BANKER UPDATE: COSTS OF DEPOSIT INSURANCE REFORM
Bankers held their breath this week as the FDIC board met to set premium rates for the second half of the year. Because the reserve ratio of the BIF, at 1.26%, is so close to the statutory minimum of 1.25%, speculation was high that the FDIC would have to increase BIF premiums.
The FDIC did not increase premiums, saying that it is not clear that assessment revenue will be needed to maintain the BIF reserve ratio at 1.25%. But it projected that the BIF could end the year with a ratio between 1.08% and 1.28%. If the ratio dips below 1.25%, premiums would be increased for BIF deposits, but not for SAIF deposits (the SAIF has a reserve ratio of 1.37%, comfortably above the 1.25% minimum). The decision was carefully scrutinized by the Congress as comprehensive deposit insurance reform legislation was on the front burner in the House of Representatives.
Costs of Reform. The large bank lobby and others have released inflated reform cost estimates in the last few weeks that are based on faulty assumptions and questionable analysis about the costs of the House bill. Please consider the following.
Chairman Powell addressed the question of the costs of deposit insurance reform in a speech last month. He said, "In many cases fears are being generated by unfounded assumptions about how the new system would work. For example, I've heard some bankers say that they believe if the FDIC had greater discretion to manage the funds, it would simply set the target at the highest possible level and peg the fund ratio there. This is ridiculous. Nothing in the FDIC's history suggests we would do that."
Chairman Powell also noted the importance of how the transitional assessment credits would work under the bill. "Using the formula in the [House] deposit insurance reform bill … we found that, under reasonable assumptions, the typical bank would not have to pay premiums for three to six years. Six years is a long time."
For example, a bank whose deposits grew at a rate of 6% percent per year since 1996 would receive an assessment credit that would last about 6 years (if premiums are set at 2 cents), 4 years (if premiums are 3 cents) and 3 years if premiums are 4 cents).
The FDIC also took a look at the cost of increased coverage alone under H.R. 3717. Its analysis shows that the potential "immediate" cost of the increased coverage on general, retirement and municipal accounts is about 3 cents, or $30,000 for a bank with $100 million in deposits.
Here is how the FDIC arrives at that number. Upon enactment, the BIF and SAIF would be merged and have a combined reserve ratio of 1.29%, 4 basis points above the 1.25% floor. (Those excess reserves can absorb some of the cost of higher coverage.) According to the FDIC, the immediate dilution of the reserve ratio due to higher coverage of existing deposits is 8.4 bp (4.4 bp for general and retirement accounts and 4 basis points for municipal accounts), bringing the reserve ratio to just below 1.21%. To restore it to 1.25% requires $1.4 billion, or a 3.1 cent premium, the FDIC calculates.
This premium estimate assumes the FDIC will keep the target reserve ratio at 1.25%. It could set it lower or higher. And this estimate also assumes that the reserve ratio would have to be immediately restored to 1.25%. The bill gives FDIC flexibility to return to the target ratio gradually.
Costs of Attracting New Deposits. These calculations do not include new deposits attracted into the system because of higher coverage. Since new deposits will be attracted over time, the costs for these deposits will also occur over time, not as a one-time charge. In fact, the bill anticipates that the FDIC will set a small, steady premium and allow the reserve ratio to float within a range. The bill establishes a premium rate of 1 basis point (1 cent) for the highest rated banks. Moreover, premium income alone is not necessary to maintain the target reserve ratio since other factors impact the reserve ratio. The fund reserves will earn over $2 billion in investment income each year, which (net of expenses and insurance losses) can be used to absorb coverage increase costs.
A Hypothetical Look Ahead: Looking years out, you are being told that raising coverage levels for general, retirement and municipal accounts will cost banks 10 basis points or $100,000 for a bank with $100 million in deposits.
Let's analyze this. This is an estimate of the total additional costs for increased coverage, it is not an annual premium cost. This estimate is also based on 4% average growth in new deposits due to higher coverage levels.
Let's look at costs and benefits of this estimate a little more closely. If a $100 million-in-deposits bank can attract 4% additional deposits ($4,000,000) due to the higher coverage limits and deploy those deposits into earning assets with a 4% net interest margin, it could earn $160,000 ($4,000,000 x 4%) more each year in net interest income-more than offsetting in one year the aggregate additional $100,000 cost of higher coverage. There is no cheaper money to be found.