Consultant Urges Improvement in FDIC Reserving
The FDIC has released a report by McKinsey & Co. that suggests ways the FDIC can improve its risk management and methods for predicting future bank failure losses. Noting that the report endorsed many current FDIC practices, FDIC chairman Don Powell commented, "The report also includes meaningful suggestions to enhance the overall accuracy, robustness, and transparency of the FDIC's reserving process."
The amount of the FDIC's contingent loss reserves for future bank failures can impact the level of FDIC insurance premiums, since the loss reserve lowers both the insurance fund balance and the ratio of fund reserves to insured deposits, which under current law must be maintained at 1.25%.
The report's recommendations are designed to remove some of the subjectivity in the reserving process, improve its accuracy and avoid wide swings in the reserve ratio. For example, in the third quarter of 2002, the FDIC set aside reserves of $447 million, which caused a drop in the BIF's reserve ratio, but when losses did not materialize as expected, the FDIC returned that amount to the BIF in the fourth quarter.
The report recommends a three-phase approach to strengthen the FDIC's risk management practices over the next 12 to 18 months. In the first phase, the report recommends improved accuracy for projections and contingent loss reserve modeling.
In the second phase, McKinsey recommends that the FDIC build best-practice financial risk management and finalize risk management models currently under development. The FDIC is urged to develop new models for projecting investment, premium and deposit growth.
The final phase of the report's recommendations is more long-term and presents options for the FDIC to consider, such as implementing more real-time risk management and potential programs for hedging or reinsurance.