Though Narrower than Expected, Bill Means Lots of Changes

The omnibus banking bill passed by Congress last week is a mere shadow of the ambitious package offered in February by the Bush administration. But the five titles will nonetheless bring significant changes, including the most sweeping overhaul of the deposit insurance system since its creation in 1933. Here are the key provisions:

Insurance fund recapitalization. The bill gives the Federal Deposit Insurance Corp.'s Bank Insurance Fund three new sources of funds.

For starters, to pay for losses expected over the next two to three years, the agency is permitted to borrow as much as $30 billion from the U.S. Treasury, up from $5 billion under current law.

In addition, it would be able to borrow from the Federal Financing Bank up to 90% of the fair market value of assets under its control. That credit line, which is intended to be repaid as assets are sold, is expected to make a minimum of $40 billion available to the agency.

Finally, the bill permits the insurance fund to borrow from member institutions.

Any borrowings not repaid by asset sales are expected to be covered by insurance premiums. The FDIC is required to establish an assessment sufficient not only to repay any borrowed funds within 15 years, but also to give the insurance fund reserves of $1.25 for each $100 of insured deposits.

Improved examinations. All insured institutions must undergo an annual, on-site examination by the primary federal regulator. State examinations can be substituted every other year. Well-capitalized, well-managed institutions with assets of less than $100 million need be examined only once every 18 months.

Independent audits. Insured institutions with assets of more than $150 million are required to obtain each year an independent outside audit, which must include a report on internal controls and compliance with laws and regulations. The process will be overseen by an audit committee composed of outside directors with access to independent legal counsel.

Assessments. The FDIC is permitted to assess institutions for the cost of all regular and special examinations and to require payment within 60 days.

Accounting reforms. The federal banking agencies must issue regulations within one year requiring banks to report off-balance sheet items on financial statements.

In addition, the agencies must require disclosure of the fair-market value of all assets, to the extent possible.

Prompt corrective action. Banks and thrifts will be classified in one of five categories according to capital adequacy.

The five categories, which supplement the existing Camel system, are:

1. Well capitalized - institutions that significantly exceed all relevant capital requirements.

2. Adequately capitalized - institutions that meet all capital measures.

3. Undercapitalized - those that fail to meet at least one capital requirement.

4. Significantly undercapitalized - institutions that are significantly below any of the relevant measures.

5. Critically undercapitalized - institutions that fall below the "critical capital level." Each agency is supposed to set the level for its own institutions. However, the test requires at a minimum that core capital equal 2% of assets.

At each successive downward level, institutions are subject to more restrictions and regulators have less flexibility in deciding how to deal with the bank or thrift.

For example, Level 3 institutions are subject to asset-growth restrictions.

An institution that falls below the critical capital level will be placed in conservatorship or receivership, unless it submits an acceptable capital restoration plan within 45 days.

Least-cost resolution. The cost test in the Federal Deposit Insurance Act is modified to require the agency to choose the least-cost method of dealing with failed institutions.

Beginning in 1995, the FDIC will not be permitted to protect uninsured depositors or creditors if that action would have the effect of causing losses to the insurance fund. An exception is made in cases where the President, the Department of Treasury, the Federal Reserve Board, and the FDIC jointly determine that closing the institution would endanger the financial system.

In that case, the FDIC must recover losses through a special industrywide assessment. The General Accounting Office is required to audit FDIC compliance each year.

Discount window limits. The Federal Reserve is barred from making discount window loans to undercapitalized institutions for more than 60 days in any 120-day period unless it first receives a certificate of viability from the primary regulator or is willing to risk losses on the loan.

However, the limits are waived if the secretary of the treasury puts in writing, following a recommendation from the chairman of the Federal Reserve, that loans are needed to prevent a severe adverse effect on a regional or national economy.

Brokered-deposit curbs. Only well-capitalized banks are permitted to accept brokered deposits, and those that do may pay no more than the average rate for their locale.

Risk-based assessments: The FDIC is required by 1994 to charge banks different insurance premiums, based on the full range of risks faced by each institution, including interest-rate risk. In addition, the bill authorizes a three-year pilot program in which the FDIC will evaluate the use of private-sector reinsurance as a means of setting risk-based premiums. The FDIC would have discretion to make the program permanent at the end of the pilot program.

Restrictions on state powers. The bill generally bars state banks from exercising powers not permissible for federally chartered institutions, including insurance underwriting.

The bill does exempt, or "grandfather," banks already lawfully engaged in underwriting insurance under state law. Therefore in Delaware, which in 1989 passed a law permitting banks to underwrite and sell insurance nationwide, Citicorp and other banks already licensed to underwrite insurance can do so, but only for Delaware residents.

There are no restrictions on the authority of states to authorize insurance brokerage activities. So Delaware banks will be still able to sell insurance nationwide.

The bill prohibits state-chartered banks from engaging as a principal in activities not permissible for national banks and from direct equity investments.

However, the bill included another exemption that permits state banks to continue to invest up to 10% of their portfolio in stocks listed on national securities exchanges, provided they are already in the business.

The exemption primarily benefits Massachusetts savings banks. Similarly, the bill also protects savings bank life insurance for thrifts in Massachusetts, New York, and Connecticut.

Deposit and pass-through insurance. Bank Investment Contracts, a fixed-income product sold primarily to pension funds, will no longer be insured above the first $100,000. The pass-through feature had made it possible to insure BICs of almost any size.

Foreign deposits. The bill generally prohibits the FDIC from protecting foreign branch deposits in dealing with a bank failure. In cases where the agency determines offshore deposits must be paid off to protect the system, it is required to recover losses through an industrywide assessment on an expanded base that has the effect of assessing foreign deposits.

Consumer provisions. Chief among the consumer protections included in the package is the truth-in-savings bill, which requires uniform disclosure of the terms and conditions of savings accounts. The bill also requires banks to give 90 days' notice before closing a branch.

A "greenlining" amendment is included that provides incentives to encourage banks to lend money in poor neighborhoods. The FDIC is required to start an affordable housing program in which it will give nonprofit organizations an opportunity to buy residential properties acquired from failed banks.

Also included is a permanent availability schedule for funds deposited in non-proprietary automated teller machines. The section also calls for a study of the paperwork and regulatory burden faced by banks.

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