|
January 30, 2001
Mr. Robert E. Feldman
Executive Secretary
Attention: Comments/OES
Federal Deposit Insurance Corporation
550 17th Street, N.W.
Washington, DC 20429
RE: Deposit Insurance Options Paper
August 2000
Dear Mr. Feldman:
The Association for Financial Professionals (AFP) welcomes the opportunity to comment on the issues presented in the Federal Deposit Insurance Corporation's (FDIC) Deposit Insurance Options Paper of August 2000, concerning potential modifications to the deposit insurance system. The paper addresses various options to deposit insurance reform in order to open debate on a number of proposals for changes in FDIC insurance premiums, insurance fund management and account coverage.
The AFP, formerly the Treasury Management Association, represents over 14,000 finance and treasury professionals who on behalf of over 4,500 corporations and other organizations are significant participants in the nation's payments system, and manage their organizations' banking relationships. In these roles, our members negotiate, monitor and approve for payment charges passed-through by banks for deposit insurance assessments paid to the Bank Insurance Fund (BIF). Organizations represented by our members are drawn generally from the Fortune 1000 and the largest of the middle market companies and they have an active interest and a sizable stake in any proposed changes to the deposit insurance assessment system. This stake is based on the premise that deposit insurance coverage is intended to insure depositors, not banks.
It is important to note that our members believe that their organizations are the dominant funders of the BIF because banks pass through the deposit insurance costs to corporate customers on the basis of balance size. Importantly, our members pay these assessments based on full balances which customarily are well in excess of the insured $100,000 limit. In effect large corporate depositors subsidize the BIF through premium costs for deposits which are not insured by the fund.
For these reasons, AFP urges that now is the appropriate time to redefine the deposit insurance assessment base and modernize an outdated and unfair deposit insurance premium methodology.
Our recommendation on this matter is simple: assess only insured balances using a pricing methodology based on average daily collected balances. This approach eliminates the inequity of paying premiums for uninsured balances, discontinues an obsolete float adjustment factor by measuring/reporting collected balances, and solves the quarter-end assessment avoidance problem by utilizing a daily average balance method.
In announcing the Options Paper, FDIC Chairman Tanoue quoted an old saying, "the best time to fix your roof is when the sun is shining." We agree that this discussion is timely for a number of reasons:
- The BIF has undergone dramatic reversal and recovery over the past decade. BIF reserves were exhausted by painful losses within the commercial banking industry in the late eighties and early nineties. The BIF now has recovered to the point where statutory required reserve levels have been exceeded.
- Deposit insurance premiums rose from 8.3 cents per $100 of assessment deposits on January 1, 1990 to 23 cents on July 1, 1991 in an effort to replenish a bankrupt BIF. Now, there are no deposit insurance premiums levied on over 93 percent of depository institutions.
- The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) enhanced the BIF's line of credit with the Treasury, mandated a move to a risk-based premium structure, and ordered a reserve level of 1.25 percent of deposits.
- Since the FDICIA, Congress has enacted two important pieces of financial sector legislation. In 1994 the Reigle-Neal Act removed most of the remaining restrictions to interstate consolidation of the banking system. Last year the Financial Modernization Act of 1999 (FMA) was signed into law. Also known as the Gramm-Leach-Bliley Act, this statute represents the single most important set of regulatory reforms since the Glass-Stegall Act of 1933. The FMA repeals many provisions of Glass-Stegall that prohibit or limit the affiliation of banks with other nondepository financial firms.
- The cumulative effect of these post-FDICIA statutes will be to accelerate the trend towards a financial system that is more integrated in terms of activities and products -- a single financial firm will be able to provide commercial banking, investment banking and insurance products. In addition, these reforms have resulted in a banking system that is more geographically integrated as the interstate consolidation of the banking system continues. However, a possible unintended effect of post-FDICIA reforms may be the defacto extension of federal deposit insurance to a larger part of the financial system.
- Technology has provided the means of modernizing bank reporting schemes originally developed about forty years ago.
- The costs to bank customers for funding the deposit insurance system threatens to become significant once again if the reserve level falls below 1.25 percent of insured deposits. The realization that these costs are largely passed through the banking system to bank customers is relatively recent, and has stirred corporate customers' interest as stakeholders in the deposit insurance system.
Basically, the Options Paper asks three fundamental questions:
- How should the FDIC price risk?
- How should losses be funded?
- How should insurance coverage levels be determined?
In conjunction with the Options Paper, the FDIC has posed specific survey questions related to the three major issues covered in the paper. We address those questions for which we have an opinion and comment.
Pricing Deposit Insurance for Individual Banks:
Q: Should the risk based premium system allow for more differentiation
among the risk profiles of the institutions in the best insurance categories?
|
A: |
The risk based premium system should allow for more differentiation among the risk profiles of the more than 9,000 institutions currently in the best insurance category. Risk exposure to the system by deposit mix characteristics should be reflected in the risk profile. An institution with deposit accounts balances primarily well in excess of the coverage limit poses less risk to the system than an institution with deposit accounts balances primarily under the coverage limit. The methodology fails to capture differences in loss potential among banks with similar ledger balances but varied deposit bases. For example, a retail bank with average account balances below the coverage ceiling has a far greater loss potential for the BIF than a wholesale bank with a similar aggregate ledger balance. A more appropriate basis for levying BIF charges would entail some determination of account types held by the institution to assess actual loss potential from accounts under $100,000.
We also believe that special premiums should be imposed on institutions with high deposit growth to help prevent the fund from falling below the required reserve ratio of 1.25 percent. Special premiums should also be assessed on de novo institutions, and institutions transferring deposit balances into the system from non-insured sources. This is an equitable approach because it limits the ability of some institutions benefiting from reserves built from past premiums which they did not pay. |
|
Q: Should there be a mandatory subordinated debt requirement to assist the
FDIC on pricing deposit insurance?
|
A: |
The use of external market information such as a subordinated debt evaluation may be helpful in assessing large bank risks for pricing purposes but likely of little value beyond the top tier institutions. In any case, the use of subordinated debt should not be mandatory. |
|
Q: Should the FDIC explore the use of re-insurance contracts or other
customized financial instruments (similar to default swaps) to obtain a
market assessment of the risk posed by specific institutions or pools of
institutions?
|
A: |
While this option may be worth exploring in order to draw on information from the re-insurance markets for deposit insurance pricing, we believe that the FDIC has access to more information about all banks than any entity in the private market. The supervisory examination process alone should generate insights that are not available to the market. |
|
Funding Deposit Insurance Losses:
Q: Is deposit insurance best viewed as the government bearing the risk and
charging a user fee, or the industry mutually insuring itself?
|
A: |
Deposit insurance is best viewed as the industry mutually insuring itself. FDICIA fundamentally changed the structure of the nation's deposit insurance system by placing the risk of loss on insured banks and effectively their depositors rather than the FDIC or the federal government. Under the system adopted in 1991, FDICIA required insured banks to recapitalize the BIF up to a level equal to 1.25 percent of all deposits. It also authorized the FDIC to assess insured banks for whatever additional amounts might be necessary to replenish the Insurance Funds whenever they fall below the 1.25 percent level. Since there is no limit to the amount of assessments which could be imposed by the FDIC, this system places all liability for deposit insurance losses on insured banks and ultimately their depositors. Federal government responsibility would arise in catastrophic situations only after the capital of the banking system is exhausted.
The essence of a mutual insurance system is that stakeholders fairly participate in the costs and benefits (policyholder dividends, lower rates, etc.) of the insurance arrangement. Corporate depositors subsidize the costs of the current deposit insurance system since deposit assessments are made on uninsured balances and utilize an obsolete and inappropriate float adjustment factor. Also, we are not optimistic that any future "dividends" (i.e., rebates) would be passed on to depositors. |
|
Q: How should we strike the balance between maintaining stable premiums
versus maintaining a stable fund?
|
A: |
The design of the funding arrangements will determine whether the industry is asked to pay for the costs of deposit insurance when the industry is healthy or when it is experiencing problems. Stable premiums avoid the prospect of charging banks the most when they can least afford to pay. The current variable premium approach is a "pay-as-you-go" system. During good times the costs are insignificant and during bad times, the costs are escalated and charged to the banks. However, banks do not absorb the premiums at any level -- but pass-through these costs (stable or variable) to bank customers.
We support the concept of variable risk-based premiums adjusted to the required reserves level which is currently set at 1.25 percent. A stable premium has the potential to grow the fund beyond projected needs. The approach lacks appeal to bank customers who pay the premium costs but are unlikely to receive any benefits of a rebate system triggered by excess reserves.
We have stated previously that we also support the concept of special premiums assessed on institutions with high deposit growth, on de novo institutions, and on institutions which transfer balances into the system from non-insured sources. This approach limits institutions from taking advantage of past premiums which they did not pay. |
|
Q: Under the user-fee model, should historical experience, analytical
methods, or market forces be used to determine the assessment revenue
needs of the insurer?
|
A: |
We reject the user-fee model based on the government bearing the risk of bank failures, and we believe FDICIA has obsoleted the user-fee model, as discussed above. |
|
Q: Should premium rates under a user-fee model be adjusted for current
insurance expenses linked to the insurance fund, or tied to a hard or soft
target?
|
A: |
We oppose the user-fee model which assumes the government bears the risk rather than the industry mutually insuring itself. |
|
Q: Under a mutual system, how should rebates be determined and allocated?
|
A: |
We oppose rebates on the basis that an equitable rebate method cannot be constructed. The entity bearing the premium cost -- the bank customer -- is unlikely to receive the value of any rebate. A fair rebate solution would require payment to the bank customer of pass-through costs based on historical balance levels at the time of assessment. We doubt this process would be undertaken by most banks on behalf of their customers. Since most banks would not pass on rebates, we prefer a system in which excess funds trigger adjustments to a variable risk-based premium system. |
|
Q: Is the current mechanism for funding systemic risk exceptions appropriate?
|
A: |
Yes, the FDIC has the latitude to impose a special assessment to defray the excess cost of systemic risk resolution. In the case of "too-big-to-fail," this special assessment is based on total assets so the costs would shift to larger banks which benefit from any exercise of "too-big-to-fail." |
|
Coverage Limits:
Q: Should the deposit insurance coverage limit be indexed to some measure
of prices, income or wealth?
|
A: |
We believe it is unnecessary to index the deposit insurance coverage limit to an economic measurement because the current deposit insurance ceiling is appropriate to the intent of the system -- if not already too high. The intent of the system is to protect the small saver whose average deposit balance in these accounts is under $6,000.
If deemed unavoidable however, any indexing scheme should be effective on a prospective basis, triggered on a five-year cycle and rounded to the nearest thousand-dollar level. |
|
Q: Would a higher coverage limit effectively address funding concerns at
smaller institutions and allow them to compete effectively with large
institutions for deposits?
|
A: |
With competition from a broad array of non-bank competitors for the consumer's discretionary funds, it is not clear that a higher coverage limit would address funding concerns at smaller institutions. In any event, we do not believe that the use of federal deposit insurance to assure bank funding for competitive purposes is an appropriate public policy issue. Deposit insurance coverage is not a competitive issue -- coverage is intended to insure depositors, not banks.
We agree with Federal Reserve Chairman Greenspan that it would be a mistake to raise the $100,000 insurance coverage limit. Over 98 percent of all domestic deposit accounts in commercial banks are under the $100,000 deposit insurance limit, and the average deposit in these accounts is less than $6,000. Since we believe that the intent for the federal deposit guarantees initiated by the Banking Act of 1933 has been to protect the small saver, the current deposit insurance ceiling is appropriate -- if not already too high.
A recent study by the American Bankers Association measured the impact of raising the deposit insurance level to $200,000. The study concluded 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. These hypothetical new deposits, plus the added protection that existing deposits between $100,000 and $200,000 would receive, would lower the Insurance Fund's reserve ratio below the required 1.25 percent and eliminate the $3 billion excess reserve above 1.25 percent now in the Insurance Fund. The study estimates that a 3-13 basis point assessment on all domestic deposits would be required to return the ratio to 1.25 percent.
This solution -- doubling the deposit insurance coverage -- translates into a costly depositor remedy to a perceived competitive problem for some banks. |
|
Q: In order to maintain competitive equity for large and small institutions, can
we rely on approaches that further reduce implicit protections for
large-bank depositors by ensuring that uninsured depositors and creditors
always bear some losses in the event of failure?
|
A: |
We do not believe that a guarantee "ensuring" losses by any depositor or creditor group in the event of bank failure is reasonable public policy. |
|
Q: Should full deposit insurance coverage be provided for municipal and
other public sector deposits? A higher coverage limit?
|
A: |
No -- to both questions. A "protected class" of deposits is not good public policy. Full coverage for certain types of deposits reopens the ‘moral hazard' question concerning excessive risk taken by institutions because deposits are fully protected. Also, a practical effect of this approach may be to chase non-insured corporate deposits because they would be subordinated to fully protected public sector deposits in the case of bank failure.
As a matter of course, corporates assume the responsibility for determining the soundness of institutions in which uninsured deposits are held. The public sector should operate on the same basis. Moreover, we understand that some states effectively provide full coverage for public sector deposits through collateral guarantees. |
|
Q: Should the deposit insurance system feature optional excess coverage in
addition to private excess coverage?
|
A: |
The FDIC should not be involved in providing optional excess coverage beyond the mandatory limits. The private sector could provide excess coverage options, provided there is a market for such coverage. Private sector actions would determine the viability of such a market. |
|
Conclusion:
AFP appreciates the opportunity to comment on the Options Paper. We hope that our observations and responses to specific questions raised by the FDIC are helpful in formulating legislative proposals over the next several months.
One critical issue for corporate America, which has not been included in the Options Paper, is the inequitable assessment methodology currently in place. AFP urges that now is the appropriate time to redefine the deposit insurance assessment base and modernize an outdated and unfair deposit insurance premium methodology. We urge the FDIC to implement our recommendation: assess only insured balances using a pricing system based on average daily collected balances. This approach eliminates the inequity of paying premiums on uninsured balances, discontinues an obsolete float adjustment factor by reporting collected balances, and solves the quarter-end assessment avoidance problem by utilizing a daily average balance method.
Please contact Frank Curran at 301.961.8827 for further discussion.
Sincerely,
|
/s/ Patrick M. Montgomery
Vice President, Finance
ULLICO
Chair
AFP Government Relations Committee |
/s/ Nolan L. North, CCM
Vice President and Assistant Treasurer
T. Rowe Price Associates, Inc.
Immediate Past Chairman
AFP Board of Directors |
|
|
|
