WASHINGTON - Merrill Lynch & Co. denied Tuesday that its fast-growing banking business is a threat to federal deposit insurance reserves.

Banking industry officials, especially those representing small financial institutions, have criticized the New York financial services company's shifting of $31 billion from uninsured money market accounts to insured accounts at its commercial banks in the past six months.

The officials have complained that Merrill Lynch is adding risk to the Bank Insurance Fund and diluting coverage while not paying premiums.

But Merrill Lynch, which has previously said little publicly about the issue, disputed these accusations.

"With the strong financial position of Merrill Lynch and its two banks, there is no way that our clients' deposit growth could pose any risk to the deposit insurance system," the company said in a statement responding to questions from American Banker.

The Merrill response came amid new warnings from the Federal Deposit Insurance Corp. that the bank and thrift funds are increasingly vulnerable.

An FDIC official said at a board meeting Tuesday that "one medium-sized bank failure" could deplete the bank fund and force the entire industry to pay premiums for the first time in four years.

Declining commercial credit quality, increasingly risky lending lines at banks, and a few fast-growing institutions adding billions of dollars in insured deposits have made the fund susceptible to economic shocks, said Fred Carns, associate director of the agency's insurance division.

Most banks do not pay premiums, because the ratio of federal reserves to insured deposits exceeds the statutory minimum of 1.25%. Though the bank fund was at 1.34% at the end of the second quarter, FDIC officials said they still worry that it could drop below the minimum quickly.

"In a time of extended economic prosperity, it is remarkable that the cushion is so small," Mr. Carns said. "One can think of a number of realistic scenarios that would cause premiums to be forced on the industry in a short period of time."

If the fund drops below 1.25% and is not recapitalized within a year, banks would face a steep premium of 23 cents for every $100 of insured deposits. The FDIC has said such an increase could force banks to pay nearly $9 billion of premiums, and lead to a $65 billion reduction in lending.

Even without a major bank failure, Mr. Carns said, some unexpected smaller losses could reduce the bank fund to 1.27% by next June, if the current growth rate of insured deposits continues. That would bring the insurance fund to its lowest point since the end of 1994.

Regulators said that the report gives further incentive for the FDIC to reform the system, by combining the bank and thrift funds to make the reserves stronger and more diversified.

"This demonstrates one of the major problems with the system as it stands now. We need to make the system better," said Ellen Seidman, director of the Office of Thrift Supervision and a member of the FDIC board.

One major factor contributing to the potential instability of the reserve is the fast growth of institutions such as Merrill Lynch. The company's $12 billion second-quarter increase of insured deposits was enough to lower the reserve ratio by 1 basis point, FDIC officials said.

While third-quarter information on the bank fund has not been released yet, Merrill Lynch's addition of $19 billion to its insured deposits during that quarter could cause at least another basis-point drop, FDIC officials said.

Banking industry representatives said it is unfair that a company not paying premiums could contribute to a dip in the reserve ratio that forces the entire industry to start paying them again.

"It's just totally wrong," said Kenneth A. Guenther, executive vice president of the Independent Community Bankers of America. "That they are bringing in and moving that much to the insurance funds into which they've paid no premiums is wrong. The fund was not meant to work this way."

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