Consider some implications of the FDIC's regulation on brokered deposits, due to take effect June 16.

On the basis of yearned 1991 data, banks with 27% of the industry's assets, including 12 of the 30 largest, would fail to qualify as "well capitalized."

Presumably, their access to funds will be inhibited. This will result in their making fewer loans in the near term.

Longer term, the new regulation will cause deeper recessions and higher rates of unemployment. The reason: Fund flows in and out of the banking sector will become more cyclical.

Also, because fewer dollars will be insured by the Federal Deposit Insurance Corp., the cost of funds will probably rise for small-business or consumer borrowers.

Moreover, the Federal Reserve will probably have to mandate higher capital standards for banking companies, since those at the current minimums will be seen as less than well capitalized.

Paradoxical Effect

Healthy companies such as Bankers Trust and Republic New York, which did not qualify as well capitalized, will have strong incentives to build their capital ratios.

The FDIC rules are in keeping with the thrust of the emerging national financial policy discussed in this space in a three-part series that concluded on May 28.

Though full implementation of the policy has been delayed by infighting in Washington, its aims are clear:

* To control or end the expansion of the American banking industry. Policymakers do not want to increase the government's exposure to loss through FDIC-insured deposits.

* To stimulate the growth of the nonbanking sector, so as to replace banks as sources of funding for economic development.

A Shift to Nonbanks

By controlling the flow of funds into the banking industry, the rules will make dollars more available for nonbanks to acquire and relend.

Under the new regulation, only banks with risk-adjusted capital ratios of 10% and common equity equal to 5% of assets will have unrestricted access to brokered deposits.

Banks that fail these tests but meet the Fed standards of 8% risk-adjusted capital and 4% common equity will be able to acquire brokered deposits, but only with FDIC permission.

It is not clear that such permission will be automatic, since the FDIC will scrutinize the applying banks' asset structures. It also seems these funds will be off-limits to any bank falling short of the Federal Reserve's minimum capital guidelines.

Restriction on Rates

However, the FDIC's rules are more stringent than even the new capital guidelines would suggest. Even if a bank has the right to obtain brokered deposits, the rate it is authorized to pay for these funds is strictly proscribed.

For example, a bank cannot pay for its deposits more than 75 basis points above its local market's cost of money.

In the national marketplace, there are two limitations on the ability to pay. If the brokered deposits are to be insured by the FDIC - that is, they are less than $100,000 in size - the rate paid cannot exceed 120% of a comparable Treasury yield plus 75 basis points.

If they are not to be insured, the maximum rate would be 130% of the comparable Treasury rate plus 75 basis points.

The effect will be to shut the banks out of some brokered-deposit markets. When the economy expands, fund providers are willing to go down the quality scale - buy junk bonds, for example - and banks won't be able to compete. Disintermediation, historically a thrift problem, will become a bank issue, too.

FDIC's Justification

The FDIC is playing down the impact of its proposed rule.

First, it justly points to the fact that Congress, in the 1991 banking legislation, mandated the regulation.

Second, the FDIC has released numbers indicating that only 400 banks (3% of all banks) and 330 thrifts (16% of all thrifts) fail to meet the minimal standards. Conversely, 72% of banks and 56% of thrifts are defined as well capitalized.

What is not mentioned is that as of Dec. 31, according to numbers in the SNL Securities data base, 32 banks with assets greater than $500 million did not meet the well-capitalized standard.

Big Segment of Assets

These banks controlled almost $1 trillion in assets, or a significant 27% of the industry's total.

They included 12 of the top 30 banks, or if tangible common equity is to be considered instead of simple common equity, 21 of the 30 largest banks at yearend 1991.

Bankers Trust and Republic National of New York, among those that did not meet the standards at that time, cannot afford to be considered as not "well capitalized." Presumably both will therefore be forced to sell common equity or shrink their balance sheets.

In essence, the equity ante has been raised for those that want to be perceived as having a strong balance sheet.

Further, the FDIC had considered setting a 6% common-equity standard for the best banks. Presumably, at some point the FDIC will mandate such a standard.

Understanding these points, it is easier to see why the economy will be harmed by this regulation.

A number of banks with large asset bases but only adequate capital ratios must find more common equity and do less lending. This will impede the economic recovery.

Further, there is a real risk that the Fed will follow the FDIC's action by raising capital requirements. The simple fact that this could happen will inhibit bank asset expansion.

During a recession, as banks reduce lending and raise reserves to handle a predictable increase in loan losses, they will have to contend with the fact that both the Fed and the FDIC can raise their capital ratios. The probability that this will happen has gotten greater, as the past decade demonstrates.

In this environment, brokered deposits may not be available to ease the burden that cash-short lenders will experience, or to help small businesses stay in operation. The recession will go deeper, more small businesses will fail, and unemployment will go higher than would otherwise be the case.

Finally, if the rating agencies are reluctant to confer high ratings on banks that are defined as only adequately capitalized, bank money costs will go higher. Money costs could also rise if there are less FDIC-insured deposits as a result of banks' inability to obtain brokered deposits.

Changing the Odds

Since nonbank competitors have no similar restrictions, their access to funds will not be inhibited. Therefore, their financial market shares will expand relative to the banks'.

This is all in keeping with U.S. financial policy, which aims to have nonsubsidized sources of funds replace those that are government-subsidized.

It is another reason to assume that nonbanks will grow faster than banks and therefore have higher multiples on their stocks - and even lower relative costs of funds.

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