WASHINGTON - Adding momentum to the deposit insurance reform debate, the Federal Reserve Board is expected today to endorse virtually all of the recommendations made by the Federal Deposit Insurance Corp. in April.

Weighing in for the first time at a House Financial Services subcommittee hearing, Fed Governor Laurence H. Meyer is expected to support merging the bank and thrift funds, imposing risk-based premiums on each institution "no matter how well capitalized and well rated it may be or how high the fund's reserves," and offering rebates based on historical contributions.

Mr. Meyer is also expected to endorse replacing the statutory threshold that requires the FDIC keep $1.25 in reserves for every $100 in insured deposits with a more flexible range.

"I want to compliment the FDIC for an excellent report that highlights the issues and develops an integrated framework for addressing them," according to a draft copy Mr. Meyer's testimony obtained by American Banker Wednesday. "We urge the Congress to use that framework for promptly developing a detailed legislative proposal that addresses the most important deficiencies in our current deposit insurance system."

According to the draft, Mr. Meyer will outline the current system's many flaws, including the fact that 92% of institutions pay nothing in premiums because they are in the best-rated risk category and the reserve ratio is above 1.25%. In particular, he reportedly will cite the so-called "free riders" -- a term that includes two brokerage houses that have moved billions of dollars to insured accounts without paying new premiums and hundreds of other institutions that have never paid for deposit insurance.

"Included in this group were banks that have never paid any premium for their, in some cases substantial, coverage and fast-growing entities whose past premiums were extraordinarily small relative to their current coverage. We believe that these anomalies were never intended by the framers of the Deposit Insurance Fund Act of 1996 and should be addressed by the Congress," Mr. Meyer is expected to say.

Mr. Meyer will reportedly endorse giving the FDIC much more leeway in determining the size of the reserve funds, and when premiums should be increased.

"In addition to widening the range, the board would recommend that the FDIC be given the latitude to temporarily relax floor or ceiling ratios on the basis of current and anticipated banking conditions and expected needs for resources to resolve failing institutions," Mr. Meyer is expected to testify.

That kind of support surprised many industry observers, who had expected the Fed to be more critical of the FDIC's recommendations. Indeed, Mr. Meyer is expected to throw water on at least one proposal -- tying the coverage level per account to inflation.

According to his testimony, the Fed opposes significantly increasing the coverage limit, and even rejects the notion of indexing coverage to inflation. (Fed Chairman Alan Greenspan came out against raising coverage levels last summer.) "The board does not support this recommendation and believes that, at this time, the current ceiling should be maintained," Mr. Meyer is expected to say. "In the board's judgement, it is unlikely that increased coverage, even by indexing, today would add measurably to the stability of the banking system."

Mr. Meyer is expected to argue that most depositors have not voiced support for increasing the coverage level because they are already adept at obtaining the coverage they want by opening multiple accounts. The Fed will also likely rebut the argument that community banks need higher coverage levels to compete with larger organizations that control several banks and therefore offer say $600,000 of insurance.

"While the board believes that such offerings are a misuse of deposit insurance, raising the coverage limit for each account would also increase the aggregate amount of insurance coverage that large multibank organizations would be able to offer, so the disparity would remain," Mr. Meyer is expected to testify.

Beyond coverage, the Fed will likely only suggest slight changes to the FDIC's proposals. For example, Mr. Meyer is expected to take issue with the FDIC's plan to cap risk-based premiums at a certain point because they fear increased premiums would only contribute to an institution's failure. Mr. Meyer will not be sympathetic.

"We believe that capping premiums may end up costing the insurance fund more in the long run should these weak institutions fail anyway, with the delay increasing the ultimate cost of resolution," he is expected to say.

But Mr. Meyer will not be the only person weighing in today.

Industry representatives and legislators are also watching the Treasury Department, which is expected to send an official today to testify before the financial institutions subcommittee. That testimony would be the first detailed comments on the topic by members of the Bush administration.

"It is an important day politically for deposit insurance reform," said Edward L. Yingling, chief lobbyist for the American Bankers Association. "Their views are going to be very significant."

Also scheduled to testify are Comptroller of the Currency John D. Hawke Jr. and outgoing Office of Thrift Supervision Director Ellen Seidman, both of whom have said they mostly support the reform effort.

But Mr. Hawke is expected to continue pushing for a provision that would have the deposit insurance funds absorb the cost of all federal and state bank supervision. He has argued that the Comptroller's Office, the OTS, and state examiners should be reimbursed for the cost of supervising banks because federal supervision of state non-member banks is already taken from the Bank Insurance Fund. But that plan has met harsh criticism from industry representatives, who say its inclusion would kill any reform bill.


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