WASHINGTON — The Treasury Department's broad study on revamping financial services regulation posited two starkly different futures for the Federal Deposit Insurance Corp., prompting a discussion over whether a shift in its mission is looming, and whether such a shift is warranted.
The study — released by the Treasury on Oct. 11 as a series of questions for public comment — asked whether the FDIC should become the primary supervisor of all banks, focus solely on deposit insurance, or maintain its current role somewhere in between.
The question addresses what some say is inconsistency in the FDIC model. Its direct oversight of thousands of small, state-chartered banks means a smoother transition in the event of a failure, but if a large bank outside that sphere were to fail, the FDIC's deference to a different agency could create problems.
The study addresses ideas for reshaping many aspects of financial regulation — such as a merger of the national bank and thrift charters — but many watchers are urging the Treasury to leave the FDIC's current system alone. The agency now has backup authority over insured institutions, and it has dispatched resident examiners to some of the largest banks.
"The system works. I'm one of those who feels that if the system works — it isn't broken — don't break it," said Ronald R. Glancz, a partner at Venable LLP and a former FDIC assistant general counsel. "The FDIC has the expertise on the small banks. That's a very valuable experience. You wouldn't want to give that up, even if you were separating the various functions."
The dynamic between the FDIC's insurance and regulatory duties had stayed largely untouched since legislative reforms in the late 1980s and early 1990s meant to curtail the savings and loan crisis. But that dynamic has remained a subject of debate.
For one thing, the direct supervision of state-chartered banks maintains the perception of an institutional conflict of interest. Such conflicts were blamed for costly resolutions in the S&L crisis, when the then-Federal Home Loan Bank Board kept many defunct institutions open to prevent expenditures from its insurance fund.
The argument is that "if the deposit insurer like the FDIC is worried about the amount of money in its fund taking a hit if they were to close a bank, and they were running out of funds in a major bank crisis, that might delay closure decisions," said George Pennacchi, a professor of finance at the University of Illinois at Urbana-Champaign and a program coordinator for the FDIC's Center for Financial Research. "In that case, maybe you would want another regulator to have that responsibility."
But Mr. Glancz said it is impossible to avoid all conflicts of interest, and he questioned whether the FDIC would hold back on closing a bank because it was worried about insurance reserves.
"Is it really a conflict, or is the FDIC able to deal with it?" he asked. "Lawyers have conflicts all the time. We deal with them."
On the flip side, there have been calls to give a deposit insurer more authority to regulate the banks it insures. According to that argument, the agency with the most knowledge about and access to a troubled institution would be best suited to resolve its failure at a low cost.
In 2001 tension and miscommunication between the FDIC and the Office of Thrift Supervision were blamed for raising the cost of resolving Superior Bank FSB. Critics said the OTS was late in closing the Hinsdale, Ill., thrift and withheld access to it from the FDIC — even barring an FDIC official from an exam two years earlier.
A similar issue was raised in the 1999 failure of First National Bank of Keystone in West Virginia.
Joseph Neely, a former FDIC board member, said no agency, including the FDIC, should have primary authority over all banks. But designating the FDIC as just the insurer "tended to be a little more cumbersome" if the failed bank were overseen by a different regulator, like the OTS or the Office of the Comptroller of the Currency.
"You don't have that regulatory oversight and authority in an institution other than a state-chartered institution … and sometimes the FDIC would find themselves being a little late to the dance," said Mr. Neely, now the chief executive at Mississippi National Bankers Bank, a Ridgeland unit of First National Bankers Bankshares Inc. in Baton Rouge. "Possibly, the compromise would be for the FDIC to take a similar role among all institutions that it's responsible for writing the check for."
Others say the problems cited in the Superior cleanup have been corrected.
"There have been tensions over this issue over time. My sense is that that part of the system is working pretty well today," said John C. Murphy, a former FDIC general counsel and now a partner at Cleary Gottlieb Steen & Hamilton LLP. "The agencies have worked out accommodations where the FDIC as insurer has visibility on some institutions."
The FDIC "should have backup authority," Mr. Murphy said. "The insurer ought to be able — if it needed to — to have visibility on institutions it insures. That ought to be done in a way that protects the insurance fund but doesn't duplicate supervision or cause unnecessary burdens on the institutions."
The Treasury's regulatory review posits mostly downsides for the other banking and thrift agencies, including cutting bank supervisory powers from the Federal Reserve Board, but the questions also explicitly ask about whether to extend the FDIC's power.
Still, an FDIC official interviewed after the study's release treaded very carefully so not to show an opinion either way, though she said more comments from the agency would come in direct response to the Treasury's query.
"It's good to constantly evaluate the regulatory structure. We're always interested in finding ways to make it more efficient and effective," said Diane Ellis, an associate director in the FDIC's division of insurance and research. "We're looking forward to working with the Treasury, and we will carefully consider all of their questions."
Observers agreed that giving the insurer direct oversight over some banks — but not others — has achieved balance, but they also saw room for improvement.
Prof. Pennacchi said objectivity questions posed by giving the insurer authority to decide when it spends its own resources to resolve a failure could be settled by eliminating the Deposit Insurance Fund. Instead, he said, an insurer could have an unlimited line of credit from the Treasury, and the insurer's judgment on how to resolve a bank would be removed from the cost equation.
"If you eliminated the focus on a Deposit Insurance Fund, a deposit insurer would have the incentive to close banks quickly, … and maybe it would create more efficient supervision," he said.
