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Deposit Insurance Reform - Claims vs. Facts

WWR ARTICLE
MARCH 29, 2002

 

1. CLAIM: Federal Reserve Chairman Alan Greenspan said that "banks of all sizes are having no difficulty obtaining funding from insured or uninsured deposits."

FACT: Most community banks rely on core deposits to fund their loan activities. They do not have access to the same alternative funding sources as larger regional or money center banks. The primary alternative funding source for community banks is the Federal Home Loan Bank System. And although this is an important funding source, the purposes for which the funds can be drawn are limited, and the cost is considerably more expensive than core deposits. Other potential sources, such as brokered deposits, are even costlier.

2. CLAIM: Chairman Greenspan adds: "In short, we cannot find indications of a problem that an increase in insured deposit ceilings is designed to address."

FACT: In most community banks, growth in core deposits has failed to keep up with the growth in bank assets (loans). In the 1990s, loan demand grew twice as fast as deposit growth. A recent study1 conducted by the Federal Reserve Bank of Kansas City found that many community bankers feel funding challenges will be a "persistent, long-term problem" that will "eventually force them to curtail lending to small businesses, farmers, and other local customers-many of whom may have few other places to turn to for their borrowing needs" [emphasis added]. This is not good news for small businesses, local municipalities, churches, farmers, ranchers, and others that rely on credit from local lenders.

3. CLAIM: Treasury Secretary Paul O'Neill said: "There is no evidence that an increase in the coverage level would promote competition or materially improve the ability of community banks to obtain funds."

FACT: Community banks lose deposits every day to larger competitors. Community banks, which are limited to $100,000 in insurance coverage, are at a disadvantage when competing for large deposits with "too-big-to-fail" banks, which enjoy de facto 100% insurance protection, or financial conglomerates such as Citigroup's Salomon Smith Barney, which can offer each of its customers $1 million in FDIC insurance coverage through ten affiliated banks.

FACT: Americans are being counseled to spread their money around to more than one institution. The American Association of Retired Persons (AARP) has issued this warning to its members: "The simplest way of protecting such money is to divide it up among several FDIC-insured banks so that no more than $100,000 is kept at any single institution." Even the FDIC has issued a similar warning on its consumer website. And without a way for local banks to attract and keep core deposits, local funds will continue to leave the community and go to national or regional banking centers.

4. CLAIM: Secretary O'Neill adds: "An increase in coverage would primarily benefit high net worth individuals and do little for the great majority of savers who have deposit balances far below the current coverage limit."

FACT: Higher coverage levels would benefit more than just "high net worth individuals."

Indeed, small businesses, which provide the bulk of local job creation, would benefit directly from higher coverage levels. A study commissioned by the American Bankers Association2 found that half of small business owners think the current level of deposit insurance coverage is too low. When asked what actions they would take if coverage were doubled, 42 percent said they would consolidate accounts now held in more than one bank; 25 percent would move money to smaller banks; and 27 percent would move money from other investments into banks. Small businesses shouldn't be forced to spread their money around to many banks to get the coverage they deserve. For small businesses, especially, aggregating their business with one bank can enhance their banking relationship. And equally important, these local businesses should be able to support their local banks, and local economies, with their deposits.

In the recent markup of the deposit insurance reform bill, Subcommittee Chairman Bachus noted that there are more than 5,000 home sales each and every day. Often, the proceeds of these sales are parked in bank accounts for six months or more due to tax implications. Most of the beneficiaries of these sales are not "high net worth individuals." Rather, they are average citizens who happen to have more than $100,000 in their bank accounts because of a lifetime event, the sale of their homes. Often, these funds represent the bulk of their life savings, or are earmarked for their retirement. It is not fair to put these funds in jeopardy by maintaining eroded deposit insurance funding levels.

Fran Sweet of Chicago is not a "high net worth individual." On November 15, 2001, the Chicago Tribune3 reported the following: "Like most people, Fran Sweet never expected her bank to fail. She gave little thought to the fact that funds she placed in an individual retirement account last summer were insured for only $100,000-a fraction of their value. Less than a month later, the institution, Superior Bank of Chicago, went under and Sweet stands to lose all but $100,000 from her retirement account. 'A hundred thousand dollars is not enough money for anyone to live on in retirement,' said Sweet, one of roughly 1,400 former Superior customers who could lose $65 million in uninsured deposits. Indeed, adjusted for inflation, the value of $100,000 in 1980 dollars is $46,210." Fran Sweet would have benefited directly from higher deposit insurance coverage levels.

A survey conducted by The Gallup Organization4 on behalf of the FDIC revealed that federal deposit insurance coverage is a "significant factor" in investment decisions, especially to more risk-averse consumers and those making decisions in older and less affluent households. 57% of respondents said deposit insurance is "very important" in determining where to invest. Six in 10 respondents said they would be likely to put more of their household's money into insured bank deposits if the deposit insurance coverage level were raised. And six in 10 said they would move their money into insured accounts as they neared retirement age or during a recession. The survey also showed that 1 in 8 households keep more than $100,000 in the bank, and about one-third of all households reported having more than $100,000 in the bank at one time or another. And importantly, the Gallup survey indicated that nearly 4 out of 5 (77%) respondents thought deposit insurance coverage should keep pace with inflation.

5. CLAIM: Senator Phil Gramm (R-TX) on more than one occasion has blamed the savings and loan crisis on the increase in deposit insurance coverage levels to $100,000 in 1980. In April, 2001, he told the Senate Banking Committee's Financial Institutions Subcommittee that, ". . . my experience with the savings and loan crisis convinces me that we should not raise the deposit insurance limit."

FACT: The increase in deposit insurance coverage levels in 1980 not only did not cause the savings and loan crisis, but indeed, probably helped stem deposit panic during this crisis period. ICBA President and CEO Ken Guenther, who was an assistant to the Federal Reserve Board at the time, wrote this account to Senator Gramm last June:

". . .in late March 1980, the Depository Institutions Deregulation and Monetary Control Act of 1980 was signed into law phasing out interest rate controls. Interest rate deregulation in a climate of rapidly rising and fluctuating interest rates broke the backs of thousands of thrifts that were sitting on long-term, fixed-rate assets.

"The S&L crisis was a direct result of the Federal Reserve's interest rate policies and the passage of legislation authorizing interest rate deregulation. These policy actions created a perfect and historically destructive storm for the savings and loan industry and hundreds of banks as well.

"Deposit insurance and, in my judgment, the $100,000 coverage level, helped stem deposit panic during this crisis period. It is my further judgment that if deposit insurance levels had been increased to $50,000 rather than $100,000 in 1980, as proposed in the bill that passed the House, there would have been the same frenzy to secure brokered deposits by CEOs of failing thrifts."

1 The Decline in Core Deposits: What Can Banks Do, by James Harvey and Kenneth Spong, Federal Reserve Bank of Kansas City, published in Financial Industry Perspectives 2001.

2 Increasing Deposit Insurance Coverage: Implications for the Federal Insurance Funds and for Bank Deposit Balances, Mark J. Flannery, December 2000 (study commissioned by the ABA).

3 Higher ceiling considered for bank deposit coverage, by Melissa Allison, Tribune staff reporter, Chicago Tribune, Thursday, November 15, 2001.

4 The Gallup Organization conducted telephone interviews with a randomly selected, representative sample of 1,658 adults who identified themselves as the people most knowledgeable about household finances age 18 or older, living in households with telephone service in the continental United States. The interview period ran from November 20 to December 23, 2000. The margin of error is plus or minus 3 percent.






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