Mr. 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) 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.
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 Reps. 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 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 1990s – 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."
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 1980s and 1990s. In the early 1990s, 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:
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.
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.
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. 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 multi-billion 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 the insurance fund posed by an existing institution that begins growing at a rate significantly above the industry average.
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.
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.
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." 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.
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…." 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.
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. Clearly, the agency could adapt that analysis to determine a reasonable ceiling to recommend to Congress.
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.
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-Penn.) and John Edwards (D-N.C.) and Reps. Frank Lucas (R-Okla.) and Mel Watt (D-N.C.) that would have set a 1.4 percent ceiling and used the excess to pay interest on FICO bonds. 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).
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.
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 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 five 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 five-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.
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 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 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.
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