As the vise continues to tighten on small banks' net interest margins, bankers are cautiously optimistic that deposit insurance reforms - especially regarding municipal deposits - might help them breathe a little easier.

Congress is considering several bills that would raise Federal Deposit Insurance Corp. coverage on deposits above the current $100,000 limit per account. Doing so, community bankers argue, could bring them more deposits, reduce their cost of funds, and increase margins as a result.

"Half of the problem in the last year has been the Fed cutting rates, and the other half is increased competition for deposits and loan dollars," said E. George Koffler, president and chief executive officer of $75 million-asset Bank of Eastern Oregon in Arlington.

The FDIC last week released a report saying that average net interest margins at banks with less than $100 million of assets - there are more than 4,800 - dropped to 4.28% in the first quarter, the lowest since the agency began tracking the data 17 years ago.

Industry experts blamed the decline on the Federal Reserve's three rate cuts during the quarter. Small banks make most of their money from lending, so any drop in interest rates is likely to hit them hardest. And the results may be worse when the FDIC releases second-quarter data this summer. The Fed has cut rates three more times this quarter.

The Independent Community Bankers of America said the findings bolstered the argument for higher coverage caps. At least four bills to do so are pending in Congress, including one sponsored by Sen. Tim Johnson, D-S.D., that would essentially double the coverage level, to $200,000. When he introduced the legislation in January, Sen. Johnson said his primary motive was to encourage investment in small towns.

"An important step to help preserve rural America is to keep local wealth in these smaller communities," he said.

Community bankers, however, seem more partial to pending bills that would raise the coverage level on municipal deposits. Charles J. Runde, president of First National Bank of Platteville in Wisconsin, said that some banks might lose deposits as customers who now divide their money among several banks consolidate accounts in one.

On the other hand, municipal deposits might be a source of new funds if the coverage cap were raised, said Sara J. Mikuta, chief financial officer of the $56 million-asset Leaders Bank of Oak Brook, Ill. Many local governments or school districts that now put their money in Treasury securities or state-run investment pools might shift funds to their local banks. The benefits, bankers say, would be twofold: more money for lending in the community and a lower cost of funds.

Rep. Paul E. Gilmor, R-Ohio, has introduced a bill that would increase deposit insurance for in-state municipal deposits up to the total equity capital of the institution. The bill came after one introduced by Sen. Robert G. Torricelli, D-N.J., in January to completely insure all in-state municipal deposits.

Craig D. Collette, president of $100 million-asset Marathon National Bank in Los Angeles, said an increase might inspire more confidence among municipal depositors. "We haven't been able to compete with the big banks for municipal deposits because municipalities are worried that a small bank would have more risk in going under," he said

The FDIC said the proposal merits more study but has not endorsed it.

Bankers in Iowa have another reason for supporting proposals to raise coverage on public deposits. In most states, if government deposits at a single bank exceed the $100,000 limit, the bank must buy bonds or additional insurance to cover the excess in the event the bank fails.

In Iowa, all banks in the state are required to pool their money to cover the uninsured public deposits at a failed bank. So when Hartford-Carlisle Savings Bank in Carlisle failed last year, 465 banks and thrifts were assessed an average fee of $21,000.

"We are insuring the guy down the street or in the next town, and we have no control over their business," said Tom B. Gronstal, president of $114 million-asset Carroll County State Bank in Carroll. Without increased coverage, he added, Iowa bankers could face frequent charges in bad economic times.

Katie Kuehner-Hebert contributed to this article.

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