This report provides information about the Proposals for Change on Federal Deposit and Share Insurance since deposit insurance for holders of accounts at banks and thrift institutions are under scrutiny for the last several congresses

Jackson, William D.

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Congressional Research Service ˜ The Library of CongressCRS Report for CongressReceived through the CRS WebOrder Code RS20724Updated September 15, 2002Federal Deposit and Share Insurance:Proposals for ChangeWilliam D. JacksonSpecialist in Financial InstitutionsGovernment and Finance DivisionSummaryLegislators, regulators, interest groups and academics are examining manyproposals for changes in the federal deposit insurance system for banks and savingsassociations and the share insurance program for credit unions.  In the 107th Congress,measures seek to change the pricing of insurance, how much coverage should exist forcustomers’ accounts, and operations of the insuring agency.  Changes could affect thefinancial condition of insured institutions, the financial strength of the insurance funds,and competitive equality among participating institutions, making deposit insurancereform a complex issue.   Signs of increasing risk, leading some to suggest that depositinsurance generally may need reform, have become dramatized with  the  collapse ofseveral banks, shrinking the Bank Insurance Fund of the FDIC.   One measure, H.R.3717, has passed the House overwhelmingly, while a Senate measure, S. 1945, hasreceived a hearing.  CRS will update this report as warranted.  See the ElectronicB r i e f i n g  B o o k  o n  b a n k i n g  a n d  f i n a n c i a l  s e r v i c e s[http://www.congress.gov/brbk/html/ebfin1.shtml] for more information on financialservices issues, and CRS Report RL31343 for specific bill comparisons.What is Deposit Insurance and How is It Administered?The full faith and credit of the United States stands behind more than $3 trillion ofinsured deposits at banks and savings associations.  This insurance guards savers’accounts up to $100,000, providing stability to banks and to the economy.   Congresslegislated  deposit insurance in the 1930s, modifying it in 1989 and 1991 in response tofinancial crises.  Congress now requires all banks and savings associations to carry federalinsurance.  FDIC has not formally insured amounts greater than the limits set by law, norforeign office deposits, although very large banks rely upon them.  Smaller institutionsfind deposit insurance very valuable, in contrast.Pursuant to P.L. 101-73 and P.L. 102-242, the independent agency Federal DepositInsurance Corporation (FDIC) provides  federal deposit insurance through two funds.  TheFDIC’s two funds are accounts maintained with the U.S. Treasury that the agency mayCRS-2call upon in case of need.  Both earn interest income for  FDIC.  The Bank Insurance Fund(BIF) dates from 1934.  Congress intended it and its ancestor the Permanent InsuranceFund to cover commercial bank deposits.  The Savings Association Insurance Fund(SAIF) is the successor to a failed fund (“Federal Savings and Loan InsuranceCorporation”)  covering savings institution deposits.  Many institutions have deposits thatthe “other” Fund insures, because of mergers and other corporate developments, thuscomplicating FDIC  administration and financing. Institutions do not “own” either Fund.  BIF and SAIF balances are on-budget assetsof the government.  BIF’s balance is $31 billion and SAIF’s balance is $11 billion.Interest on these amounts has long been more than enough to cover FDIC’s operations,including the costs of closing failed institutions.     FDIC may require banks and savings associations to pay semiannual assessments toreflect their own risk and, by statute, must make their premiums reflect the size of BIFand SAIF.  Both Funds have target ratios of 1.25% ($1.25 per $100) of their balanceagainst insured deposits. That percentage is a statutorily targeted Designated ReserveRatio (DRR).  The resulting DRR carries large consequences.  If either Fund exceeds thatvalue, then its members do not have to pay assessments into it, unless low capital ormanagerial deficiencies make them individually risky.  Institutions regard fund balancesmuch above than 1.25% as “excess deposit insurance” which FDIC should refund tothem.  Institutions argue that, in the general spirit of tax cuts, institutions that paid intothe respective Fund should get back their “surplus.”  In the other direction, should eitherFund fall below its DRR, institutions must pay (at a general rate of up to 23 cents per$100 of insured deposits) to fill the fund’s shortfall.  That jump would greatly increasethe near-zero cost of federal insurance, which is a necessity for doing business.  Manyprefer to smooth out assessments over time as needed to maintain adequate fund balances.FDIC is considering whether to charge BIF-insured banks for their insurance.  At 1.26%,BIF is hanging just above the so-called cliff point below which assessments are called forby law; while  SAIF is better capitalized at 1.38% (both as of June 30, 2002.) A separate organization insures “share” accounts at credit unions: the National CreditUnion Share Insurance Fund (NCUSIF).  Congress created NCUSIF in 1970.  TheNational Credit Union Administration (NCUA) administers it.  While all federallychartered credit unions must belong to NCUSIF, state-chartered ones may or may notchoose to join it.  Federally insured credit unions fund NCUSIF differently than BIF andSAIF.  Credit unions, owning NCUSIF, put 1% of their total “shares” (deposits) intoNCUSIF.  Their contributions remain assets on the books of the credit unions,representing their investment in NCUSIF.   NCUSIF invests in government obligations,retaining the earnings on them.  NCUA may also levy a premium if needed.  It has metits target ratio of 1.30% of  insured deposits  without charging for its insurance as a rule. Background: The Purpose and Problem of Deposit InsuranceThe purpose of deposit insurance is twofold: it is, first, to protect depositors againstrisks they cannot control, and, second, to enhance economic stability.  In exchange forthese benefits, however, the insurance also entails some hazards for the government.  Purpose.  Deposit insurance, as provided by the government, makes deposits safeby assuring depositors that they can get their money even if their bank fails.  It protectsCRS-3the depositors from a sudden and unforeseen loss of wealth.  It also protects the economyagainst sudden contractions due to a loss of liquidity in the banking system.The current federal deposit insurance program commenced during the Depressionyears, in response to just such a loss of liquidity.  When some banks failed, depositorswho were not first in line to withdraw their money lost much or all of their balances.Depositors in other banks, fearing further failures, “ran” to withdraw funds from theirown, otherwise-healthy banks while cash was still on hand.  Even a sound bank cannot withstand a run.  Deposits are used to make loans whichbanks cannot immediately call in to pay off depositors.  If an entity with deep pocketscannot stem the run, more banks fail through contagion.  The overall effect is to shrinkthe money supply, curtail lending for business and other economic activity, and thus tocontract the economy.Deposit insurance stops such contractions, so that bank runs have not occurred onthe national level since its inception.  They have occurred locally, when federal depositinsurance was absent, with effects ranging from inconvenience to genuine hardship.Taxpayers of affected states eventually bore much of the burden of cleaning up afterfailures of institutions insured by state instrumentalities.The Problem of Moral Hazard.  A problem for policymakers is the tradeoffbetween protection and the loss of market discipline in financial institutions that comesfrom the insurance.  Observers know it in the industry as “moral hazard.”  That is,depositors have no reason to be concerned about the risks a bank takes with their fundssince government insurance protects them.  Banks, knowing that depositors have noreason to care, have a financial incentive to take on greater risks than they otherwisemight, in the expectation of earning greater returns.  Bankers retain profits from riskyinvestments.  Catastrophic losses fall on government should the investments mostly fail.If a deep-pocket insurer has not insured depositors, they and other bank creditorshave every reason to monitor a bank’s riskiness.  If they perceive that their funds are notwell handled, they may require higher interest rates on their monies to compensate for theextra risk.  That  brings down the returns from risky investments for a bank and, therefore,discourages risk-taking.  The behavior of uninsured, but presumingly knowledgeable,depositors gives regulators another way of monitoring the complex activities of banks andof protecting against serious systemwide problems.  Such monitoring facilitates theregulation of very large banks, funded mainly by uninsured large deposits, that presentsystemic risks to the nation’s financial system.  Issues The 106th Congress saw a resurgence of interest in examining various issuessurrounding federal deposit insurance.  Legislators, regulators, interest groups, andacademics examined a growing list of complex questions.Congressional consideration of possible changes in federal deposit and shareinsurance began in February 2000 when the House Banking Subcommittee on FinancialInstitutions held hearings on FDIC-related problems of depository institutions, and on apossible merger of BIF and SAIF.   Interest was evident in asking:CRS-4—Should Congress increase the $100,000 coverage for deposits at banks and savingsassociations, and shares at credit unions?  Should inflation, perhaps retroactively since1980, and in future years, be used to “index” FDIC coverage to preserve the purchasingpower of deposits? —Should FDIC insure deposits of municipalities at a greater level?—Should FDIC insure retirement and pension accounts at a greater level? —What should institutions pay for deposit insurance coverage and associatedregulation?  Should premiums be smoothed out over time?—If the fund balances in BIF and SAIF exceed the amounts necessary to provideadequate coverage, what should be done with the excess?  Would refunds leave FDIC inweakened condition?—Is free or low-cost deposit insurance an unwarranted subsidy to banks in theircompetition with nonbank financial firms?  Or does it offset costs of complying withbank-only regulations?—Should Congress merge BIF with SAIF, as a 1996 statute planned?—Are there better avenues to monitor and restrain risk-taking before it results inFDIC payouts?  Must large institutions be deemed too-big-to-fail: posing such systemicrisk to the economy that America must prop them up rather than close them?—Should rapidly-growing banks, who have paid little or no assessments, be assessedpremiums to compensate FDIC for its increased exposure to payouts and the downwardchange in fund reserve ratios?—What changes affecting FDIC operations might apply to credit unions? Policy Considerations Policymakers must weigh many factors in considering possible changes.  A key issueis how to provide the benefits of deposit insurance without lessening the incentives forthe managements of banks, savings associations, and credit unions to engage in prudentoperating practices.  Owners and managers at covered institutions may take on greaterrisks, in the expectation of greater rewards, if they know that customers are unlikely towithdraw their deposits, as described above.  The effectiveness of examination andsupervision  arrangements thus has an important bearing on the exposure of the insurancefunds. Regulation of banks and savings associations to prevent failure ideally wouldprevent FDIC from having to make good on its guarantee.  Government can make nosystem failure-proof, however.  In a competitive economy, bad business decisionsresulting in closure guide future capital  investment away from practices that failed.Banks and savings associations are not exempt from this truth.    Tradeoffs exist among proposals for change.  For example, increased accountcoverage at banks and savings associations could require more reserves at BIF and SAIF,making it less likely that the costs of FDIC insurance remain  low.  Alternatively, shouldrisk increase in financial markets, or the Funds’ coverage of insured deposits become verythin, institutions might have to make larger payments.  Competitive equality is animportant consideration for different institutions (large versus small, banks and savingsassociations versus credit unions, for example).   Any expansion of the federal safety netthrough FDIC has to be paid for, and appropriations are not viewed as appropriate meansof payment, which necessarily would come from covered institutions. CRS-5FDIC Recommendations and Congressional ActivityAt a House Financial Institutions Subcommittee Hearing in May 2001, outgoingFDIC Chairman Tanoue said the agency would like the 107th Congress to make statutoryimprovements to its practices, policies,  and structure.  It seeks to merge the BIF and SAIFfunds.  It would like to charge regular premiums based on institutions’ risks, whatever thelevel of the reserve ratio of the fund(s).  It seeks to adjust premiums gradually up or downas the health of the fund(s) might change.  If it makes rebates, the agency would base themon past contributions to building up the fund(s).  It seeks to index the basic accountcoverage, to keep pace with future inflation, not necessarily to sharply boost standardminimum account coverage to $130,000.   The agency believed that its recommendationswould produce a stronger, more properly priced, less volatile, system of deposit insurance.Current FDIC Chairman Powell carried forward much of the FDIC’s reform effort.Regulators and Administration officials endorsed many of FDIC’s recommendations ata House Financial Services Subcommittee hearing, July 26, 2001.  They approved ofmerging the two Funds, charging premiums to all institutions, and replacing the DRR andassociated premium pricing with a more flexible approach giving FDIC greater discretion.They disagreed somewhat over the FDIC’s proposal to index coverage to inflation, andsome opposed increasing the  basic dollar amount coverage per account.  The next day saw closure of the undercapitalized $2.3 billion Superior Bank.  Withthat collapse as backdrop, the Senate Banking Committee held its hearing on depositinsurance reform, August 2, 2001.  Regulators repeated their views on public policyissues.  Superiors’ closure added momentum to legislation to merge BIF  with SAIF  andto strengthen supervision of institutions, perhaps giving FDIC a larger role.Another House hearing explored reforms on October 17.  In it, FDIC ChairmanPowell expressed support for merging the two funds, indexing future account coverageto inflation, raising coverage for retirement accounts, and changing the pricing of FDICinsurance to reflect risks rather than through statutory formulas.  LegislationBills of 2001.H.R. 557, Deposit Insurance Fairness and Economic Opportunity Act, would providepayments for, and to, insured institutions if FDIC funds accumulate excess amounts.S.128, Meeting America’s Investment Needs in Small Towns Act of 2001, would makeperiodic cost of living adjustments to basic insurance of $100,000.  The measure wouldretroactively start adjustments as of 1980,  increasing coverage to about $200,000 peraccount, and would make future adjustments for inflation every 3 years.  S. 227,Municipal Deposit Protection Act of 2001, would provide full FDIC coverage to within-state deposits of governmental bodies.  H.R. 746 is similar to S. 128.  H.R. 1293, DepositInsurance Stabilization Act, would merge the BIF and SAIF insurance funds, and wouldalso permit FDIC to impose fees on institutions if their activities cut the deposit insurancefund(s) below the DRR of $1.25.  It would repeal the automatic assessment of 23 centsper $100 that FDIC must charge when the insurance funds(s) become undercapitalized.H.R. 1355, Deposit Insurance Funds Merger Act of 2001, would similarly merge BIF andCRS-6SAIF into one fund. The House version of the Municipal Deposit Insurance ProtectionAct of 2001, H.R. 1899, would fully insure deposits of within-state municipal depositorsup to the total equity capital of banks holding them.Bills of 2002.In 2002, further legislation of a comprehensive nature came onto the congressionalagenda.  H.R. 3717, the Federal Deposit Insurance Reform Act of 2002, was marked upby the House Subcommittee on Financial Institutions and Consumer Credit on March 7,2002.  It was then further approved by the House Financial Services Committee on April17 with a 52-2 favorable report. With several changes made to increase its appeal, H.R.3717 passed the House by 408-18 under a suspension of  rules, May 22, 2002.H.R. 3717 would now do several basic things. (1) It would create a range of reserveratios, rather than the existing Designated Reserve Ratio minimum of 1.25%. (2) It wouldmerge BIF with SAIF, into a single Deposit Insurance Fund.  (3) It would increasestandard account protection to $130,000.  (4) It would index future basic coverage toinflation every 5 years.  (5) It would double coverage of many retirement (IRA and“401(k)”) accounts, that is, to $260,000.  (6) It would increase insurance coverage ofmunicipal deposits.  (7) It would give parity in account coverage to federally insuredcredit unions.  (8) It would allow FDIC to charge a small premium to institutions that donot currently pay premiums.   S. 1945, the Safe and Fair Deposit Insurance Act of 2002,has generally similar objectives but somewhat different details for several aspects ofproposed  reform.  The House-passed H.R. 3717 now largely resembles its Senatecounterpart.   S. 1945 received a hearing in the Senate Banking Committee on April 23,2002.  CRS Report RL31343 compares provisions of the two measures.Administration and some bank resistance remains to increasing standard coverageper account to $130,000 and retirement accounts to twice as much with consequent publicand private-sector costs and risks; while other portions of FDIC-related bills are lesscontentious.  Safety of wealth in light of unsettled securities markets, an increasinglyaging population, and the implosion of retirement savings plans of Enron and otherentities have raised important risk concerns for congressional consideration.  Competitiveconsiderations remain important.  Industry groups are far from united in their views ondesirability of reforms: some providers seek to avoid having to pay for changes in theways FDIC does business and, especially, for increasing its formal protection on accounts.For further discussion, see; CRS Report RL31343, Deposit Insurance Reform:Comparison of H.R. 3717 and S. 1945, 107th Congress; CRS Report RL31463, DepositInsurance: Raising the Coverage Limit; and, CRS Report RL31552, Deposit Insurance:the Government’s Role and Its Implications for Funding.

Federal Deposit and Share Insurance: Proposals for Change

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Federal Deposit and Share Insurance: Proposals for Change

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