Five years ago today, Congress handed regulators broad new powers in the Federal Deposit Insurance Corp. Improvement Act.
Though the industry has rebounded from near-catastrophe in the early 1990s, the verdict on FDICIA may not be decided for years.
"We won't know the overall assessment until the next time the banking industry is in serious trouble," said Mark W. Olson, a partner in the Washington office of Ernst & Young.
Passed by lawmakers stung by the costly bailout of the savings loan industry, the act gave regulators new authority to shut down weak institutions and limit losses to the federal deposit insurance funds.
The law established five levels of capital ranging from "well- capitalized" to "critically undercapitalized" and requires regulators to impose increasingly harsh penalties on banks as their condition deteriorates. As an institution grows weaker, the government can replace management and eventually close the bank.
By taking this "prompt corrective action," regulators can stop reckless management and stem government bailouts. But even fans of the act admit it has never been tested in an industrywide threat.
"FDICIA is a great step forward, but the great unknown is what happens when the industry goes through its next down cycle," said W. Roger Watson, FDIC research director.
Treasury Under Secretary John D. Hawke Jr. said he is confident that the law's safeguards can stave off a crisis. "I think FDICIA is built on very solid ground," he said.
By measuring bank capital correctly and moving quickly, regulators can provide a "strong, if not complete, protection of the government's interest."
Still, Mr. Hawke conceded the law is "internally inconsistent" because it placed a long list of new regulatory burdens on the industry, many of which infuriated bankers.
"If the promise of FDICIA is realized, it ought to be a charter of freedom" and "liberate banks from a lot of the current restrictions," Mr. Hawke said.
More than a dozen new regulations, were enacted by FDICIA, including Truth-in-Savings, new limits on state-chartered banks, and 90-day notification for branch closings.
Ever since, banks have been lobbying Congress and regulators to roll back many of the law's regulations. They've enjoyed modest success.
*Civil liability for Truth-in-Savings violations will be eliminated in 2001.
*The exemption from external audits of management controls has been increased from $150 million in assets to $500 million.
*External auditors no longer must verify compliance with safety and soundness laws.
*Notification eliminated for closings if other branches are near or if a branch has been acquired from a failing institution.
Despite the regulatory burdens, many industry experts praise the FDIC law for instituting higher capital requirements and risk-based premiums, which lowered the cost of deposit insurance for well-managed institutions.
"The industry is enjoying terrific health, and I think FDICIA is a part of the reason," said Robert E. Litan, director of economic studies for the Brookings Institution.
Brian P. Smith, economics director at America's Community Bankers, agreed. "Financially, the law has been a stunning success," he said. "It has bolstered the insurance system, and the industry is as strongly capitalized as it's been in 40 years."
Today, well-capitalized banks hold 98% of the industry's assets, up from only 25% in 1990, according to the FDIC. Though the economic expansion that began in late 1991 revived industry earnings, the act motivated banks to build capital.
"The law institutionalized the concept of a well-capitalized bank," said James H. Chessen, chief economist at the American Bankers Association. "No bank really wants its capital to be considered merely 'adequate."'
Mr. Chessen lauded a requirement that forces regulators to close failed institutions at the lowest cost to the government. The provision forbids federal funds from being used to protect uninsured depositors.
Lawmakers and regulators had long angered the industry by arguing that some big banks and their uninsured depositors must be propped up to avert aftershocks that damage the economy. "This took a significant step in eliminating the 'too big to fail' concept," Mr. Chessen said.
But critics of the law said the regulatory burdens far outweigh the benefits.
"Someday we will be in the middle of a banking crisis and will really regret that regulators don't have greater ability to use their judgment," said William M. Isaac, a former FDIC chairman and current head of the Secura Group.
L. William Seidman, also an ex-FDIC chairman, added that the law's prompt corrective action requirements could fuel, rather than stem, government losses. "If we had these very strict interpretations when I was there, we might have had to close a lot of major institutions that ended up surviving."
Both men argued that regulators stemmed a major banking crisis in the late 1980s and could have checked the earlier savings and loan debacle if not for congressional interference.
"I believe all FDICIA has done is put more burdens on the industry and tied regulators' hands when trying to handle difficult situations," Mr. Isaac said.
But one banker, whose institution survived a capital crunch, said he feels regulators still have sufficient leeway.
"Though they are married to the FDIC fund, they understood we wanted also to protect shareholders as best as possible," said Gregory R. Shook, senior vice president of Branford Savings Bank in Branford, Conn.
Branford's capital twice fell below 2% of assets, the level considered "critically undercapitalized," yet the officials gave the institution time to raise money in the stock market.
"There is some flexibility," Mr. Shook said.