Mr. Chairman, Senator Gramm, and Members of the Committee, I appreciate the opportunity to provide the Administration's views on reform of the deposit insurance system. Chairman Powell and the FDIC staff are to be commended for their valuable contributions to the policy discussion of deposit insurance reform. I am also grateful for the Committee's interest in holding a hearing on this important issue.
Our current deposit insurance system is intended to balance the interests of savers and taxpayers by aiming to protect them both from exposure to bank losses and, thereby, to promote public confidence in the U.S. banking system. Consistent with this objective, the Administration believes that some improvements could be made in the system's operation and fairness. Specifically, the Administration favors reforms that would: (1) reduce the system's pro-cyclical bias by allowing the insurance fund reserve ratio to vary within a range and eliminating triggers that could cause sharp changes in premiums; (2) improve the system's risk diversification by merging the bank and thrift insurance funds; and (3) ensure that institutions appropriately compensate the FDIC for insured deposit growth while also taking into account the past contributions of many institutions to build fund reserves.
While these improvements are worth pursing, there is no sound public policy purpose to be served by an increase in deposit insurance coverage limits. There is no financial benefit to savers to be derived from increased coverage limits because individuals can today hold insured deposits, up to the limits, at any number of banks. The only credible benefit to savers is that of greater convenience, but this is of potential use to only that small fraction of the population that has sufficient savings, which they choose to hold in the form of deposits, to have any possible need for coverage in excess of $100,000. Increased coverage limits would provide no benefit to the overwhelming majority of Americans but, as taxpayers, it would expose them to additional risk. Higher coverage limits would mean greater contingent liabilities of the Government and weaker market discipline, exposing the insurance fund and taxpayers to increased risk of loss. Weighing the ephemeral benefits of increased coverage against the significant costs of added risk and the erosion of market discipline, the Administration cannot support an increase in coverage limits, whether directly or by indexing.
My statement will first discuss those reforms that we think would enhance the operation and fairness of the system. I will then review why we do not support coverage limit increases.
Reducing the Pro-cyclical Effects of Deposit Insurance Pricing
Reserves should be allowed to grow when conditions are good to better enable the fund to absorb losses under adverse conditions without sharp increases in premiums. Allowing the reserve ratio to vary within a range would help to reduce the potential pro-cyclical effects of deposit insurance pricing.
The existing designated reserve ratio of 1.25 percent of reserves to insured deposits was historically derived roughly as the average reserve ratio over part of the FDIC's history. As it is based on an average, it is logical to provide for reserve growth above that level when conditions are good (and for reserves to decline below that level when conditions are unfavorable).
We support the FDIC's recommendation that it have authority to adjust the designated reserve ratio periodically within prescribed upper and lower bounds. FDIC should also have greater discretion in determining how quickly it achieves the designated reserve ratio that it selects. This flexibility would help reduce potential pro-cyclical effects by stabilizing industry costs over time and avoiding sharp premium increases when the economy may be under stress. In the context of these reforms, it would also be appropriate to eliminate the current requirement that premiums rise to a minimum of 23 cents per $100 of domestic deposits when the fund is expected to remain below the designated reserve ratio for more than a year.
We are mindful that efforts to achieve a more counter-cyclical policy require that depository institutions build insurance reserves in good times to pre-fund future losses. To do otherwise could leave the fund exposed to years of low reserves following a rash of bank failures in the future and could increase the likelihood of prolonged high premiums (and, at the extreme, taxpayer assistance). Such an outcome would be unwelcome both economically and politically. Determining the appropriate statutory range for the designated reserve ratio requires striking a balance between the burden of pre-funding future losses and the pro-cyclical burden of replenishing the insurance fund in a downturn. Within the range, the actual designated reserve ratio should always be under study by the FDIC, with public notice and comment concerning any proposed change. A key benefit to giving the FDIC greater flexibility to adjust the designated reserve ratio is that it may better achieve low, stable premiums over time.
Premiums, Assessment Credits, and Rebates
The FDIC currently lacks authority to charge over 90 percent of banks and thrifts any premium for deposit insurance. The insurance funds' existing capacity to absorb losses comes primarily from the high premiums paid by institutions in the first half of the 1990s. Some large financial companies have rapidly increased insured deposits in recent years through their multiple subsidiary depository institutions - without compensating the FDIC. According to FDIC data, insured deposit growth from sweep programs conducted by two of these companies has reduced the Bank Insurance Fund reserve ratio by 4 basis points. In addition, hundreds of other recently chartered banks and thrifts have never paid insurance premiums.
To ensure that institutions appropriately compensate the FDIC for insured deposit growth, Congress should remove the current restrictions on FDIC premium-setting while authorizing the agency to provide assessment credits (i.e., offsets) against future premiums based on each institution's recent history of premium payments. We find reasonable proposals by the FDIC and others that would initially allocate these credits to institutions that contributed to the build-up of insurance reserves in the early-to-mid 1990s. According to FDIC, the credits would allow many of these institutions to continue to pay no premiums for a period of several years under reasonable assumptions about the health of the economy and banking system. On an on-going basis, assessment credits would permit the FDIC to collect proportionally greater payments from institutions with rapid insured deposit growth than from those growing more slowly.
As a tool for managing insurance fund reserve levels, we prefer assessment credits to rebates, which would drain the insurance fund of cash. We would also want to avoid placing a "hard cap" on the fund that would trigger large mandatory cash rebates. Such a cap would conflict with the important objectives of allowing reserve growth under good conditions and smoothing industry payments over time.
We also are sympathetic to the FDIC's request for more flexibility to vary premiums according to the risk that an institution poses to the insurance fund. Ideally, an institution's risk-based premium should account for the riskiness of its assets, the structure of its liabilities, the strength of its capital base and management, and the effect that its failure would have on insurance fund reserves. The range in premiums should be sufficiently wide to reflect the spectrum of relative financial and managerial soundness among the nation's depository institutions, and thereby to have the desired behavioral effects.
Merging the Bank and Thrift Insurance Funds
We support a merger of the bank (BIF) and thrift (SAIF) insurance funds and we urge the Congress to merge the funds as soon as practicable regardless of whether it chooses to pursue other reforms in the near term. A larger, combined insurance fund would have a greater ability to diversify its risks than either fund separately. It would make sense to merge the funds while the industry is strong and while a merger would not unduly burden either BIF or SAIF members. A merged fund would also prevent the possibility that institutions posing similar risks could pay significantly different premiums for the same FDIC insurance, as was the case in 1995 and 1996. Incentives created by a premium disparity could result in a wasteful expenditure of industry resources in order to avoid higher assessments. Finally, a merger would underscore the fact that BIF and SAIF are already hybrid funds: each one insures the deposits of commercial banks, savings banks, and savings associations. Indeed, commercial banks now account for 43 percent of all SAIF-insured deposits. A merger would simply recognize the commingling of the funds that has already taken place and that is likely to continue.
Deposit Insurance Coverage Limits
While we support the FDIC's efforts to secure the improvements to the deposit insurance system that I have just outlined, we see no sound public policy purpose that would be served by an increase in current or future coverage limits. Consumers do not need an increase in coverage limits and would receive no real financial benefit. An increase in coverage limits would reduce - not enhance - competition among banks in general but would not predictably benefit any particular class or category of banks. Higher coverage limits would mean greater contingent liabilities of the Government and weaker market discipline, exposing the insurance fund and taxpayers to increased risk of loss.
Higher Coverage Limits Would Not Benefit Consumers
Last summer, the Treasury Department testified before a House subcommittee that we "see no evidence that the current limit on deposit insurance coverage is burdensome to consumers." Since then, we have continued to look for such evidence and found none. The vast majority of bankers with whom we have spoken since that time - from institutions of all sizes - have provided no evidence to the contrary. We have received no calls, no letters, from consumers demanding increases in coverage to avoid the inconvenience of having to place deposits in excess of $100,000 at more than one institution.
Increasing the deposit insurance limit would do little - if anything - for most savers. Consumer finance survey data from the Federal Reserve indicate that the median deposit balance is far below the current ceiling. Only approximately three percent of households with deposit accounts held any uninsured deposits, and the median income of these households was approximately double the median income of households with deposits under $100,000.
Ample opportunities already exist for savers with substantial deposits - including retirees and those saving for retirement - to obtain FDIC coverage equal to several times $100,000. Without much difficulty, they may place deposits in several FDIC-insured institutions or establish accounts within the same institution under different legal capacities that qualify for separate coverage (e.g., individual, joint, IRA). Many consumers feel comfortable putting substantial amounts into uninsured but relatively safe money market mutual funds, and there are other low-credit risk investments available for retirement savings or for other purposes. Thus there is no widespread consumer concern about existing coverage limits.
Higher Coverage Limits Would Not Benefit Banks or Promote Competition
Proponents of higher coverage limits have claimed that they are necessary for community banks to remain competitive in attracting funds. Yet there is no evidence that community banks have had trouble attracting deposits under the existing coverage limits. In fact, the Federal Reserve has shown that smaller banks on average have grown more rapidly and experienced higher rates of growth in both insured and uninsured deposits than larger banks over the past several years.
Furthermore, because higher coverage limits would apply to all depository institutions, multi-bank holding companies now offering $200,000 in coverage through two subsidiary banks would be able to offer, for example, $260,000 if the coverage limit was raised to $130,000. Thus these companies could continue offering twice the level of coverage available from a single-bank company. In fact, given the ability of major financial companies to sweep large volumes of funds between uninsured investments and insured deposit accounts in several subsidiary banks, higher coverage limits may improve the competitive position of these companies in deposit-taking vis-à-vis small banks. Therefore, it is hard to see how higher limits could improve community banks' ability to compete with larger banks for deposits.
Competition is essential to keeping banks vital. Banks compete for large deposits by demonstrating the soundness of their balance sheet and operations to such depositors. This competition for funds enhances the entire credit allocation mechanism. In general, raising coverage limits would reduce the amount and rigor of credit judgments by large depositors, thereby weakening the competition for funds and the efficiency of credit allocation.
Indeed, there is no credible evidence that increased coverage limits would serve to promote competition among banks. I believe that one reason the issue of coverage limits has surfaced is precisely because the decline in the real value of the coverage limit over the last two decades has served to promote a healthy competitive dynamic among banks in vying for the attention of customers. Continuing the current fixed ceiling on deposit insurance coverage, while permitting individuals to hold insured accounts at more than one institution, provides consumers with the potential benefits of greater total insured deposits if they need them and fosters a competitive discipline on bankers to provide quality services to their customers. Indexation of deposit insurance coverage limits would remove this discipline and only serve to reduce competition from what it otherwise would be.
Not only would higher coverage limits erode competition among banks, at the same time banks would face upward pressure on premiums. By diluting insurance fund reserves, higher coverage limits would mean that more reserves would be necessary just to meet the existing designated reserve ratio of 1.25 percent of reserves to insured deposits. Recent FDIC estimates indicate that, for example, raising the general coverage limit to $130,000 and retirement account coverage to double that amount would lower the combined fund reserve ratio initially by 4-5 basis points as existing uninsured deposits convert to insured status. As new deposits are brought into the banking system by the coverage increase, the total drop in the reserve ratio could be 9-10 basis points. Higher coverage limits for municipal deposits would result in an additional decline in the reserve ratio.
Higher Coverage Limits Would Increase Insurance Fund and Taxpayer Risks
Given the lack of potential benefits for consumers or of potential improvement in banking system competition, we cannot justify the increase in the Government's off-balance sheet liabilities that would result from higher deposit insurance coverage limits. These higher contingent liabilities enlarge the exposure of the insurance fund, and ultimately of taxpayers, to potential future losses.
Moreover, increasing the overall coverage limit could weaken market discipline and further increase the level of risk to the FDIC and taxpayers. Proposals for even higher levels of protection of municipal deposits than of other classes of deposits would only exacerbate this problem. Providing substantially higher coverage for municipal deposits would significantly reduce incentives for state and local government treasurers to monitor risks taken with large volumes of public sector deposits. Should the FDIC largely protect these funds, an important source of credit judgment on the lending and investment decisions of local banks would be lost.
Weaker market discipline runs the risk of additional supervisory or regulatory measures that might eventually be necessary to offset the risks to the insurance fund and taxpayers. Because of the absence of identifiable benefits, we would want to avoid actions such as a coverage limit increase that would risk the possibility of greater cost burdens on our banking system.
Funding of Supervision Costs
In considering reform of deposit insurance pricing, it is important to recognize that a significant portion of insurance fund expenditures is not for the resolution of failing institutions, but for the FDIC's supervision of almost 5,500 state-chartered commercial and savings banks. While these state banks pay fees for the fraction of supervision performed by state authorities, they are not charged fees for the significant share of supervision that is performed by the FDIC. (State banks that are supervised by the Federal Reserve are treated in a similar manner.) National banks and savings associations, by contrast, are charged for 100 percent of their supervision, and in addition must subsidize FDIC's costs to supervise state banks through their contributions to the insurance funds (and the fund's earnings on those contributions). This uneven distribution of supervision costs is a real problem that should be addressed. All of the federal and state bank supervisory agencies should continue to have the resources necessary to promote safety and soundness. We look forward to working with Congress and the FDIC Board to devise a solution to this problem.
Let me conclude by re-affirming the Administration's support for several of the deposit insurance recommendations advanced by the FDIC. We believe that these reforms would improve the operation and fairness of the system, and we look forward to working with Congress and the FDIC on their implementation. However, the Administration does not support an increase in deposit insurance coverage limits, whether by raising the limit directly or by indexation.
Thank you for the opportunity to appear before the Committee today.
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