over the statutory reserve
ratio. Healthy institutions that are not paying a premium today paid
extraordinary premiums in the 1990's -- in effect prepaying for today's
coverage. Despite the rhetoric being used, they are not getting free
coverage.
Congress should not let the objective of comprehensive reform be
the enemy of the necessary--stabilizing the deposit insurance system.
The Most Urgent Issue
The most urgent deposit insurance issue that we face today stems,
in part, from the strength of the system. Since both the BIF and SAIF
are above their statutorily required 1.25 percent ratio, the FDIC does
not currently charge a premium to healthy institutions. A few companies
are taking advantage of that situation by shifting tens of billions
from outside the banking system into insured accounts at banks they
control. Unfortunately, the magnitude of these deposit shifts dilutes
the deposit insurance funds and reduces the designated reserve ratio.
The problem is not that the FDIC is holding too few dollars-- earnings
have kept BIF and SAIF balances relatively stable --but that those
dollars are being asked to cover a rapidly rising amount of deposits in
a few institutions. As former FDIC Chairman Tanoue said, ``other banks
can rightly say that they are subsidizing insurance costs for these and
other fast-growing banks.'' \2\
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\2\ Speech, May 10, 2001 (p. 2).
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As last week's failure demonstrated, this situation could worsen
very quickly. A combination of rapid growth and just a few failures
could trigger a 23 basis point premium. For my bank the cost of such a
premium would be $1.4 million annually. For all banks in South Dakota
the cost would be $31 million. That much capital can support over $300
million in lending. These premiums could come at the worst possible
time --when the national economy and some local economies are shifting
to a different pace. Whenever they might come, they would divert
resources from communities and shift them to Washington.
How large is this free-rider problem? In 2000, Merrill Lynch swept
$36.5 billion from its Cash Management Accounts into insured accounts
at its two affiliated banks, effectively reducing the BIF reserve ratio
by 2.15 basis points. Merrill has swept an additional $11 billion into
those banks this year.
Another major firm, Solomon Smith Barney has swept a total of $17
billion into its six BIF- and SAIF-insured affiliates this year, making
this program especially attractive to large investors. The FDIC now
estimates that all of this activity has lowered BIF's reserve ratio by
at least 3 basis points.
ACB does not object to growth in insured deposits. These firms'
activities are permissible under the current law, which never
anticipated the current scenario. But two companies' growth plans are
diluting the funds and reducing the designated reserve ratio at the
possible expense of all insured banks. Without this dilution, the BIF
reserve ratio would have increased, rather than fallen. And the FDIC is
faced with a statutory prohibition on assessing for this growth.
Because of these high-growth programs, institutions in every State
could be forced to pay premiums. These institutions collectively paid
billions into the FDIC in the late 1980's and the 1990's. In the early
1990's, all FDIC-insured institutions paid approximately 23 basis
points each year--again, $230,000 for each $100 million in deposits--
$900,000 annually for my bank. And in 1996 SAIF-insured institutions
paid an additional 66 basis points--a total of $4.5 billion. My bank's
share was $2.6 million. Those substantial payments brought the FDIC
back to health. Now these premiums are being used, in effect to cover
new deposits at a few rapidly growing institutions.
To correct this situation, Congress should quickly pass H.R. 1293,
or similar legislation. The bill does three things:
Permits the FDIC to impose a fee on existing institutions for
excessive deposit growth so that the required reserve ratio can be
maintained. Currently, the FDIC may impose an excessive deposit
growth fee on new institutions or new branches. By allowing the
FDIC to impose fees on existing institutions, H.R. 1293 would
address the current ``free-rider'' problem.
Merges the BIF and the SAIF. According to the FDIC, merging
the BIF and the SAIF would create a more stable, actuarially
stronger deposit insurance fund. A single, larger fund would be
less affected by either rapid growth or losses from failures.
Allows for flexible recapitalization of the deposit insurance
fund. If the reserve ratio of the merged fund falls below the
required level of 1.25 percent, the bill would give the FDIC
flexibility in recapitalizing the fund over a reasonable period of
time. By repealing the automatic assessment of 23 basis points,
H.R. 1293 would give the FDIC authority to use a laser beam
approach, rather than a sledgehammer, to recapitalize the insurance
fund.
ACB believes that Congress should act quickly on this legislation
to help ensure the continued strength of the FDIC and prevent the
unnecessary diversion of billions of dollars away from community
lending to homeowners, consumers, and small businesses.
How the Excess Growth Premium Would Operate
Ironically, Congress permits the FDIC to impose special assessments
on de novo institutions.\3\ Congress recognized that these institutions
can be expected to grow at rates that exceed the industry average and
impose other risks. However, because of their relatively small size,
they cannot be expected to dilute a multibillion dollar deposit
insurance fund. The same thing cannot be said about an existing
institution--now effectively exempt from premiums--that embarks on a
new business plan that could add tens of billions to the insured
deposit base. So the law correctly recognizes that de novo institutions
are relatively risky. However, the law forces the FDIC to ignore the
risk to the institution and to the insurance fund posed by an existing
institution that begins growing at a rate significantly above the
industry average.
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\3\ 12 U.S.C. 1815(d)(1)(A).
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A growth premium would avoid dilution of the fund by making the
fund whole with respect to any excess growth, preventing the imposition
of unnecessary premium costs on other institutions. The special growth
premium would apply only to those institutions whose growth imposed a
material impact on the fund. It would also not apply to growth through
merger or acquisition. By definition, these deposits are already
included in the insured deposit base, so shifting them from one
institution to another does not dilute the fund.
Assessing a special premium only on significant growth would allow
premium-free growth by an ordinary institution that had developed a
particularly successful business plan. But it would address the case
of, for example, a diversified financial firm that was simply
transferring significant amounts of uninsured funds under its effective
control into its insured bank.
ACB believes that the special premium should compensate the fund at
the then-current reserve ratio to avoid dilution of the fund. The FDIC
should have the flexibility to collect this premium over a reasonable
period to avoid imposing an undue shock on the affected institutions.
While the premium might be collected over time, it should be booked
immediately as a receivable in the fund to maintain its coverage ratio.
Additional Provisions
While ACB urges you to take immediate action on legislation to deal
with the free-rider issue and eliminate the 23 basis point ``cliff,''
we welcome consideration of some additional reforms to the deposit
insurance system. Our positions on these issues are discussed in detail
in our comprehensive report to the FDIC, which we released in January.
A copy of that report was distributed to you along with this testimony.
What follows is a summary of ACB's position on issues on which a prompt
consensus might emerge.
Coverage
The industry has a mixed reaction to proposals to change deposit
insurance coverage levels. Most ACB members are skeptical that
increases in general deposit insurance coverage levels would
significantly increase funding. Former FDIC Chairman Helfer is even
more skeptical. Last year, she said, ``There is very little evidence
that doubling the coverage limits will expand the deposit base of
smaller banks. Community bankers that I have talked to think that very
little benefit will result from a significant increase in coverage
limits.'' \4\ Depositors with large sums may shift insured deposits
from one bank to another to consolidate balances or take advantage of
higher interest rates. But one bank's gain may well be another bank's
loss.
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\4\ The Deposit Insurance System: What Reforms Make Sense?; Ricki
Helfer, December 4, 2000; Address to America's Community Bankers, pp.
9-10 (Helfer, December 4, 2000).
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A better approach would focus on increasing coverage for retirement
savings, such as IRA and 401(k) accounts. Coverage should be increased
to an amount substantially above the general coverage level. This is
not a new concept; in 1978 Congress provided for $100,000 coverage for
retirement savings accounts, two and one-half times the then-current
level for regular savings. Higher retirement account coverage would
provide a stable funding source for community lending and is extremely
important to retirees and those nearing retirement.
Additional retirement account coverage would help implement an
important national policy. Congress has just provided substantially
enhanced tax incentives to encourage individuals to accumulate
retirement savings. These individual savings are often replacing
resources that employers previously provided through defined-benefit
pension plans. This shift in retirement funding has increased the
burden on individuals to manage their own assets. As individuals
respond to tax incentives, their retirement assets often exceed by
substantial amounts the current $100,000 coverage limit. Since planners
generally recommend that individuals shift these savings into more
secure and stable investments as they approach retirement, a
substantial increase in deposit insurance coverage for retirement
savings would be particularly helpful. These plans could be easily
defined by requiring that they meet the standards of the Internal
Revenue Code. The increased coverage would also be useful if Congress
adopts some version of private accounts under the Social Security
System.
In addition to a substantial increase in retirement coverage, to
help maintain the role of deposit insurance in the Nation's financial
system ACB supports indexing coverage levels. Congress should use as a
base the last time it adjusted coverage primarily for inflation, which
was done in 1974. At that time, it increased coverage to $40,000.
According to the FDIC, if adjusted for inflation since that time, the
current coverage limit would be approximately $135,000.
As long as the fund is above its statutory minimum of 1.25 percent
of insured deposits, a modest increase in coverage should not require
an additional minimal premium. If unacceptable premium increases are a
condition for an immediate increase in coverage, Congress should at
least index coverage from the current $100,000 level.
Indexing on a going-forward basis would certainly not justify any
premium increase. However, it would maintain ``the same relative
importance of deposit insurance in the economy over time. . . .'' \5\
Indexing using the current level would also end the debate over what
year and level should be the basis for indexing. Depository
institutions and the economy have adjusted to the current level of
coverage. Indexing would effectively maintain that level without the
need for more Congressional action.
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\5\ FDIC Options Paper, August 2000, p. 44.
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To simplify and reduce the cost of implementation, as well as to
promote consumer understanding, we recommend that any increases be
instituted only in $10,000 increments. Some ACB members are especially
concerned that frequent small adjustments and accompanying disclosures
would be more costly than any benefit they might realize from increased
deposit funding.
Congress Should Set a Ceiling on the Fund
ACB recommends that Congress set a ceiling on the deposit insurance
fund's designated reserve ratio (DRR), giving the FDIC the ability to
adjust that ceiling using well-defined standards after following full
notice and comment procedures. In deciding the actual ceiling amount,
ACB recommends that Congress ask the FDIC to provide it with a firm
recommendation on where it should set a statutory ceiling. The agency
has already done considerable historical analysis on the level of the
funds and income needed to maintain them.\6\ Clearly, the agency could
adapt that analysis to determine a reasonable ceiling to recommend to
Congress.
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\6\ 60 Fed. Reg. 42680 (August 16, 1995).
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ACB agrees with Former FDIC Chairman Helfer's comment:
I believe it is possible for the FDIC to develop analytical
tools that will permit it to identify a ceiling on the funding
needs of the deposit insurance system at any particular time--a
DRR that would change as circumstances change. . . . The
purpose of establishing a ceiling DRR is so that insurance
funds will not grow beyond a size that can be justified on the
basis of the needs of the deposit insurance system, thereby
withdrawing capital from banks who could have contributed to
economic growth by leveraging those funds to meet the economic
needs of their communities. Amounts accumulated in the system
over and above the DRR ceiling should be rebated to banks to
facilitate economic activity, which benefits every one.\7\
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\7\ Helfer, December 4, 2000, p. 12.
Before increasing the ceiling, the FDIC should be required to find
that a higher level is needed to meet a substantial and identifiable
risk to the fund or the financial system. In addition, Congress should
require the FDIC to follow a full notice and comment process under the
Administrative Procedure Act before making any change to the ceiling.
Excess Reserves Should Be Returned to Institutions That Paid Premiums
Reserves in the fund that exceed the ceiling should be returned to
insured institutions based on their average assessment base measured
over a reasonable period and based on premiums paid in the past.
Rebatable premiums would include the 1996 SAIF special assessment, but
not the high-growth special assessments.
During the 106th Congress, ACB supported legislation introduced by
Senators Rick Santorum (R-PA) and John Edwards (D-NC) and Reps. Frank
Lucas (R-OK) and Mel Watt (D-NC) that would have set a 1.4 percent
ceiling and used the excess to pay interest on FICO bonds.\8\ After the
FICO bonds mature, excess funds above the ceiling would be rebated. The
bill would have given the FDIC authority to change the ceiling. Reps.
Lucas and Watt have reintroduced that legislation in the current
Congress (H.R. 557).
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\8\ S. 2293 and H.R. 3278.
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ACB continues to believe that this is a constructive solution to a
serious potential problem that could be caused by a substantially
overcapitalized insurance fund. However, a broader approach could lead
to full rebates more promptly than provided in the Lucas / Watt bill.
The FDIC should also consider risk factors when calculating any
rebate. This would allow the FDIC to provide a risk-based incentive to
institutions without imposing a premium on the healthy institutions.
Under a broader rebate program, these incentives could come into play
before the FICO obligation ends. The riskiest institutions would get no
rebates, while the safest institutions would get higher than average
rebates. Those in between could expect average rebates. These
differential rebates would provide the same risk-reduction incentive as
variations in premiums. All institutions would know that as the fund
approached the ceiling, they could expect to benefit by operating in a
less risky manner.
Whatever the mechanism Congress provides, resources not needed for
reasonably foreseeable deposit insurance purposes should not remain in
Washington.
Risk-Based Premiums
Just as ACB urges Congress to prevent the imposition of a 23 basis
point premium, we also support the current statutory language that
prevents the FDIC from imposing premiums on well-capitalized and well-
run institutions when reserves are above required levels. The FDIC and
others have recommended that the Congress repeal this policy,
contending that institutions are getting ``free'' deposit insurance
coverage. This is like contending that a single-premium annuity policy
is free.
Look at the numbers: From 1992 through 1996, BIF-insured banks paid
a total of $19.9 billion, while SAIF-insured institutions paid over
$8.4 billion. In 5 years, the total paid was a staggering $28.3
billion. During that period, a $100 million deposit SAIF-insured
institution paid $1.8 million in premiums. A comparable BIF institution
paid $810,000. Those payments would cover 36 years of premiums for a
SAIF institution and 16 years for a BIF institution if they paid the
average premium assessed between 1950 and 1990.
The industry stepped up to the plate to recapitalize their funds.
As a result, the FDIC got the money over a 5 year period, gaining the
opportunity to earn substantial interest that built up the funds. That
is just the way a single premium annuity works. An insurance company
charges less in nominal dollars than it expects to pay out, making up
the difference and earning a profit by investing.
Conclusion
ACB appreciates this opportunity to present our views on the
significant deposit insurance issues before you today. The deposit
insurance system is still strong, but could be made even stronger. We
urge you to move quickly to give the FDIC the flexibility that it needs
to deal with the strains imposed by extraordinary growth in insured
deposits at a few institutions. Prompt passage of legislation like the
Ney/Tubbs Jones bill (H.R. 1293) will strengthen and stabilize the
system.
In addition, Congress may wish to seek an early consensus on
additional issues that could be added to this legislation. Indexing
coverage, providing for increased coverage of retirement accounts,
capping the size of the fund and providing for the rebates could result
in comprehensive reform that would substantially improve the system.
Deposit insurance is an essential part of our banking system. While
a variety of opinions exist within the industry regarding what reforms,
if any, should be enacted, general consensus exists that any reform
should leave the FDIC stronger. It should continue and strengthen the
original mission of the FDIC to protect depositors. America's Community
Bankers is committed to working with you and your Committee, and others
in the industry to help forge a bill that can move expeditiously
through Congress.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM ROBERT I.
GULLEDGE
Q.1. Some of the past concern about raising the deposit
insurance level above $100,000 was the moral hazard of putting
the American taxpayer at risk if financial institutions fail.
Give me your thoughts as to why we should raise the deposit
insurance level above $100,000 and place the American taxpayer
at risk.
A.1. The reasons for raising the insurance level above $100,000
are covered in detail in my written statement submitted for the
hearing record, but I will summarize them below. The ICBA does
not agree that raising the deposit insurance level above
$100,000 will materially increase the risk to the American
taxpayer. This is more fully described in my written statement,
and also summarized below.
Higher deposit insurance coverage levels would benefit
communities, consumers, and small businesses. It would help
address the funding challenges and competitive inequities faced
by community banks and ensure that they have lendable funds to
support their communities.
Inflation has severely eroded the real value of FDIC
coverage, which has been a bulwark of consumer confidence in
our financial system, in the two decades since it was last
adjusted. The current limit is inadequate for today's savings
needs, particularly growing retirement savings needs.
Higher coverage would benefit consumers. A recent Gallup
consumer survey conducted for the FDIC showed that: 57 percent
of respondents cited Federal deposit insurance as ``very
important'' in determining where to invest; one in eight
households keep more than $100,000 in the bank; one-third of
all households reported having more than $100,000 in the bank
at one time or another; and nearly four out of five (77
percent) respondents thought deposit insurance coverage should
keep pace with inflation.
Reports of the 816 uninsured depositors at the recently
failed Superior Bank, FSB demonstrate well the need for
increased coverage. Some of those who will lose substantial
sums include an injured worker who deposited a $145,000
disability settlement the day before the thrift failed; and a
woman who deposited $120,000 in proceeds from the sale of her
deceased mother's home days before the thrift failed. Many of
the uninsured had their retirement savings at the thrift,
including one person with $3 million in an IRA. The ICBA
supports substantially higher coverage levels for retirement
savings.
These stories demonstrate that depositors with more than
the coverage limit are not necessarily wealthy or capable of
exercising ``depositor discipline'' by scrutinizing their
banks. If Federal bank regulators can be surprised by the true
financial condition of a bank (as in the case of both the
Superior and Keystone National Bank failures), then how can we
expect the ordinary depositor to exercise ``depositor
discipline''?
Higher coverage would benefit small businesses. A recent
ABA survey of small business owners found that half think the
current level of deposit insurance coverage is too low. If the
coverage were doubled, 42 percent said they would consolidate
accounts now held in more than one bank; 25 percent would move
money to smaller banks; and 27 percent would move money from
other investments into banks.
Higher coverage would benefit our communities. Consumers
and small businesses shouldn't be forced to spread their money
around to many banks to get the coverage they deserve.
Customers should be able to support their local banks, and
local economies, with their deposits.
Higher coverage levels are needed to enable community banks
to maintain sufficient core deposits to meet community lending
needs as they lose deposits to mutual funds, brokerage
accounts, the equities markets and too-big-to-fail banks. Since
1992, deposit growth has lagged the growth in bank loans by
about half--hence small banks are finding it harder to meet
loan demand that supports economic growth. And because of their
small size, the community banks lack access to the capital
markets for alternative sources of funding.
Community bankers in agricultural and rural markets are
particularly faced with these difficulties. As the Federal
Reserve Board noted in the attached July 27 letter to
Representative Spencer Bachus (R-AL), who Chairs the Financial
Institutions Subcommittee (House Financial Services), asset and
deposit growth at small banks in agricultural and rural areas
(see lines 6 and 7 of accompanying chart) between 1995 and 2000
has failed to keep pace with asset and deposit growth for small
banks in metropolitan areas (see line 8).
Also, growth of uninsured deposits at agricultural banks
(far right column of line 6) greatly lags growth of uninsured
deposits at all other banks for this period, averaging 3.9
percent annually compared to double-digit percentage annual
increases at all other institutions. And other Federal Reserve
data shows deposit growth for all small banks is lagging loan
growth. We believe this to be direct evidence of the
difficulties many community bankers face in attracting and
maintaining core deposits to meet loan demand.
FDICIA reforms minimize taxpayer exposure. Higher coverage
limits will not necessarily increase exposure to the FDIC or
the taxpayers. A variety of factors serve to minimize any
increase in exposure to the FDIC or the taxpayers from bank
failure losses due to an increase in deposit insurance coverage
levels.
The reforms in bank failure resolutions instituted by the
Federal Deposit Insurance Corporation Improvement Act of 1991
FDICIA-- including prompt corrective action, least cost
resolution, depositor preference, and a special assessment when
a systemic risk determination is made--are all designed to
reduce losses to the FDIC.
It is ironic to talk about the moral hazard of increasing
deposit insurance coverage to account for inflation when the
trend of greater and greater deposit concentration in fewer and
fewer banks that are likely too-big-to-fail continues. This
deposit concentration, not an increase in coverage levels,
presents the greatest systemic risk and ``moral hazard'' in our
financial system and to the loss exposure of the FDIC and the
taxpayer. And even if an emergency determination of systemic
risk is made by the Secretary of the Treasury, and if all
depositors--and creditors--at Large Complex Banking
Organizations (LCBO's) are again made whole, a special
assessment on all banks will be levied to recover all of these
bailout costs.
Q.2.a. Mr. Plagge's testimony says ``there is general, although
not unanimous, support with the banking industry for
permanently indexing the level of deposit insurance coverage.''
What percentage of your membership supports indexing the level
of deposit insurance coverage? What percentage of your
membership supports covering municipal deposits? What
percentage of your membership supports covering IRA's, and
other retirement accounts? What percentage of your membership
would be willing to pay a small, steady premium?
A.2.a. While we have not conducted a formal, membership-wide
survey of community banker support for indexing coverage,
covering municipal deposits, IRA's and other retirement
accounts, and paying a small, steady premium, the ICBA strongly
supports all of these proposals as part of a comprehensive
approach to deposit insurance reform.
On the procedural level, the ICBA formulates its public
policy positions through a multifaceted input and review
process involving the organization's banker-elected and banker-
composed Executive Committee, Board of Directors (composed of
over 100 bank and thrift executives from 48 States), 13
separate issue committees (e.g., Federal Legislation, Policy
Development, Regulation Review), as well as consulting with
individual community bankers and State community banking trade
associations affiliated with the ICBA.
In addition to being approved and ratified by the ICBA's
Policy Development Committee, Executive Committee and Board of
Directors, our current policy resolutions were ratified by
unanimous voice vote of the 1,300 community banker delegates to
the ICBA Annual Convention held in Las Vegas, Nevada in March
2001. Our policy resolutions on ``Deposit Insurance'' and
``Community Bank Funding and Liquidity'' are attached.
Our stance in strong support for comprehensive deposit
insurance reform, including provisions to both substantially
increase current coverage levels and index this new base for
future inflation, is the result of community-banker
deliberations over the course of the last several years. This
process was intensified in March 2000 following former FDIC
Chairman Donna Tanoue's announcement at the ICBA Annual
Convention in San Antonio, Texas that her agency would be
undertaking a thorough review of and make recommendations on
Federal deposit insurance reform. Chairman Tanoue's speech
mentioning proposals to increase and index coverage levels for
inflation since 1980 drew a standing ovation from the community
banker delegates at the convention.
Throughout this process, all of the above-noted issues (and
other possible reforms) have been considered, and often
reconsidered, by various ICBA committees and ultimately our
Executive Committee and Board of Directors. This process has
provided our banker membership with extensive and repeated
opportunities to weigh in on the issues under consideration and
formulate the trade association's positions and advocacy
strategies.
With regard to paying a small, steady premium, I would
reiterate my testimony at the August 2 hearing that the ICBA
believes ``that in a carefully constructed, integrated reform
package which includes substantial increases in deposit
insurance coverage levels, bankers would be willing to pay a
small, steady premium in exchange for increased coverage levels
and less volatility in premiums.'' This will enable bankers to
better budget for premiums and will help avoid unexpectedly
high premiums during economic downturns. In addition, we
believe premium swings would be less volatile and more
predictable, and it would also result in ``free riders,'' like
Merrill Lynch and Salomon Smith Barney which have now pumped
upward of $100 billion into insured deposits, paying some level
of premiums and thereby reduce further dilution of the
insurance fund(s) reserve ratio.
Q.2.b. Mr. Plagge's testimony also discusses a study which
shows that ``doubling coverage could result in net new deposits
to the banking industry of between 4 percent and 13 percent of
current domestic deposits, with the lower end of the range more
likely.'' Also doing this ``would lower the BIF-SAIF reserve
ratio below the required 1.25 percent.'' Is this worth the
potential cost? Is it worth the potential for premium increases
that would accompany a significant increase of the insurance
limit?
A.2.b. The premium costs of an increase in deposit insurance
coverage must be considered in the context of comprehensive
reform. The ICBA believes that community bankers are willing to
pay a small, steady, fairly priced premium as part of a
comprehensive package that includes a substantial coverage
increase. In a comprehensive package, the hard target 1.25
percent reserve ratio would likely be replaced by a flexible
range in order to reduce premium volatility. Premiums would
remain steady as long as the reserve ratio stayed within the
range. Thus, a dip in the reserve ratio below 1.25 percent in
such a scenario would not result in increased premiums.
Q.2.c. What do you think of Mr. Hage's proposed bill to merge
the BIF and the SAIF, allow for flexible recapitalization of
the deposit insurance fund and permit the FDIC to impose a fee
on existing institutions for excessive growth?
A.2.c. We believe Mr. Hage's proposed bill is too narrow.
Instead, the ICBA supports a comprehensive approach to deposit
insurance reform as more fully described in our answer below to
Question 3.
Q.3.a. Mr. Powell indicated that perhaps all the FDIC proposed
reforms did not have to be in one package. What would be on
your ``must have in the bill'' list if you were making one?
A.3.a. The ICBA's preference, as noted in Answer 2 above, would
be comprehensive legislation that: (1) substantially raises
coverage levels and indexes the new base for future inflation;
(2) increases coverage for public deposits and retirement
products; (3) removes the current hard 1.25 percent designated
reserve ratio in favor of a flexible range, with rebates, based
on past contributions, when the fund exceeds the upper end of
the range; (4) repeals the current statutory requirement that
banks pay a 23 cent premium when the fund(s) drop below the
DRR; and (5) institutes a pricing structure that fairly
evaluates the risks of individual banks without undue
complexity or cost, including the payment of a small, steady
premium. Also, in the context of a comprehensive bill, the ICBA
would not oppose merger of the BIF and the SAIF into a single
insurance fund.
The ICBA's bottom line on deposit insurance reform remains
that we cannot support any legislative proposals that do not
substantially increase current coverage levels and index the
new base for future inflation.
Q.3.b. Should these reforms be done now?
A.3.b. Yes. The ICBA fully shares the view stated in the FDIC's
recent report ``Keeping the Promise: Recommendations for
Deposit Insurance Reform'' that the time for comprehensive
action is now in a noncrisis atmosphere. Indeed, the recent
Superior Bank, FSB failure should serve as a catalyst for
action. Delay in dealing with the S&L crisis of the late 1980's
not only prolonged the problem, but also greatly increased the
costs of the bailout.
The ICBA is also concerned that a piecemeal approach to
deposit insurance reform will not result in all the important
issues being addressed adequately, or possibly at all. Should
Congress move on a limited package this year, as some suggest,
momentum for action on other critical topics could well be
lost. That would be unfortunate, as the ICBA joins the Senate
Banking Committee's Financial Institutions Subcommittee
Chairman Tim Johnson (D-SD), Representative Bachus, and others
who believe the best way to deal with this complex situation is
to face all the issues directly in a proactive fashion. To do
otherwise could be an invitation to larger obstacles down the
road.
2001 ICBA POLICY RESOLUTIONS
[Excerpts]
DEPOSIT INSURANCE
A strong and well-functioning Federal Deposit Insurance System is
the foundation on which consumer confidence in our banking and
financial system rests. That confidence in turn plays a pivotal role in
maintaining stability during difficult economic times. The Federal
Deposit Insurance System has worked well for more than 65 years, but
following the ``financial modernization'' accomplished in the Gramm-
Leach-Bliley Act, it is now time to review and modernize our Federal
Deposit Insurance System as well.
Increased Coverage Levels
ICBA strongly supports increasing deposit insurance levels and
regularly indexing them for inflation to adequately preserve the value
of its protection going forward. Deposit insurance coverage levels have
not been increased in 20 years--the longest period in FDIC history
without an increase. Deposit protection has been eroded in half due to
inflation since 1980 and is inadequate for today's savings needs,
particularly growing retirement savings needs. The less deposit
insurance coverage is really worth due to inflation erosion, the less
confidence Americans will have in the protection of their money, and
the soundness of the financial system will be diminished.
Adequate deposit insurance levels are also critical to community
banks' ability to attract core deposits to support community lending as
they lose deposits to mutual funds, brokerage accounts, the equities
markets, and ``too-big-to-fail'' banks. Increased coverage levels will
help local communities by enabling depositors to keep more of their
money in local banks, where it can be reinvested for community projects
and local lending.
The ICBA also supports full deposit insurance coverage for in-
market municipal (public) deposits--taxpayer funds that should not be
put at risk. State deposit collateralization requirements make it
harder for community banks to compete for these deposits with larger
banks. Many loaned-up community banks do not have securities available
to use for collateral. Those that do must tie up assets in lower-
yielding securities affecting their profitability and ability to
compete. Full deposit insurance coverage of in-market municipal
deposits would free up the investment securities used as collateral,
enable community banks to offer a more competitive rate of interest to
attract municipal deposits, and enable local governmental units to keep
deposits in their local banks and communities.
Other Deposit Insurance Reform Issues
The FDIC has undertaken a timely and a comprehensive review of the
Federal Deposit Insurance System. In addition to the issue of coverage
levels, the FDIC is reviewing two other key issues: Fairness in deposit
insurance pricing and funding insurance losses over time. The ICBA
supports this comprehensive review and--in conjunction with an increase
in the coverage level--supports efforts to reform the system to:
Adequately assess deposit growth at rapidly growing
institutions--which currently pay no insurance premiums to offset
the dilution in the reserve ratio caused by their deposit growth
(``free rider'' problem).
Appropriately differentiate pricing for individual
institutions based on risk.
Reduce premium volatility by smoothing out premium payments to
remedy the current procyclical nature of deposit insurance
premiums--with premiums lowest when the industry is healthiest and
highest when the industry is weakest and can least afford to pay--
caused by the hard target reserve ratio.
Provide appropriate options for rebate of excess fund reserves
to the industry.
More equitably apportion the costs of systemic risk
protection, recognizing that the benefits of a stable financial
system goes beyond the banking system alone.
COMMUNITY BANK FUNDING AND LIQUIDITY
[Priority]
Community banks are facing serious funding and liquidity challenges
as they find it harder and harder to attract and maintain core deposits
to match asset growth and support community lending. According to the
FDIC, deposits increased by only 4.1 percent in 1999, the smallest
annual increase since 1993, while bank lending increased 7.8 percent.
Community banks continue to see disintermediation of deposits to mutual
funds, brokerage accounts, the equities markets, tax-free credit unions
and ``too-big-to-fail'' banks. Alternative sources of funds at
competitive prices for community banks are scarce because community
banks lack ready and efficient access to the capital markets. By
contrast, large commercial banks can access the capital markets for
funds and use securitization to supplement deposits. High tax rates on
traditional saving instruments such as certificates of deposit further
encourage investment in higher risk investments and drain community
bank core deposits.
Deposit Insurance Coverage Levels
To stem the deposit flight out of local communities and enable
community banks to better compete with the emerging financial
conglomerates, the ICBA urges that Federal deposit insurance coverage
levels be increased, and indexed for inflation going forward.
Deposit insurance coverage has been frozen at $100,000 since 1980.
Inflation alone has cut the real value of deposit insurance protection
in half. The ICBA strongly supports an increase in deposit insurance
coverage levels in order to help community banks attract additional
core deposits. Improved access to Federal Home Loan Bank advances will
help (see below), but more is needed as advances are not a complete
substitute for deposits. Increased coverage levels will allow
depositors to keep more of their money in local banks, thus boosting
the supply of lendable funds at community banks and providing funds to
keep local economies prosperous.
While community banks now have more alternative funding sources,
these sources cannot be relied on as a complete replacement for
deposits. Community bankers recognize this and their examiners caution
against too great a reliance on nontraditional funding sources.
Community banks need to offer higher levels of deposit insurance to
avoid overdependence on Federal Home Loan Bank advances.
Federal Home Loan Bank Access
Federal Home Loan Bank System modernization provisions included in
the Gramm-Leach-Bliley Act of 1999 represented a significant step in
addressing community bank funding problems by providing Community
Financial Institutions (insured depository institutions with less than
$500 million in assets) greatly enhanced access to the Federal Home
Loan Banks for long-term fixed-rate funding.
The ICBA will continue its work to expand eligibility for direct
access to longer-term funding sources as these provisions are
implemented. The ICBA strongly encourages the FHLB's to move forward to
implement their expanded collateral options available for Community
Financial Institutions (CFI's) as rapidly as possible without
jeopardizing safety and soundness. We urge the FHLB's to develop the
products and programs to support their CFI members lending to
agriculture and small businesses as envisioned by the legislation.
Other Sources
ICBA will continue to work to improve community bank access to
other longer-term funding from sources including the Farm Credit
System, Farmer Mac and the Federal Reserve banks in order to be better
able to meet their local lending demand. We call upon the Federal
Reserve to review the operations of its discount window as a potential
new long-term funding window for community banks.
ICBA will continue to interface with banking regulators on the
growing importance of community bank use of nondeposit sources of
liquidity. ICBA will work to educate its members about funding
alternatives and the asset/liability management challenges that arise
with their use.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM JEFF L.
PLAGGE
Q.1. Some of the past concern about raising the deposit
insurance level above $100,000 was the moral hazard of putting
the American taxpayer at risk if financial institutions fail.
Give me your thoughts as to why we should raise the deposit
insurance level above $100,000 and place the American taxpayer
more at risk?
A.1. The severe effect of inflation over the last 21 years has
cut the real value of the $100,000 insurance limit in half.
Thus, the coverage that individuals and importantly, small
businesses, have received has diminished significantly over
time. The importance of deposit insurance to maintaining the
confidence of our system requires very careful consideration of
the real value of the protection provided.
A very important part of your question is what risk this
poses to taxpayers. A critical provision, enacted in the FDIC
Improvement Act of 1991, makes banks entirely responsible for
any losses or other expenses of the FDIC. In effect, this means
that the entire capital of the banking industry stands behind
the funds. Therefore, the taxpayer risk is extremely small
under our current system and an increase of the insurance limit
would have no appreciable effect on this.
Some observers have commented that the increase of the
insurance limit from $40,000 to $100,000 in 1980 contributed to
the losses in the S&L crisis. While this increase may have made
it easier for some high-flying S&L's to fund their risky
activities, the failure on the part of the S&L's regulator to
close insolvent institutions was the primary cause of the
significant losses. This, of course, was exacerbated by poor
accounting methods, insufficient capital and lack of prompt
regulatory action to prevent abuses from taking place or
becoming worse. With such lax regulatory oversight, those high-
flying S&L's could have raised any level of funding regardless
of whether the limit were $40,000 or $100,000.
Q.2.a. Mr. Plagge, your testimony says ``there is general,
although not unanimous, support with the banking industry for
permanently indexing the level of deposit insurance coverage.''
What percentage of your membership supports indexing the level
of deposit insurance coverage?
A.2.a. While it would be impossible to say with any precision
what percentage of our membership supports indexing, it is fair
to say that the vast majority believes that indexing the fund
going forward--whether the fund is indexed from $100,000 or
some higher base level--would be appropriate. As I said in my
statement, support is not unanimous. There are some
institutions that believe that no change-- either increasing
the current base of $100,000 or indexing going forward--should
be undertaken. We base our response on discussions within our
Government Relations Council (about 130 bankers from every
State and all bank sizes), but also discussions held in
numerous forums and meetings throughout the country over the
last 18 months.
It is very important to remember that as the real value of
the insurance limit has fallen with inflation, it becomes
increasingly difficult, particularly for smaller institutions,
to raise sufficient amounts of funds to meet loan demand in
their communities. For many banks, a source of funding is the
number one issue. Recent increases in loan-to-deposit ratios
demonstrate that many community banks are searching for funds
to support loan demand. Thus, there is an important public
policy issue that underlies the need to keep the insurance
coverage limit revised to reflect inflation.
Q.2.b. What percentage of your membership supports covering
municipal deposits?
A.2.b. It would be difficult to estimate a percentage with any
precision as there are varying opinions on increasing coverage
for municipal deposits, and frankly, there is not a consensus
within the industry. Some of our members support full coverage
on municipal deposits. They believe that there is no economic
difference to the municipality whether the deposits are fully
secured or fully insured by the FDIC, yet there is a big
difference in the management of the collateral, which is costly
and time-consuming to administer and often absorbs resources
that would have otherwise been used for lending. There are also
other bankers who support a system that would allow them to
purchase additional insurance from the FDIC to cover these
deposits, perhaps at limits to $5 million or $10 million
(reflecting the level of deposits that are often associated
with these deposits). As the collateral rules are dependent on
State law and regulation, the opinions on the importance of
coverage vary from State-to-State. There are also bankers who
want no change. ABA believes that the issue should be under
consideration as legislation is developed. It is worth noting
that there is precedent under current deposit insurance
practices for a differentiation between municipal and other
deposits.
Q.2.c. What percentage of your membership supports covering the
IRA's, and other retirement accounts?
A.2.c. The vast majority of bankers support a differential
coverage limit on IRA's, Keoghs, and other retirement accounts.
Again, there are some institutions that are opposed to any
increase of any sort in the level. As noted in ABA's testimony,
there is precedent for differential coverage: Between 1978 and
1980, the coverage for IRA's and Keoghs was two-and-a-half
times ($100,000) the limit at that time ($40,000). The recent
failure of Superior Bank has highlighted the fact that many
people have retirement savings that exceed the insurance limit.
This is not ``hot'' money and well-deserves special
consideration. Moreover, the retirees are hardly the source of
market-discipline that would constrain risk-taking at financial
institutions.
Q.2.d. What percentage of your membership would be willing to
pay a small, steady premium?
A.2.d. Increasingly bankers have become concerned about the
potential costs that a revised risk-based assessment system
would involve. Thus, there is very strong and near universal
opposition to any reform that would entail additional costs to
the industry. The ABA strongly opposes this concept when the
fund is above 1.25 percent of insured deposits. The industry
does recognize that there is potential for the fund to fall
below the 1.25 percent level and that costs would arise at that
time. Moreover, changes such as increasing the insurance limit
above $100,000 might move the reserve ratio closer to the 1.25
percent designated reserve level and increase the likelihood
that new premium payments would have to be made. However, those
potential costs are far different than the immediate increase
in premiums for approximately 4,500 banks that has been
suggested in examples presented by the FDIC. These banks, among
the 92 percent of the industry currently in the 1A risk-
category, pay no premiums. The prospect of paying higher
premiums when the fund has over $3 billion in excess capital is
very disturbing for the industry. In this regard, I attach a
letter, recently sent by ABA President Donald Mengedoth to the
House Financial Services Committee, which addresses this issue
in detail.
Q.2.e. Is it worth the potential for premium increases that
would accompany a significant increase of the insurance limit?
A.2.e. There were many bankers, particularly community bankers,
who had expressed a willingness to pay some small premium if
the insurance limit was raised to $200,000. They believe they
would benefit from new deposits flowing into their banks from
such a change. They recognized that the current reserve ratio
would decline and thus might run the risk of paying some small
premium in the future. As political opposition to doubling the
insurance limit has increased and as the realities of the
potential costs of greater premiums due to the reduction of the
reserve ratio, the acceptability of paying any new costs has
fallen dramatically. The concern over paying greater costs has
also risen as the suggestions about splitting up the top-rated
category has made it clear that some institutions that pay no
premiums today would be required to pay something if these
changes were adopted.
It is important to differentiate between the two types of
additional costs. Under the current premium structure, any
increase in the insurance level, even indexing, would raise the
potential for additional premiums because the insurance funds
would move closer to the 1.25 percent designated reserve ratio.
That loss of cushion is acceptable to most, but not all, banks
in this context. The second costs--asking banks not currently
paying premiums to pay when the fund is above 1.25 percent--is
completely unacceptable to the great majority of our members
and to ABA.
Q.2.f. What do you think of Mr. Hage's proposed bill to merge
the BIF and the SAIF; allow for flexible recapitalization of
the deposit insurance fund and permit the FDIC to impose a fee
on existing institutions for excessive deposit growth?
A.2.f. We believe it is too narrow. The provisions in Mr.
Hage's bill provide a reasonable starting point for any reform.
As ABA pointed out in our testimony, there are other very
important considerations--including capping the funds,
providing rebates and adjusting insurance levels for
inflation--that should be considered as part of any
comprehensive plan. We are pleased that the FDIC and the other
banking regulators recognize the need for a comprehensive
approach to reforming the deposit insurance system.
Q.3. Mr. Powell indicated that perhaps all the FDIC proposed
reforms did not have to be in one package. (a) What would be on
your ``must have in the bill'' list if you were making one? (b)
Should these reforms be done now?
A.3. We have serious doubts about proceeding in stages, frankly
because we doubt there would be a second stage. In our written
statement we have laid out the many issues that should be
considered as part of any comprehensive reform of the FDIC. We
believe that any narrowing of the list or prioritizing would
tend to limit the possibility that a complete review of the
issues be undertaken.
From our discussions at our large Summer Planning Meeting
two messages were heard loud and clear: First, that industry
would be opposed to any reform that would raise the cost of the
system to the banking industry; and second, that any reform
package should include a cap on the fund and a rebate or
dividend system.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM CURTIS L.
HAGE
Q.1. Some of the past concern about raising the deposit
insurance levels above $100,000 was the moral hazard of putting
the American taxpayer at risk if financial institutions fail.
Give me your thoughts as to why we should raise the deposit
insurance level above $100,000 and place the American taxpayer
more at risk?
A.1. ACB supports a modest increase in general coverage levels
indexed from the $40,000 level Congress set in 1974, since that
was the last time coverage was adjusted solely to account for
inflation. Depending on the index used, that would result in
coverage of approximately $135,000. We also support indexing
coverage to account for future inflation. We do not believe
such an increase in coverage would pose additional risk to the
taxpayers because the ``real,'' or inflation-adjusted level of
coverage would be unchanged. Moreover, the deposit insurance
funds remain strong and banking industry capital--the first
line of defense against losses--remains at historically high
levels.
Nevertheless, ACB would not an advocate an increase in
general coverage levels if it were accompanied by unacceptable
increases in costs or if debate over the issue threatened to
delay action on more urgent deposit insurance reform issues.
ACB believes Congress should act quickly to deal with the
rapid growth in deposits at a few ``free rider'' institutions.
As I said in our testimony, ACB urges Congress to act this year
on a bill to merge the Bank Insurance Fund (BIF) and the
Savings Association Insurance Fund (SAIF), eliminate the
mandatory 23-basis-point premium, and give the FDIC authority
to impose premiums on excess deposit growth.
ACB does not believe that a modest increase in coverage
levels or indexing would greatly increase the total amount of
insured deposits. Frankly, our members believe that there would
be some shuffling of deposits among insured institutions, but
no major infusion of deposits from outside the system. Since
there would be only a modest increase in total insured
deposits, a premium increase would not be justified.
However, we agree with the FDIC that indexing coverage
would be helpful to maintain the relative position of deposit
insurance in the Nation's economy. Indexing would allow an
individual to maintain the same relative level of coverage
without opening multiple, additional accounts at different
institutions.
While ACB does not advocate a substantial increase in
general coverage levels, we strongly support providing a
substantial increase in retirement account coverage. As I said
in our testimony to the Committee, Americans are increasingly
responsible for managing their own retirement funds and need a
safe haven for these important assets. In the recently passed
tax legislation, Congress encouraged even greater growth in
these accounts. Clearly, substantially increased deposit
insurance coverage would help implement this public policy.
Q.2.a. Mr. Plagge's testimony says ``there is general, although
not unanimous, support within the banking industry for
permanently indexing the level of deposit insurance coverage.''
What percentage of your membership supports indexing the level
of deposit insurance coverage?
A.2.a. ACB has not surveyed our membership on this question
explicitly. However, in the fall of 2000, we formed a deposit
insurance team of 32 members to comprehensively examine the
FDIC's deposit insurance options paper, which raised the
possibility of indexing. The team's consensus was that if it
was not possible to obtain modest increases in coverage in the
short run, the Congress should at least index coverage going
forward. That would maintain the relative role of deposit
insurance in the Nation's economy without adding significant
new risk to the FDIC. This conclusion (as well as the Team's
other recommendations) was later endorsed unanimously by the 70
members of ACB's Government Affairs Steering Committee and
Board of Directors.
Q.2.b. What percentage of your membership supports covering the
municipal deposits?
A.2.b. ACB members hold differing views on increased coverage
for municipal deposits. This generally reflects differences in
State and local practices. For example, in Minnesota local
governments have joined together to form mutual funds,
effectively by-passing insured depository institutions. In
other States, not all depository institutions are eligible to
accept municipal deposits. On the other hand, some minority
owned institutions believe they might benefit from increased
coverage for these deposits. In sum, ACB believes that
policymakers should avoid imposing an across-the-board premium
for increased coverage that would not benefit all institutions.
Q.2.c. What percentage of your membership supports covering the
IRA's and other retirement accounts?
A.2.c. As indicated in my reply to question 1, ACB strongly
supports a substantial increase in coverage for retirement
accounts. ACB's deposit insurance team believes that this has a
solid basis in public policy and would be a major benefit to
the Nation's retirees and those approaching retirement. In
addition, these deposits would be a major boost to community
lending by providing a stable base of long-term funding.
Q.2.d. What percentage of your membership would be willing to
pay a small, steady premium?
A.2.d. ACB strongly supports maintaining the current statutory
language preventing the FDIC from imposing premiums on well-
capitalized and well-run institutions when FDIC reserves are
above the required levels. We reject the notion that by not
paying premiums currently, these institutions are getting
``free'' deposit insurance coverage. My bank and thousands of
others have already paid for our coverage. From 1992 through
1996, insured institutions paid a total of $28.3 billion into
the insurance funds. That is a large majority of the
approximately $42 billion now available in BIF and SAIF. Much
of the additional amount is the interest earned on the money we
paid in.
Q.2.e. Mr. Plagge's testimony also discusses a study which
shows that ``doubling coverage could result in net new deposits
to the banking industry of between 4 percent and 13 percent of
current domestic deposits, with the lower end of the range more
likely.'' Also doing this ``would lower the BIF-SAIF reserve
ratio below the required 1.25 percent.'' Is this worth the
potential cost?
A.2.e. ACB does not believe that doubling deposit insurance
coverage--which could reduce the reserve ratio below the
required 1.25 percent--would be worth the potential cost. As I
indicated in response to question 1, we would expect only a
very modest increase in deposits as a result of doubling
coverage. ACB believes that prompt action on legislation to
permit banks to pay interest on business checking accounts
would do far more to improve banks' ability to attract
deposits. We strongly urge the Senate to act on this proposal,
which has already passed the House as H.R. 974.
Q.2.f. Is it worth the potential for premium increases that
would accompany a significant increase of the insurance limit?
A.2.f. As indicated in my answers to other questions, ACB does
not support a significant increase in general coverage limits
in large part because they would likely be accompanied by
unacceptable premiums.
Q.3.a. Mr. Powell has indicated that perhaps all of the FDIC-
proposed reforms did not have to be in one package. What would
be on your ``must have in the bill'' list if you were making
one?
A.3.a. ACB's ``must have in the bill'' proposals are contained
in H.R. 1293, the Deposit Insurance Stabilization Act,
introduced by Representatives Bob Ney (R-Ohio) and Stephanie
Tubbs Jones (D-Ohio). That bill fully addresses the concern
that one or both of the deposit insurance funds could fall
below the 1.25 percent ratio, triggering a damaging 23 basis
point premium. H.R. 1293 contains three elements:
Permits the FDIC to impose a fee on existing
institutions for deposit growth that materially dilutes the
insurance funds, so that the required reserve ratio can be
maintained. Currently, the FDIC may impose an excessive
deposit growth fee on new institutions or new branches. By
allowing the FDIC to impose fees on existing institutions,
H.R. 1293 would address the current ``free-rider'' problem.
Merges the BIF and the SAIF. According to the FDIC,
merging the BIF and the SAIF would create a more stable,
actuarially stronger deposit insurance fund. A single,
larger fund would be less affected by either rapid deposit
growth at a few institutions or losses from failures.
Allows for flexible recapitalization of the deposit
insurance fund. If the reserve ratio of the merged fund
falls below the required level of 1.25 percent, the bill
would give the FDIC flexibility in recapitalizing the fund
over a reasonable period of time. By repealing the
automatic assessment of 23 basis points, H.R. 1293 would
give the FDIC authority to use a laser beam approach,
rather than a sledgehammer, to recapitalize the insurance
fund.
ACB believes that Congress should act quickly on this
legislation to help ensure the continued strength of the FDIC
and prevent the potential diversion of billions of dollars away
from community lending to homeowners, consumers, and small
businesses.
Q.3.b. Should these reforms be done now?
A.3.b. ACB strongly urges the Congress to act this year on the
proposals contained in H.R. 1293. We would welcome action on
other issues--such as providing for rebates and substantially
increasing coverage for retirement accounts. However, if the
list of comprehensive reform proposals is too long for the
Congress to pass this year, we ask that you set priorities,
enact what you can this year, and return to the rest next year.
Further large transfers from uninsured money market funds
into insured deposits, accompanied by just a few costly
failures, could easily trigger large premium assessments across
the country. There is no way to predict those events with any
accuracy. But unless Congress acts now, the matter will be
outside your control. That is a risk we should not take and one
we can avoid.
RESPONSE TO ORAL QUESTION OF SENATOR JOHNSON
FROM CURTIS L. HAGE
I would like to take this opportunity to supplement my
response to Chairman Johnson's question on this topic.
Q.1. Senator Johnson asked for responses to a Treasury
Department suggestion ``that Federal Home Loan Bank advances
and other secured capital be considered in the deposit
insurance assessment base. The FDIC's report said that a bank's
reliance on noncore funding, which may include these advances,
should be considered risky.''
A.1. My bank has relied for years on Federal Home Loan Bank
advances; they are a core part of my funding. Advances are a
stable and reliable supplement to my core deposit base. With
these options, I do not have to rely on other funding sources,
such as the higher-cost brokered deposits. The FHLBank advances
are over-collateralized as required by regulation and they add
strength to a properly run depository institution as an
alternative source of funding. My use of advances makes my
institution more stable, reducing the likelihood that the FDIC
would suffer any loss associated with our insured deposits.
It is true that a bank might use advances, or any other
funding source, to finance risky operations. However, the risk-
based premium structure is in place precisely to impose
appropriate costs on more risky activities. If the FDIC finds
that certain types of lending or other activities increase the
risk of failure, then it should impose a premium to reflect
that risk. The additional risk would stem from the activity,
not how that activity is funded, especially when the funding
source is as stable as advances from the Federal Home Loan Bank
System.
While it is true that the collateral supporting advances
stands ahead of the FDIC in the event of an institution failure
and resolution, appropriately used advances provide necessary
funding flexibility, helping ensure that depository
institutions remain healthy. Adding advances as a risk factor
would unnecessarily raise costs to the detriment of consumers
and businesses that ultimately benefit from the responsible use
of advances.
Now that the System is more fully open to the commercial
banks, advances are becoming more important to community
lending throughout the country. Given the shortage of deposits
in many communities, it would not make sense to artificially
discourage depository institutions use of Federal Home Loan
Bank advances for housing and community development.