How much money does the Bank Insurance Fund need?

Congressman John LaFalce opined at a recent House Banking Committee hearing: "A serious case can be made for raising the standard for both insurance funds from 1.25% to 1.5%."

Rep. LaFalce's comments were only mildly outrageous compared with remarks made by a witness described as "an independent bank consultant."

That witness observed, "The fund was at 1.245% in 1981, and that was insufficient, as it dwindled to a negative number in 1991 and 1992." He called for the two insurance funds to be merged and went on to say, "The 1.25% designated reserve ratio in the resultant combined fund should be viewed as a floor with a goal of a 1.5% ratio in the immediate future and perhaps a longer-term goal of even more if warranted."

The hearing was not very auspicious, assuming Congress wishes to deal intelligently with the looming disparity between the deposit insurance premiums paid by banks and thrifts. It's hard to know where to begin in correcting the false premises underlying the above statements.

It might be appropriate to start by pointing out that there is no deposit insurance fund. The Federal Deposit Insurance Corp. collects premiums (taxes, to be more precise) from banks and turns them over to the Treasury. If the FDIC collects more taxes than it spends, the surplus reduces the federal deficit.

The Treasury computer duly records the payments made by the FDIC. The money itself, being fungible, is spent on welfare, missiles, school lunches, and the like. Should the FDIC need money to handle a bank failure, the Treasury borrows the funds in the market. That outlay by the FDIC increases the federal deficit.

The object in collecting premiums from the banks is not to build a fund but to ensure that over time the deposit insurance program pays for itself. The so-called fund is simply a running scorecard to show whether banks have paid more in than they have taken out.

The banks' record is outstanding over the past 60 years. The witness at the recent hearing could cite only two years (1991-1992) when the running scorecard showed a nominally negative balance.

The balance was only "nominally" negative because the General Accounting Office had required the FDIC to create some $15 billion of excess reserves to cover losses the GAO feared the FDIC might suffer. The GAO, in setting the reserve level, grossly overestimated the FDIC's future losses and gave no offsetting credit for its income stream, which was far more certain than the projected losses.

So the FDIC fund was never negative in real terms, despite handling the most severe banking crisis since the Great Depression. It's more than a little difficult, in view of this record, to fathom the case for increasing the size of the nonexistent fund.

The 1.25% ratio set by Congress was determined by taking the average ratio of the fund to insured deposits over the FDIC's first 50 years. A number of things suggest the make-believe fund does not need to be anywhere near that level.

The recent law allowing nationwide banking should reduce materially the number of failures, as banks diversify geographically. About 85% of failed- bank assets during the 1980s were lodged in just four states that suffered severe regional economic slumps. Indeed, students of history will recall that the federal deposit insurance system was adopted during the Great Depression over the objections of those who believed a nationwide branching law would be a preferable way to resolve the banking crisis.

We also now have an early-intervention law that allows the FDIC to take over a bank when it still has positive capital. This law, coupled with the new federal depositor preference statute, should reduce greatly the losses from banks that do fail.

Finally, there is the new premium system, which puts deposit insurance premiums on a pay-as-you-go basis. There is no longer a maximum annual premium banks may be assessed. The FDIC is required to levy whatever premium is necessary to cover the FDIC's losses and expenses and maintain the nonexistent fund at 1.25%.

Those who don't understand or care about the facts concerning the adequacy of the nonexistent FDIC fund should at least give some consideration to the politics of the issue. Bankers held their collective noses in 1991 and allowed Congress to pass the most punitive piece of banking legislation in modern U.S. history.

Banks permitted their premiums to be tripled, agreed to build the FDIC fund to 1.25%, accepted unlimited liability to maintain the fund at 1.25%, and swallowed an enormous increase in their regulatory burden. Congress, in return, agreed that once the nonexistent fund reached 1.25% banks need only pay the premiums necessary to maintain it at that level.

The looming premium disparity between banks and thrifts presents difficult political issues. They will be resolved only if knowledgeable people work through the issues in a spirit of good will. That will never happen if there is even a hint that commitments made in times past amount to just so many empty words.

A strong case exists for reducing materially or even eliminating the concept of a deposit insurance fund. If it moves in that direction, Congress has the ability to make the problems of the Savings Association Insurance Fund much more manageable. Mr. Isaac, a former chairman of the Federal Deposit Insurance Corp., is chairman and chief executive officer of Secura Group, a financial services consulting firm based in Washington.

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