WASHINGTON — Seven state treasurers and the American Bankers Association are seeking the Federal Deposit Insurance Corp.'s help to bolster state programs that back public deposits.

They argue that more failures in these states could spur higher costs and asset seizures at banks that participate in the programs, which in turn could cause more collapses.

The treasurers are pressing the FDIC to invoke the "systemic risk" clause — a measure the agency has used only recently to handle the potential collapses of massive institutions — in dealing with failing community banks with significant municipal deposits.

The FDIC "has to look at what else happens when Bank of Small Town America goes down," said Washington Assistant State Treasurer Wolfgang Opitz.

At issue are programs designed to protect towns, school districts and other municipalities that have deposits above the FDIC's $250,000 insurance limit and stand to lose money if their bank fails. Such programs essentially set up their own system to cover uninsured municipal deposits.

After a bank failure, other participating banks typically are liable to pay assessments or pledge collateral to fund losses if the failed bank's remaining assets will not cover the cost. In some cases, if a bank cannot afford the extra assessment, the state may seize collateral from it.

The issue has attracted the most attention in the state of Washington, where the $446 million-asset Bank of Clark County's failure in January triggered the first assessment to cover municipal deposits in the program's 25-year history. The fees totaled $15 million and were based on each bank's share of public deposits.

The state also wants banks to pledge more collateral to safeguard the program. Currently participants must put up collateral equal to 10% of their public deposits, but the state is working on a plan to raise that figure to 100%.

Local bankers are concerned that pledging more collateral could hurt other banks.

"Many public depositaries are concerned that some of the less healthy institutions could be forced to close by the higher collateral requirements, thus triggering another assessment that could set off a cycle of more closures and assessments," Washington State Treasurer James L. McIntire and his six counterparts wrote in a Feb. 20 letter to FDIC Chairman Sheila Bair.

State bankers argue that at least a temporary six-month agreement to invoke the systemic risk exception would give them time to adjust. "That's where the systemic risk piece comes in," said James Pishue, the president and chief executive officer of the Washington Bankers Association. "If a bank is unable to pay that assessment, and the collateral has to be liquidated, … it's an indication that there could be some systemic risk."

Observers say granting the states' request would be a significant step by the FDIC. For starters, it is facing its own funding issues; its reserves have fallen to $18.9 billion, and it is planning a special fee to try and bolster the Deposit Insurance Fund.

Some say a federal effort to shore up state insurance systems could increase premiums for the entire banking industry.

"There already is a lot of friction with healthy banks unhappy that they have to pick up the pieces and pay for the bailout of reckless banks," said Kip Weissman, a partner at Luse Gorman Pomerenk & Schick PC.

In addition, the agency is reluctant to invoke the systemic risk exception. Under current law, when a bank fails, the FDIC can cover uninsured deposits only if it is the "least costly" option for the fund. The agency can sidestep that requirement if it determines — in consultation with the White House and the Federal Reserve Board — that a bank's failure would pose systemic risk.

In a March 9 letter supporting the state treasurers' request, Wayne Abernathy, the ABA's executive director of financial institutions policy and regulatory affairs, said that may be an option the FDIC should follow. "We believe it is appropriate to invoke the systemic risk exception in situations where declining to do so could trigger additional bank failures," he wrote. "The eventual cost to the Deposit Insurance Fund could under some conditions be far smaller by taking steps in the context of one failure to avoid the failure of others."

In an interview, Abernathy said a systemic risk exception would be in the FDIC's interest. "We're saying that if drawing upon the pledges from the other banks in the pool would cause some other bank failures and result in even higher losses to the FDIC, then it makes sense for them to use a systemic risk waiver in order to save the FDIC money," he said.

State finance officials said that even if the agency did not invoke the legal exception, it would be important for the FDIC to explore all options and find bids covering uninsured public funds that meet the least-cost test.

Iowa Treasurer Michael Fitzgerald, who signed the Feb. 20 letter, said in an interview that officials want to "encourage the FDIC to apply the maximum amount of pressure possible when they sell the bank" to cover all deposits. "I have heard from one bank that is real concerned about taking public deposits who felt that, in this environment, they could be subject to a huge assessment," he said.

Andrew Gray, an FDIC spokesman said it tries to arrange deals for failed banks that cover uninsured deposits, though that is not always possible. The agency will offer a failed institution in a "variety of ways," including whole-bank transfers and transactions that cover only the insured deposits or all of them, but it can only accept a bid that meets the legal test.

Institutions that opted into the FDIC's temporary program to cover zero-interest checking deposits can have such accounts completely covered, he said. The FDIC invoked the systemic risk waiver when launching the program in October, citing the need to support liquidity. The expanded coverage will last until the end of this year.

Some observers argued that if the FDIC went further to grant special treatment for banks in the state insurance funds, it could cause friction among other institutions already paying high premiums. "There would be some pushback about the FDIC taking on any more exposure than it already has," said Robert Clarke, a former comptroller and now a partner at Bracewell & Giuliani LLP.

But others argued it will benefit the entire industry if invoking systemic risk will prevent more failures. "It's asking the FDIC to consider the domino effect," said Karen Thomas, the director of government relations at the Independent Community Bankers of America. "Instead of looking at the individual failed institution and what is the least expensive way to resolve that institutions, it has to consider the costs that flow from that."

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