GREENSPAN: IN HIS OWN WORDS
On April 23, Federal Reserve Chairman Alan Greenspan testified before the Senate Banking Committee on deposit insurance reform. In his testimony, Chairman Greenspan went to considerable lengths to tell the committee and the world about the community banking competitive market. This was in the context of his firm policy position: "We support a reduction in the real value of coverage…. Basically we think it is too high already to do what it is supposed to do…. While opposing indexing the ceiling will erode it in real terms, we think that is good, not bad." The chairman repeatedly stated that federal deposit insurance carries a subsidy.
Greenspan's position goes to the heart of community banks' customer relations and funding costs. The Federal Reserve additionally has made no recommendations doing away with the codification of too big to fail in existing law (FDICIA) or for handling the free rider problem. The chairman also is highly critical of community banks' growing dependence on Federal Home Loan Bank advances. His strong and repeated advocacy of lower depositor protection has been defeated in the House Financial Services Committee. His ongoing purpose is to gut the increased deposit insurance levels in the pending deposit insurance reform legislation in the House and the Senate. He is supported by the largest banks in our nation.
We thought that community bankers would like to see what Chairman Greenspan is saying about their industry and funding challenges. We encourage you to respond to him c/o the Federal Reserve System, 20th Street and Constitution Ave., N.W., Washington, DC 20551. Or, call your local Federal Reserve Bank. Of course, please keep ICBA, your representative and your senators advised of your feelings. Do it now, while the legislation is moving forward in both houses of Congress. How would your customers react to Chairman Greenspan's strong advocacy of erosion of existing deposit insurance levels? AARP supports increased coverage levels.
Below are excerpts from Chairman Greenspan's testimony.
"Depositors. Our surveys of consumer finances suggest that most depositors have balances well below the current [$100,000 limit] and those that do have larger balances have apparently been adept at achieving the level of [coverage] they desire by opening multiple insured accounts. Such spreading of asset holdings is perfectly consistent with the counsel always given to investors to diversify their assets-whether stocks, bonds, or mutual funds-across different issuers. The cost of diversifying for insured deposits is surely no greater than doing so for other assets. An individual bank would clearly prefer that the depositor maintain all of his or her funds at that bank, and would prefer to eliminate the need for depositor diversification by being able to offer higher deposit insurance coverage. Nonetheless, the depositor appears to have no great difficulty-should he or she want insured deposits-in finding multiple sources of fully insured accounts."
"Depository Institutions. Does the problem to be solved by [increased coverage] concern the individual depository institution? If so, [it] would seem disproportionately a small bank issue since insured deposits are a much larger proportion of total funding at small banks than at large banks. But smaller banks appear to be doing well. Since the mid-1990s, adjusted for [mergers], assets of the smaller banks, those below the largest 1,000, have grown at an average annual rate of 13.9%, almost twice the pace of the largest 1,000 U.S. banks. Uninsured deposits at these smaller institutions have also grown more rapidly than at larger banks-at average annual rates of 22% at the small banks versus 11% at the large banks... . Clearly, small banks have a demonstrated skill and ability to compete for uninsured deposits. To be sure, uninsured deposits are more expensive than insured deposits, and bank costs would decline and profits rise if their currently uninsured liabilities received a government guarantee. But that is the issue of whether subsidizing bank profits through deposit insurance serves a national purpose. [Throughout] the 1990s, small banks' return on equity was well maintained. Indeed, the attractiveness of banking is evidenced by the fact that more than 1,350 banks were chartered during the past decade."
Too-Big-To-Fail. "Some small banks argue that they need enhanced [coverage to compete] with large banks because depositors prefer to put their uninsured funds in an institution considered too big to fail. [However], small banks have more than held their own in the market for uninsured deposits. [The Board also] rejects the notion that any bank is too big to fail. In 1991, Congress made it clear that the systemic-risk exception to the FDIC's least-cost resolution of a failing bank should be invoked only under the most unusual circumstances. Moreover, the resolution rules under the systemic-risk exception do not require that uninsured depositors and other creditors, much less stockholders, be made whole. [The market] clearly believes that large institutions are not too big for uninsured creditors to take at least some loss."
Free Riders & Multi-Bank Coverage. "Another argument often raised by smaller banks regarding the need for increased [coverage] is their inability to match the competition from those large securities firms and [BHCs] with multiple bank affiliates, offering multiple insured accounts through one organization. The Board agrees that such offerings are a misuse of deposit insurance. But, raising the coverage limit for each account is not a remedy since it would also increase the aggregate amount of insurance coverage that large multi-bank organizations would be able to offer. The disparity would remain."
"Conclusion. There may come a time when the Board finds that households and businesses with modest resources are having difficulty in placing their funds in safe vehicles and/or that there is reason to be concerned that the [coverage level] could endanger financial stability. Should either of those events occur, the Board would call our concerns to the attention of the Congress and support adjustments to the ceiling by indexing or other methods. But today, in our judgment, neither financial stability, nor depositors, nor depositories are being disadvantaged by the current ceiling. Raising the ceiling now would extend the safety net, increase the government subsidy to banking, expand moral hazard, and reduce the incentive for market discipline, without providing any real evident public benefits. With no clear public benefit to increasing deposit insurance, the Board sees no reason to increase the scope of the safety net. Indeed, the Board believes that as our financial system has become ever more complex and exceptionally responsive to the vagaries of economic change, structural distortions induced by government guarantees have risen. We have no way of ascertaining at exactly what point subsidies provoke systemic risk. Nonetheless, prudence suggests that we be exceptionally deliberate when expanding government financial guarantees."