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81–065 PDF 2002

S. HRG. 107–595

COMPREHENSIVE DEPOSIT INSURANCE

REFORM: RESPONSES TO THE

FDIC’S RECOMMENDATIONS FOR REFORM

HEARING

BEFORE THE

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

OF THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

ON

THE FEDERAL DEPOSIT INSURANCE CORPORATION’S RECOMMENDATIONS

FOR IMPROVING THE DEPOSIT INSURANCE SYSTEM

AUGUST 2, 2001

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

JON S. CORZINE, New Jersey

DANIEL K. AKAKA, Hawaii

PHIL GRAMM, Texas

RICHARD C. SHELBY, Alabama

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN ENSIGN, Nevada

STEVEN B. HARRIS, Staff Director and Chief Counsel

WAYNE A. ABERNATHY, Republican Staff Director

MARTIN J. GRUENBERG, Senior Counsel

SARAH DUMONT, Republican Professional Staff Member

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator

GEORGE E. WHITTLE, Editor

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

TIM JOHNSON, South Dakota, Chairman

ROBERT F. BENNETT, Utah, Ranking Member

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

CHRISTOPHER J. DODD, Connecticut

JACK REED, Rhode Island

EVAN BAYH, Indiana

JON S. CORZINE, New Jersey

JOHN ENSIGN, Nevada

RICHARD C. SHELBY, Alabama

WAYNE ALLARD, Colorado

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

NAOMI GENDLER CAMPER, Staff Director

MICHAEL NIELSON, Republican Professional Staff Member

(II)

CONTENTS

THURSDAY, AUGUST 2, 2001

Page

Opening statement of Senator Johnson ................................................................. 1

Prepared statement .......................................................................................... 29

Opening statements, comments, or prepared statements of:

Senator Gramm ................................................................................................ 3

Senator Bunning ............................................................................................... 4

Senator Sarbanes .............................................................................................. 5

Prepared statement ................................................................................... 30

Senator Bennett ................................................................................................ 12

Senator Reed ..................................................................................................... 25

Prepared statement ................................................................................... 30

Senator Miller ................................................................................................... 27

Senator Allard ................................................................................................... 31

WITNESSES

Robert I. Gulledge, Chairman, President & Chief Executive Officer, Citizens

Bank, Inc., Robertsdale, Alabama, Chairman of the Independent Community Bankers of America, on behalf of the Independent Community Bankers

of America ............................................................................................................. 7

Prepared statement .......................................................................................... 31

Response to written questions of Senator Miller ........................................... 54

Jeff L. Plagge, President & Chief Executive Officer, First National Bank

of Waverly, Iowa, on behalf of the American Bankers Association ................. 9

Prepared statement .......................................................................................... 41

Response to written questions of Senator Miller ........................................... 64

Curtis L. Hage, Chairman, President & Chief Executive Officer, Home Federal Bank, Sioux Falls, South Dakota, First Vice Chairman, America’s

Community Bankers, on behalf of America’s Community Bankers ................. 10

Prepared statement .......................................................................................... 48

Response to written questions of Senator Miller ........................................... 71

Response to oral questions of Senator Johnson ............................................. 74

(III)

(1)

COMPREHENSIVE DEPOSIT INSURANCE

REFORM: RESPONSES TO THE

FDIC’S RECOMMENDATIONS FOR REFORM

THURSDAY, AUGUST 2, 2001

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS,

Washington, DC.

The Subcommittee met at 10:03 a.m., in room SD–538 of the

Dirksen Senate Office Building, Senator Tim Johnson (Chairman of

the Subcommittee) presiding.

OPENING STATEMENT OF SENATOR TIM JOHNSON

Senator JOHNSON. I would like to call the Subcommittee to order.

Good morning. I am pleased to convene the first meeting of the

Financial Institutions Subcommittee of my Chairmanship on a

topic that has been of great interest to me for a great many years.

Federal deposit insurance is one of the cornerstones of our banking

and financial system. This insurance gives depositors the confidence they need to fully utilize America’s financial institutions.

Since I began service in Congress in 1987, we have seen some real

ups and some real downs in the banking industry, and it is a great

privilege today to Chair a hearing on a matter of such importance

to our Nation’s bankers, and indeed, to our country as a whole.

I would first like to recognize Ranking Member Bennett, who I

am told has a hearing conflict right now and, hopefully, will be able

to join us later. I am pleased that Senator Gramm is able to join

us here this morning. But I do want to thank Ranking Member

Bennett in particular for working with me on a great range of

banking issues. He has a very distinguished business background.

I value his insights. Obviously, I appreciate Chairman Sarbanes,

who conducts all of his hearings in a dignified and thoughtful manner and I aspire to live up to the high standards that he has set

for the Senate Banking Committee.

As everyone in the room knows, or surely will find out in short

order, comprehensive deposit insurance reform is an enormously

complex issue. I will resist the opportunity today to recite a history

of banking reform, and steer clear of too many statistics—at least

until the question and answer period. While the body of literature

on deposit insurance is vast, I would note that there appears to be

more consensus than there is disagreement on potential reforms.

At today’s hearing, the financial services industry will respond to

the FDIC’s recommendations for comprehensive reform of the FedVerDate 11-MAY-2000 07:09 Aug 15, 2002 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 81065.TXT SBANK4 PsN: SBANK4
2

eral Deposit Insurance System. The FDIC, in my view, has identified some significant weaknesses in the current system.

In particular, it is hard to argue with the FDIC’s observation

that the current system is procyclical. That is, in good times, when

the funds are above the designated reserve ratio of 1.25 percent,

92 percent of the industry pays nothing for coverage. But in bad

times, institutions could be hit with potentially crushing premiums

of up to 23 basis points. I think that most industry members agree

that this so-called ‘‘hard target’’ presents a very real threat to their

businesses.

Of course, this means that any movement in the funds down toward 1.25 percent increases the anxiety level of bankers and regulators alike, whether that movement comes from fast growth of

certain institutions, or from institutional failures like we saw last

Friday in the case of Superior Bank of Illinois. The numbers are

still preliminary, but cost estimates of the failure start at around

$500 million, which would reduce the SAIF ratio by seven basis

points. I say this not to be alarmist, but I would urge caution

against becoming simply complacent in good times and resisting

changes that make sense over the long term and have the potential

to enhance the overall stability of our system.

I am particularly interested in hearing from the witnesses about

their positions on premiums. I would note that there is unanimity

among the Federal banking regulators that institutions should pay

regular deposit insurance premiums, though not with respect to

how we should determine those premiums.

Now, I understand that 92 percent of the industry is free from

current premium payments, and it certainly presents an interesting psychological and political challenge to persuade folks to pay

for something that they currently get for free. On the other hand,

I am not the first to note that very few things in life are, in fact,

free. If you are getting something of value, eventually, you have to

pay for it. The question is not whether you will have to pay up; it

is when and how much.

I am also interested in hearing comments about the erosion in

value of deposit insurance. I think my position is well known. I believe that we need to increase, and index, coverage levels. Over the

last 20 years, coverage values have decreased by more than half,

and previous increases were unpredictable both in terms of amount

and timing. I expect to hear a spirited debate on that topic, and

I believe it should be included in any discussion of comprehensive

reform.

I would urge everyone involved in this debate to take a step back

and recognize that when we talk about deposit insurance, we are

talking about the foundation of our financial system. I think it is

simply irresponsible to take a short-term approach, or to politicize

these issues. And while I am open to persuasion on just about

every component of reform, I am firm in my belief that we all share

the common goal of a safe and sound banking system.

As many of you know, I am committed to ensuring that our small

banks and thrifts—which play such an important role in rural

States such as mine, South Dakota—have the tools they need to

survive. I am also well aware of the value that our larger banks,

thrifts, and bank holding companies bring to this country. I believe

3

my strong support of financial modernization speaks for itself, and

would simply add that I am committed to finding a reform package

that considers the needs and interests of all members of our financial services community.

Now some might argue that it will be impossible to craft changes

to our deposit insurance system that will bring all the interested

parties together, but I reject that argument. First, every single

bank and thrift in this country benefits from our world-class deposit insurance system, and it is in everyone’s interest to find an

acceptable set of changes. Second, I believe that our witnesses will

tell us that the industry is, in fact, close together on many of the

core reform issues. Finally, the regulators themselves have said

that they are approaching consensus on a great many of these

issues. I am optimistic that we will be able to develop a sound and

comprehensive reform policy.

I am looking forward to hearing what my colleagues and our witnesses have to say and I will now turn to my good friend and colleague from Texas, Senator Gramm, for any opening statement

that he may have.

STATEMENT OF SENATOR PHIL GRAMM

Senator GRAMM. Well, Mr. Chairman, first of all, I want to thank

you for this hearing. It has been my great pleasure to work with

you on banking issues now for several years. I have appreciated

your interest in small banks.

Let me say that, without question, I represent more small banks

and bankers than any other Senator, other than my colleague, Senator Hutchison. And if there is a small banker in Texas who does

not support me, I do not know him.

So, I am very concerned about the health of small banks. I am

not one of these people who believes the future of America’s financial system is going to be dominated by large banks. There are a

lot of niches where small banks can be very successful, and I think

that people are finding these niches in my State.

I do believe we need a comprehensive reform of deposit insurance, and I want to congratulate you for your interest and leadership in this area. I want to pledge to you that I am willing and

eager to work with you to try to deal with the problem we have.

We need to keep in mind that we have two different insurance

systems. We have two types of institutions with very different charters and powers, that for all practical purposes have the same deposit insurance. And this is something that needs to be looked at

very closely. Should we merge the funds, and if we do, should we

change charters so that all financial institutions within the same

insurance fund have the same powers? I think these are the issues

that ought to be looked at.

I would say that my experience with the S&L crisis convinces me

that we should not raise the insurance limit.

I remember vividly from those terrible days of the S&L crisis

where institutions were broke, and it was obvious that, at some

point, they were going to be closed. But because of deposit insurance, deposits would come into a failing institution by the tens of

millions of dollars and seize a higher rate of return with absolute

4

certainty that the taxpayer was going to pick up the bill—if and

when that institution failed.

I believe that this created tremendous instability in the system.

I do not want to add to that by adding to these limits.

I think I am in good company with Alan Greenspan. I have not

yet talked to the new Secretary of the Treasury or the new FDIC

Chairman about this issue in any great detail, and I do not remember whether the Comptroller of the Currency joined the Secretary

of the Treasury and Alan Greenspan in opposing last year’s proposals to raise deposit insurance limits.

There are a lot of issues here that we do have agreement on, and

I think this is an important area. I want to thank our witnesses

for their time today.

I have to go to a Budget Committee thing. We have some people

downstairs that want to take back the tax cut and they need to be

beaten into submission.

[Laughter.]

I want to thank you, Mr. Chairman, for holding this hearing, and

to pledge to you that I have an open mind on these issues and I

hope and believe we can work together.

Thank you.

Senator JOHNSON. Thank you, Senator Gramm.

Senator Bunning.

STATEMENT OF SENATOR JIM BUNNING

Senator BUNNING. Thank you, Mr. Chairman, for holding this

very important hearing and I would like to thank our witnesses for

testifying today.

It is good to have the industry represented here on the topic of

Federal deposit insurance reform. A little while back we had the

regulators here and we touched upon many of the same issues that

we will be talking about today. It will be very helpful to have your

take on these issues.

Last April, the FDIC issued its paper, ‘‘Keeping The Promise—

Recommendations for Deposit Insurance Reform.’’ There are many

ideas in that paper that I believe there were a great deal of support

for. Merging the BIF and the SAIF funds is an idea that has been

around a long time. In fact, it has been around since I started in

the House Banking Committee in 1987.

There is a great deal of support for merging the funds. But it

seems it has always been caught up in the bigger plans for overall

deposit insurance reform. Because of the desire for reform, the

funds have not been merged. I also believe there is a consensus to

adjust the reserve ratios. The current 1.25 hard cap with 23 basis

points under capitalization could very likely be imposed in a time

of great concern to the banking industry when banks could least

afford a readjustment.

By giving the FDIC some flexibility, we can prevent turning hard

times into crisis times. I also believe there is a lot of consensus to

price premiums on a risk basis. I do not believe, however, there is

a consensus on raising and indexing for inflation the insurance levels. When the regulators were here on June 20, Chairman Greenspan hesitated to speak for the Fed. But in the past, he says he

opposes raising the insurance levels.

5

The OCC has also expressed concern about raising the levels.

The FDIC and the OTS have supported indexing the levels for inflation. I also have concerns about raising the deposit insurance

levels. I am leery of putting the taxpayer on the hook for higher

levels of coverage.

I am also skeptical that raising the levels will lead to a great

deal of increased deposits for smaller banks. I believe the deposits

have shrunk in the smaller banks because those deposits have been

going to higher returning uninsured vehicles. I do not believe those

deposits would be put into banks.

Mr. Chairman, once again, thank you for holding this hearing

and I look forward to our witnesses’ testimony.

Thank you.

Senator JOHNSON. Thank you, Senator Bunning.

I am pleased that our Chairman, Senator Sarbanes, could join us

this morning at this initial hearing of our Subcommittee.

And on very short notice, Chairman Sarbanes, do you have any

opening comments that you would like to share with us?

STATEMENT OF SENATOR PAUL S. SARBANES

Chairman SARBANES. I would just like to make a few remarks,

Mr. Chairman.

First of all, I want to thank you as Chairman of the Financial

Institutions Subcommittee for holding this morning’s hearing on

the very important subject of possible Federal Deposit Insurance

System reform. Obviously, any reform effort will require thorough

analysis of the issues and today’s hearing is an opening contribution to that effort.

As we are all of course aware, the FDIC in April published a report on reforming the deposit insurance system, which included,

among other things, merging the two funds, charging insurance

premiums based on the institution’s risk to the insurance fund, socalled ‘‘risk-based premiums,’’ shifting from a fixed reserve ratio of

1.25 percent of insured deposits to a target range of reserve ratios,

to avoid sharp swings in insurance premiums and to counter the

cyclical economic movements.

At the moment, the way it works, it often ends up pushing the

cycle along rather than countering the cycle.

Rebating premiums based on an institution’s historical contributions to an insurance fund when the fund grows above a target

level. And indexing deposit insurance coverage levels to the inflation rate.

Last week, the various Government agencies, in a hearing on the

other side, announced their views on the FDIC’s various recommendations, and they picked some and left others by the wayside.

Obviously, we need to review their positions very carefully.

Let me say, I think today’s hearing is particularly timely in light

of last Friday’s failure of a major thrift, Superior Bank of Illinois.

It is the eleventh largest depository institution to fail in our history. Reports suggests that it may cost the SAIF as much as $500

million. Furthermore, customers with uninsured deposits—in other

words, amounts over and above the $100,000 figure—may lose over

$40 million.

6

I am very much concerned about this failure and have taken

steps to inquire into its causes. We have asked the GAO, under the

leadership of the Comptroller General, to examine the situation,

not as much the specific one, as a general examination, because the

specific one will be examined by the Inspector General of the

Treasury Department, which has authority over the Office of Thrift

Supervision, and by the Inspector General of FDIC. And we have

asked both of them to submit their reports to us so that we may

have an opportunity to review them.

The statute actually requires the Inspector General at Treasury

to write a report when the deposit insurance fund incurs a material

loss. The statute also requires that the report be made available to

Congress upon request and it requires the IG’s report to review the

agency’s supervision of the institution, including the agency’s implementation of prompt corrective action, to discuss why the institution’s problems resulted in a material loss to the deposit insurance fund. And it also calls for recommendations for preventing

such losses in the future.

Pursuant to that statute, I have already requested of the Inspector General that the report be made available to the Congress upon

its completion.

We look forward to receiving these two IG reports and the study

from the GAO as we examine this situation. And in a sense, it is

a timely reminder of the role of the insurance fund. It is a timely

reminder of the potential exposure eventually to the taxpayer, if

things really go amiss, as we experienced in the savings and loan

crisis when we ended up footing a very large bill.

So, Mr. Chairman, I am pleased to join you and I am looking forward to hearing from the witnesses.

Thank you very much.

Senator JOHNSON. Thank you, Chairman Sarbanes.

I am pleased that we are able to have a very distinguished panel

with us here this morning.

Mr. Robert Gulledge is here on behalf of the Independent Community Bankers of America. He is Chairman of the ICBA. Mr.

Gulledge is Chairman, President, and CEO of Citizens Bank of

Robertsdale, Alabama.

Mr. Jeff Plagge is here on behalf of the American Bankers Association. Mr. Plagge is President and CEO of the First National

Bank of Waverly, Iowa.

Mr. Curt Hage is here on behalf of America’s Community Bankers. Curt is the First Vice Chairman of the ACB. Curt is Chairman,

President, and CEO of Home Federal Bank in Sioux Falls, South

Dakota, and a good friend of mine. And I might note that David

Bochnowski, the Chair of the ACB, graciously stepped aside and is

allowing Curt to come before the Subcommittee today. I know the

Subcommittee is very well served by Mr. Hage’s testimony.

Welcome to the Subcommittee. Rather than using the formality

of the 5 minute clock because we have a relatively small panel and

just one panel, we will forego that.

I would invite panel members to summarize their statements if

they so wish. Their full statements will be placed into the record.

With that, why don’t we begin with Mr. Gulledge.

7

STATEMENT OF ROBERT I. GULLEDGE

CHAIRMAN, PRESIDENT & CHIEF EXECUTIVE OFFICER

CITIZENS BANK, INC., ROBERTSDALE, ALABAMA

CHAIRMAN OF THE INDEPENDENT COMMUNITY

BANKERS OF AMERICA

ON BEHALF OF THE

INDEPENDENT COMMUNITY BANKERS OF AMERICA

Mr. GULLEDGE. Good morning, Chairman Johnson, Senator Sarbanes, and Senator Bunning. I am Bob Gulledge and I am President of Citizens Bank, an $80 million asset community bank in

Robertsdale, Alabama. I am also the Chairman of the Independent

Community Bankers of America, on whose behalf I appear today.

Mr. Chairman, I want to commend you for moving this important

issue forward. It has been 10 years since Congress last took a systematic look at the deposit insurance program. Now is the time,

during a noncrisis atmosphere, to modernize our very successful

Federal Deposit Insurance System, by adopting a package of interrelated reforms.

First, deposit insurance coverage levels have been badly eroded

by inflation and must be increased and indexed for inflation.

Today, in real dollars, deposit insurance is worth less than half of

what it was in 1980, and even less than what it was worth in 1974,

when coverage was raised to $40,000.

Higher coverage levels are critical to meet today’s savings and retirement needs. A recent Gallup poll showed that nearly four out

of five consumers think that deposit insurance should keep pace

with inflation. Higher coverage levels are critical to support the

local lending of community banks as they increasingly face liquidity pressures in trying to meet loan demand for our small business

and agricultural customers.

Community banks’ funding sources other than deposits are

scarce. Consumers and small businesses shouldn’t have to spread

their money around to get coverage they deserve. They should be

able to support their local banks, and local economies, with their

deposits.

Meanwhile, the examiners and the U.S. Treasury are warning

against our growing reliance on Federal Home Loan Bank advances

and other noncore funding sources such as brokered deposits.

We do not have access to the capital markets like the large

banks do. In troubled times, we, unlike large banks, are many

times ‘‘too small to save.’’ A recent Grant Thornton survey revealed that nearly four out of

five community bank executives say higher coverage levels will

make it easier to attract and keep core deposits.

The growing concentration of deposits and of financial assets in

fewer and fewer organizations, not an increase in coverage, presents the greatest systemic risk and ‘‘moral hazard’’ in our financial system and to the loss exposure of FDIC.

Chairman Johnson, ICBA strongly supports your legislation,

S. 128, which would substantially raise coverage levels and index

them in the future. This feature of deposit insurance reform is essential for our support of legislation. The ICBA also supports full

FDIC coverage for municipal deposits and higher coverage for

IRA’s and other retirement accounts.

8

Second, we must address the free-rider issue. Over the course of

last year or so, Merrill Lynch and Salomon Smith Barney have

moved around $100 billion into insured accounts without paying a

penny in insurance premiums, thereby reducing the reserve ratio.

Further, by owning multiple banks, they offer their customers

higher coverage levels than we can. This is a double-barreled inequity that we think must be addressed.

Third, a risk-based premium system must set pricing fairly. Currently, 92 percent of banks pay no premiums. The FDIC says that

this is because the current system underprices risk.

The proposal to charge all banks premiums, even when the fund

is fully capitalized, faces controversy in our industry. But we believe that as part of an integrated reform package, which includes

a substantial increase in the deposit insurance limit, most community bankers would be willing to pay a small, steady, fairly priced

premium in exchange for increased coverage levels and less volatility in the premiums. This is also one way to make sure that the

‘‘free-riders’’ pay their fair share, also.

Fourth, the 1.25 percent hard-target reserve ratio and the requirement of a 23 percent premium when the fund is below target

should be eliminated. The U.S. Treasury and the regulatory agencies recommend using a flexible range, with surcharges as the ratio

gets too low and rebates if the ratio gets too high.

We believe that the current system is dangerously procyclical

with premiums the highest when banks and the economy can least

afford it. Using a more flexible target would help to eliminate

substantial fluctuations in premiums and avoid intensifying an

economic downturn by diverting lending funds out of the banking

industry.

We also strongly support the FDIC proposal to base rebates on

past contributions to the fund rather than on the current assessment base. This would avoid unjustly rewarding those who haven’t

paid their fair share into the fund.

Fifth, the FDIC proposes to merge the BIF and the SAIF. The

ICBA supports the merger only so long as it is a part of an overall

comprehensive reform package.

In conclusion, Mr. Chairman, now is the time to consider these

important FDIC reforms. Thousands of communities across the

country and millions of consumers and small businesses depend on

their local community banks. And without substantially increased

FDIC coverage levels, indexed for inflation, community banks will

find it increasingly difficult to meet the credit needs of our communities and consumer, agriculture, and small business customers.

The less that deposit insurance is really worth due to inflation

erosion, the less confident Americans will be about their savings in

banks. Thus, the soundness of our financial system will then be

diminished.

Congress must not let this happen and we urge Congress to

adopt an integrated reform package as soon as possible.

I thank you for the opportunity to comment and I will be happy,

Mr. Chairman, to answer questions.

Senator JOHNSON. Thank you, Mr. Gulledge.

We will turn next to Mr. Plagge.

9

STATEMENT OF JEFF L. PLAGGE

PRESIDENT & CHIEF EXECUTIVE OFFICER

FIRST NATIONAL BANK OF WAVERLY, IOWA

ON BEHALF OF THE

AMERICAN BANKERS ASSOCIATION

Mr. PLAGGE. I want to thank you, Mr. Chairman, for holding this

hearing. We certainly appreciate your long-term support of a strong

banking system and the financial system in general and your leadership on this particular issue.

Assuring that the FDIC remains strong is of utmost importance

to the banking industry and the consumers nationwide.

Over the past decade, the industry has gone to great lengths to assure the insurance funds are strong. In fact, with $42 billion in

combined financial resources, the FDIC is extraordinarily healthy.

The outlook is also very good.

The banking industry is extremely well-capitalized, profitable,

and reserved for potential losses. Thus, now is a great time to consider how we might improve an already-strong system on a comprehensive basis.

A consensus is key to any bill being enacted. To fulfill this goal,

we have held extensive discussions with bankers, Members of Congress and staffs, and the FDIC. And as you noted, some differences

remain between our three organizations, but in most cases, our positions are very similar.

Our three associations have agreed that it is imperative to discuss these issues together and work together with this Committee

to develop legislation that would have broad support.

Just this weekend, this issue was again brought before our organization’s bankers at the ABA summer meeting. This meeting

brings together our board of directors, government relations council, and the leadership of all State banking associations and others.

My testimony today reflects the conclusions reached during this

meeting.

I must add, however, that while there is a willingness to go forward, we do have deep concerns about legislation that might increase bank costs or become a vehicle for extraneous amendments.

If that were to be the case, support amongst many of our banks

and bankers would quickly dissipate.

Indeed, the consensus at our summer meeting was more so than

ever that the ABA will oppose any FDIC reform legislation that results in increased premiums when the insurance funds are already

above the 1.25 percent ratio as they are today. Fortunately, we also

believe, however, that by working together, a consensus bill could

be developed that would have broad support.

In my testimony today, I would like to make several key points

that are also in the written testimony that was submitted.

First, today’s system is strong and effective, but some improvements could be made. The current system of deposit insurance has

the confidence of depositors and banks. Strong laws and regulations buttress this financial strength. Even more important is that

the bank industry has an unfailing obligation to meet the financial

needs of the insurance fund.

Second, as you have noted, a comprehensive approach is required. Because insurance issues are interwoven, any changes

10

must consider the entire system. We are pleased that all the issues

are now on the table. We recognize that any final bill might not

cover all of these issues in full, but we certainly appreciate the

comprehensive process that the Congress and this Committee is

pursuing.

The issues that we feel should be considered include: Number

one, the impact inflation has on the $100,000 insurance level and

how it can be addressed in the long term; number two, the fact

that very fast growing institutions can dilute the fund ratios without paying any premiums; number three, the current counterproductive and procyclical premium requirement when the fund

falls below the 1.25 percent ratio; number four, the need to cap the

growth of the fund at some point and provide rebates; number five,

the possibility of basing rebates on the history of bank payments

into the fund; number six, insurance levels on municipal deposits;

and number seven, merger of the insurance funds in general.

Our summer meeting participants emphasized that caps and rebates need to be included in the deposit insurance legislation.

My third and final point is that the changes should only be

adopted if they do not create new material costs or burdens to the

industry. The example used by the FDIC in its report would result

in unacceptable premium increases for many banks. The current

system is strong and we see no justification for such increases

when the insurance funds are above the required reserve ratio.

Banks have paid for their insurance and, in fact, they have prepaid and they continue to pay almost $800 million a year to cover

the FICO interest payments, even though the current institutions

that are paying these bills had nothing to do with the S&L crisis.

We thank you, Mr. Chairman, for this opportunity to express our

views and we look forward to working with the Committee to find

workable and comprehensive solutions.

Senator JOHNSON. Thank you, Mr. Plagge.

Mr. Hage.

STATEMENT OF CURTIS L. HAGE

CHAIRMAN, PRESIDENT & CHIEF EXECUTIVE OFFICER

HOME FEDERAL BANK, SIOUX FALLS, SOUTH DAKOTA

FIRST VICE CHAIRMAN, AMERICA’S COMMUNITY BANKERS

ON BEHALF OF

AMERICA’S COMMUNITY BANKERS

Mr. HAGE. Mr. Chairman and Members of the Subcommittee, I

am Curt Hage, Chairman, President, and CEO of Home Federal

Bank in Sioux Falls, South Dakota. I am representing America’s

Community Bankers today in my capacity as First Vice Chairman.

We are pleased to have this opportunity to present our views on

deposit insurance reform.

America’s Community Bankers welcomes your interest in comprehensive reform. At the same time, we believe there are serious

potential problems facing the deposit insurance system that Congress must act on immediately.

Last week’s failure of Superior Bank and the failure of the First

National Bank of Keystone in 1999 should remind us of the importance of strengthening the Federal Deposit Insurance System. If

the list of comprehensive reform proposals is too long for Congress

11

to pass this year, we ask that you set priorities, enact what you

can this year, and then return to the rest of the issues next year.

America’s Community Bankers urges Congress to enact three

major deposit insurance reform provisions this year:

First, merge the BIF and the SAIF into a single, stronger deposit

insurance fund.

Second, give the FDIC flexibility in recapitalizing the deposit insurance fund if the fund falls below the 1.25 percent reserve requirement. Current statute requires the FDIC to impose a 23 basis

point premium if a fund dips below the required reserve ratio level

for longer than a year.

The real dollar cost of this arbitrarily set premium would be sig- nificant. For my bank alone, that premium would cost $1.4 million.

For all banks in the State of South Dakota, that would be $31 million—enough capital to support over $300 million in additional lending. In a rural State like South Dakota, $300 million would

make a big difference in helping our State continue to grow.

We recommend that Congress allow the FDIC to recapitalize the

fund using a laser-beam approach, not a sledgehammer.

Third, allow the FDIC to impose a special premium on excessive

deposit growth, if such growth would threaten the health of the

deposit insurance fund.

A few companies have shifted tens of billions of dollars from outside the banking system into insured accounts at banks that they

control. While legal, this has diluted the deposit insurance funds

and reduced the reserve ratio of the BIF by three to four basis

points. It is time to give the FDIC authority to counter this freerider problem.

Fortunately, there is already legislation introduced in the House

to address these three priority issues. H.R. 1293, the Deposit Insurance Stabilization Act, introduced by Representatives Bob Ney and

Stephanie Tubbs Jones. ACB asks Congress to either pass this legislation immediately or to make it the centerpiece of comprehensive

reform legislation that can be enacted this year. In any case, the

provisions found in H.R. 1293 should be enacted before either the

BIF or the SAIF falls below the 1.25 percent reserve ratio level.

We agree with the incoming FDIC Chairman Don Powell that

Congress need not deal with all deposit insurance issues at once.

But ACB’s strong support for addressing the most pressing matters

certainly does not rule out adding other provisions if a consensus

can be quickly developed.

In the area of coverage, ACB strongly believes that Congress

should focus on increasing protection for retirement savings and

also urges substantially increasing coverage for retirement savings

plans, such as IRA’s and 401(k) accounts.

With respect to general increases in deposit insurance coverage,

ACB supports indexing coverage levels from 1974, which, according

to the FDIC, would bring the coverage limits to approximately

$135,000. This would help maintain the role of deposit insurance

in the Nation’s financial system.

ACB also recommends that Congress set a ceiling on the deposit

insurance fund’s designated reserve ratio, giving the FDIC the

ability to adjust that ceiling using well-defined standards after following full notice and comment procedures.

12

In determining the actual ceiling level, Congress should consult

the FDIC. Once a ceiling has been set, reserves in the fund that

exceed the ceiling should be returned to insured institutions based

on their average asset base measured over a reasonable period and

based on premiums paid in the past. For example, S. 2293, introduced by Senators Santorum and Edwards in the 106th Congress,

provides one approach that Congress might take.

Finally, ACB strongly supports preserving the current statutory

language preventing the FDIC from imposing premiums on wellcapitalized and well-run institutions when reserves are above the

required levels. These institutions have already paid dearly for

their coverage.

Mr. Chairman, let me sum up by reiterating ACB’s strong belief

that Congress should address the most pressing needs of the deposit insurance system immediately—acting quickly to give the

FDIC the flexibility it needs to deal with the strains imposed by

the free-rider problem.

If a consensus can develop around other deposit insurance reform

measures, we welcome their consideration and inclusion.

Deposit insurance is an essential part of our banking system.

While a variety of opinions exist on the issues, general consensus

exists that any reform should leave the FDIC stronger. It should

continue and strengthen the original mission of the FDIC to protect

depositors.

America’s Community Bankers is committed to working with you

and your Committee, and others in the industry, to help forge a bill

that can move expeditiously through Congress.

Again, Mr. Chairman, thank you for this opportunity to testify

on behalf of America’s Community Bankers. I welcome any questions that you or any Member of the Subcommittee might have.

Senator JOHNSON. Thank you, Mr. Hage.

My able colleague and friend, Senator Bennett, is able to join us

now. And what I would suggest is that Senator Bennett share with

us some opening thoughts, and then with the permission of the remainder of the Subcommittee, we would move directly on to questioning at that point.

Senator Bennett.

COMMENTS OF SENATOR ROBERT F. BENNETT

Senator BENNETT. Thank you very much, Mr. Chairman. I appreciate your holding this hearing.

When I first joined this Committee as a very freshman Member

and sat at the end of the table on the other side, I had no idea

what BIF and SAIF were. I would go home filled with the excitement of a new Senate election and my appointment to the Banking

Committee and have bankers sit me down and say, where are you

on the issue of BIF and SAIF? And I said, well, I am in favor of

SAIF. Everybody likes to be safe.

[Laughter.]

What is BIF? That sounds like a statement on a Saturday morning cartoon.

So, I now have been immersed in BIF and SAIF issues for nearly

8 years and had thought they had gone away. I thought that the

problems had all been solved. But as you hold this hearing, I realVerDate 11-MAY-2000 07:09 Aug 15, 2002 Jkt 000000 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 81065.TXT SBANK4 PsN: SBANK4
13

ize that I was wrong. The problems have not all been solved. They

have simply changed. We are no longer dealing with the issue of

bailing out savings and loans. We are now dealing with the issue

of prosperity and too much money in BIF and SAIF.

I am grateful to you, Mr. Chairman, for highlighting the issue

again and bringing it back up in the next context so that we do not

simply ignore it.

I think that is a salutary thing for you to be doing. I appreciate

the witnesses and the information they have shared with us here

today. And I hope that, maybe with your leadership, Mr. Chairman, we finally can get to the point where we can forget it and let

it go on. But life being what it is around this town, I am not sure

we will ever do that.

Thank you.

Senator JOHNSON. Thank you, Senator Bennett.

If it is all right with Senators Allard and Reed, we will proceed

on with questioning. But certainly, your statements will be placed

into the record.

In the process of trying to find how much consensus is possible

on FDIC reform, we had an opportunity to seek out the opinions

of a wide range of authorities, not the least of all the panel before

us here today.

We also looked to the viewpoints of the FDIC itself, the Fed, the

Treasury, the OCC, and the OTS. And I thought it might be useful

to display a chart, which we have on the stand here, which demonstrates a great many of the key components of FDIC reform.

There actually is a great deal of consensus, admittedly, a bit less

consensus on the indexation issue. Certainly on the other issues,

there is a great deal of general consensus among these agencies.

I would ask Mr. Plagge and Mr. Hage that, with the FDIC, the

Fed, the Treasury, the OCC and OTS in unanimous position, recommending that banks and thrifts, in fact, pay annual premiums

for deposit insurance coverage, it is my take on their perspective

that they are suggesting that a steady premium system would not

necessarily require banks and thrifts to pay more. They would pay

a steady amount each year rather than 23 basis points into the

hard target, and that variability in premiums would be reduced,

not increased. Their attitude appears to be making an assumption

that these institutions will never have to pay premiums because we

will never break 1.25 percent, which may not be a realistic position

to take.

I wonder if you would share again with me a bit of deliberation

about why your organization is right and these institutions are

wrong on the issue of premiums.

Mr. Plagge.

Mr. PLAGGE. Okay. I will start that. It is an interesting discussion. And having served on the ABA board level and then also on

the Government Relations Council at the ABA, as well as at the

State level, what we find with our bankers that have been brought

into the discussion is they become almost more emphatic about the

fact that we have prepaid into the fund.

The combined funds today are extremely strong—1.37 percent, I

believe is the ratio when you look at them combined. In fact, congratulations to Congress for designing a system that has worked.

14

We put the fund together. We have been far above the 1.25 percent, and we continue to pay $800 million a year toward the $12

billion obligation for the FICO interest. So, we look at it as, we

have paid. We want to continue to make sure that the fund is extremely strong. And at this point, it just seems to us that the system in that regard is working.

Every dollar that comes out of our institutions, and I am in a

small, $140 million institution in rural Iowa, is money that we cannot loan back into the economy, cannot do the kinds of things that

we are doing. And as one banker told me, we already bought this

car. It is paid for. The system is working in that regard. Let’s not

continue to put more money into that fund.

Last, our bankers tell us, and I agree, that right now, the fund

is building at approximately $1.5 billion more each year just based

on the excess earnings in the fund over and above the operating

cost to the FDIC. So in fact, the fund will continue to grow as it

stands today over and above the FICO premiums and so forth that

are being paid.

Senator JOHNSON. Mr. Hage.

Mr. HAGE. Thank you, Senator Johnson.

I think we need to put a couple of pieces into perspective to make

this puzzle look like a whole picture.

I do not know of any of our members who are suggesting that

we shouldn’t pay any premium for deposit insurance. Historically,

we have paid for those premiums and have paid for that coverage

and I think it has been appropriate.

The situation we are in today is that we have overpaid or prepaid for the present insurance level required. And so, our members

are concerned about the equity of getting that prepayment back

where it belongs.

Normal conditions without the aberrations of huge inflows of

free-rider deposits probably wouldn’t raise the issue to the level it

is today. But they are linked.

We have a number of beneficiaries who are not paying for any

coverage, yet getting full coverage at the expense of those of us who

have prepaid. And I think that is unfair and wrong. So an important ingredient of getting back to paying a correct premium is to

rebalance who should pay and how much should they pay.

Second, there seems to be a growing notion, as I get reports of

conversations around Capitol Hill and perhaps around the country,

that somehow this is a free system that we are living off of.

It is not free at all. We have paid for this deposit premium. We

have accumulated those balances. My company alone since 1991

has paid over $10.4 million in premiums. I have gotten value for

that. But a lot of that is prepaid and I would like it back. And let

those who are now putting uninsured money into the system pay

their fair share like the rest of us have.

That is really the key ingredient, to get it rebalanced and get it

fairly structured so all participants are paying appropriately for

participation in the deposit insurance fund.

Senator JOHNSON. Thank you, Mr. Hage.

I am going to suggest that Members of the Subcommittee abide

by the 5 minute clock, so that everybody gets a fair opportunity.

15

And having my time expire here, I will try and behave myself and

set a good example. So, I would turn next to Senator Bunning.

Senator BUNNING. Thank you, Mr. Chairman.

This is for any of the panelists. Do you believe that deposits are

down in smaller banks because insurance reform has not kept up

with inflation or because depositors are putting their money in

other uninsured vehicles that have the potential for higher returns? Anyone who would like to speak on that would be fine.

Mr. GULLEDGE. I do believe that deposits are down in the smaller

banks. I think that customers are in many instances following the

rates that they are getting for other nonbank products. But also,

there are quite a number of people who are leaving community

banks to take their funds simply because we are not in a day when

$100,000 coverage is indicative of a person being rich.

Some of these people who are taking their retirement accounts,

their life event funds are being taken to other banks and other

products simply because we do not have the insurance coverage to

give them the protection that they are seeking and that they expect

from the FDIC coverage.

Mr. HAGE. Senator Bunning, I think we saw in the last 5 to 6

years, maybe longer, a huge disintermediation or shift from commercial bank deposits, thrift and community bank deposits, because of higher rates of return and a high confidence level in equity

markets and mutual fund markets. I think that it had relatively

little to do with the deposit insurance coverage limit itself as a

stand-alone concept.

Today, with the lack of confidence given the recent market readjustment, we have seen new inflows of deposits back into community banks. Whether that will stay or not, I do not know.

I do know that people have and are accumulating higher balances on an individual basis, particularly in their retirement funds.

And I think as we see the baby boomers reach retirement age, their

appetite for risk is going to decrease. They are going to pay more

attention to how much insurance coverage they can get to assure

return of their principle rather than return on their principle.

Senator BUNNING. During the Chairman of the FDIC’s testimony,

she addressed the FDIC’s concerns regarding the issue of rapid

deposit growth and its impact on the rest of the industry. Do you

see a trade-off between reform in this area versus stifling the very

initiative of practices that Gramm–Leach–Bliley was intended to

encourage?

Mr. HAGE. Senator Bunning, I would draw a distinction and definition of rapid deposit growth that I think is important. If we are

talking about deposit growth——

Senator BUNNING. Those are her words, not mine.

Mr. HAGE. I understand. But just to clarify the issue, if we are

talking about deposit growth, meaning one bank gives up its deposits by competitive forces to another bank, that is deposit growth for

the bank, but it has no change on the fund itself because both sides

of that transaction were insured. So bank-to-bank deposit growth

has no effect, effectively, on the insurance funds.

Funds like we see today that are in money market funds that

were not previously insured now moving into the deposit insurance

system through banks and thrifts that have been properly charVerDate 11-MAY-2000 07:09 Aug 15, 2002 Jkt 000000 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 81065.TXT SBANK4 PsN: SBANK4
16

tered, that has an impact. It may well be a one-time impact given

the environment we have come from and the environment we are

into today. But it nevertheless is a very significant impact today. Over $50 billion have moved into the insured deposit funds with

no premium attached. That is significant.

Senator BUNNING. How does the ABA feel?

Mr. PLAGGE. I would echo that. In fact, from a personal example

standpoint, we started a new bank in a close-by community. Literally, all the money that has come into the growth of that bank

has come from other banks within the system. And so, the impact

is basically a neutral impact to the FDIC.

The funds that are flowing in from the money market funds and

so forth, obviously have had an impact. As my counterpart mentioned, it looks like it may be coming to an end as far as the

amount of that impact. Most of that money that would flow in in

the large amounts has. But it certainly can move the percentages

a lot greater than anything that happens within the industry itself,

the banking industry.

Senator BUNNING. In meeting with the community bankers in my

area, Kentucky and most of the area that surrounds the greater

Cincinnati area, I have not heard one complaint, not one, from any

of them about merging the funds or charging too much or increasing the amount of insured deposits. Not one of them have ever

come to me and said, this is something that we really think is

strongly needed.

So unless we can really see a great improvement, it is going to

take a lot of momentum to get this done. And I have a personal

banker who is a community banker and they are so happy, it is unbelievable how happy they are. They are making a lot of money.

Mr. HAGE. Senator, I think that you have issued a challenge for

all three of our industry trade groups to awaken the issues to your

bankers.

Chairman SARBANES. Well, I am sure that you will be hearing

from them now.

[Laughter.]

Senator BUNNING. All right.

[Laughter.]

Senator JOHNSON. Thank you, Senator Bunning.

Senator Sarbanes.

Chairman SARBANES. Examination of this issue actually raises a

lot of, in a sense, basic questions, and I would like to ask a couple

of those on the way to sort of gaining an analytical framework.

What do you think the deposit coverage should be and what is the

rationale for it?

And in answering that question, I would like you to abandon the

rationale that simply takes an old figure and then adjusts it for inflation because that assumes that the old figure was correct, or

under changing circumstances, even today, represents an appropriate base off of which to work. I do not know whether that is the

case or not.

What should the figure be and what is the rationale for that figure? Should there be no limit? And if the answer to that is no, why

should there be a limit? If there should be a limit, at what level?

Why? What is the underlying rationale for arriving at that figure?

17

Mr. HAGE. Senator, I would offer that I do not know that there

is a clear, single number answer to your question. The foundation

of the question I think reflects the real heart of the issue here.

What is it that we as a society should protect in terms of individual’s wealth accumulation? What was magical about $5,000 cov- erage at the beginning, going to $15,000, to $20,000? I do not really

know.

The related facts are that through incentives in the currently

passed tax act, we have encouraged individuals to accumulate more

wealth for retirement. We have a generation of baby boomers coming into retirement that will be unprecedented in the numbers of

people. We know there is a strain on Social Security.

So, I think there is a connection between how much deposit insurance coverage we should provide and how much at-risk wealth

accumulation we should permit.

More than getting to a very specific number I think is an active

process which I think has been and can continue to be actively administered through FDIC. Giving them some more flexibility to

continually look at the insurance coverage ratio limit would be a

strength. Giving them some flexibility in setting the premiums that

would be necessary to maintain various ratio coverages that might

be determined based on the risk profile of our public depository institutions I think would be a very healthy start. But I do not know

that I could give you a specific number that would be any more

legitimate than the numbers we have today.

Chairman SARBANES. Should it be part of the rationale to look

at what percentage of the American people may, in fact, have savings at a certain level, where we would say, well, for ordinary people, we want to provide them the safety net. But we are not going

to provide a safety net without limit. And for people of greater

wealth, they presumably have their own investment strategies and

they are used to putting their money at risk and so forth. Therefore, we are not going to cover everything for everybody. Is that a

reasonable factor to include in the evaluation?

Mr. HAGE. I would agree with that, Senator. I do not think it is

important that we provide 100 percent coverage. I think there is

some healthiness to having segments of wealth at risk. I think it

is a balance for public policy.

As you as an elected body make policies that may put our Nation

in positions of debt or not, the balance of how much risk that puts

on deposit accumulation and protection I think is an integral ingredient of that.

Chairman SARBANES. Obviously, if we start examining the whole

range of this, we put in the statute of the 1.25 percent figure that

the FDIC is supposed to work off of. But I guess I would have to

start looking at what the rationale is for that figure.

Actually, you point out, Mr. Plagge, in your statement: ‘‘As a result of failure last week, the FDIC’s SAIF will reportedly lose $500

million, 5 percent of the total in the fund. A loss that size would

reduce the SAIF’s reserve ratio from 1.43 percent of insured deposits to 1.36 percent.’’ Now that means that just two more failures

of this magnitude would bring that deposit fund below the 1.25 percent, and would then kick in a mandated 23 basis point premium

on all institutions in the fund.

18

People are seeking not to have that fall off the cliff, so they do

not want the automatic mandatory premium when you go below

1.25 percent. And of course, one argument made for that is you

may well be going below the 1.25 percent because of worsening economic circumstances.

So, you are imposing an additional burden that is countercyclical—I mean, it is procyclical. The press is on not to do that,

to do—I think you say later, a laser effect. And I think there is

some argument for that. But it would seem to me that would seem

to carry with it the proposition that the figure would have to be

higher in good times in order to build up the fund.

You, of course, have addressed the so-called free-rider, people

that are sweeping in the deposits, and I think that is a reasonable

issue to be looked at, and I am appreciative of that.

But again, what is the magic of the 1.25 percent? Maybe that is

not an adequate figure, particularly if we are going to raise the

amount of coverage.

This thing can erode very quickly. And those of us who went

through the S&L’s are still scarred by the experience. We ran out of the fund. It was all gone. In the end, there was, what, $160 billion? I forget the figure. The figure was so enormous, I have forgotten how much it was. What is the response on that point?

Mr. PLAGGE. I might comment on that. I think, especially in particular to the failure last week, there is a little bit of an issue of

what caused the failure and is it a bigger-picture issue going on or

is it more like a Keystone issue, where there was particular issues

with an institution?

Chairman SARBANES. Well, we are going to look at that. And of

course, they were very heavy into high-risk lending and so forth.

Mr. PLAGGE. I think the other thing is it is always important to

remember that both funds have the ability to set aside another

fund within the fund for reserves. And from what I understand, approximately $250 million had already been reserved in the subfund

for that particular failure.

Time will tell us what the actual loss is. I think the percent I

have heard in the past over historical purposes is approximately 13

percent is the average loss. Now if you get into unusual situations

like this one or Keystone where there are other issues going on, obviously, that percent can change.

But the 1.25 percent, for whatever reason they came to that

number, whether it was historical discussion at that time or longterm discussion, that is up for debate, obviously.

The fact remains that we are almost 1.37 percent today. So even

the 1.25 percent, which was considered the right number back in

previous discussions, we have exceeded that now and it appears

that, based on past failures, for instance, the Keystone case, the

numbers were large as a percentage as well. But, again, it was an

individual situation and there hasn’t been a lot of follow-up behind

it. We hope that is the case in this S&L failure as well.

Chairman SARBANES. Mr. Chairman, I see my time is up. I would

just close with this observation.

If you increase the amount of coverage, you obviously increase

the extent to which you are placed at risk, ultimately the taxpayer.

It seems to me that then raises the question of what is a proper

19

figure for the fund, particularly if we are going to move in the direction of not replenishing the fund quickly if it drops below whatever the established level is.

So if you do not replenish it on the downside—or replenish it

more slowly, I guess—it raises a question of whether you have to

boost it more to have more of a margin to absorb these losses.

Now, we have been through a pretty good period in terms of failures and so forth. And so that tends to shape your thinking. But

the system is not in a sense there for the good times. The system

is there for the bad times. Therefore, we have to be thinking in

those terms.

Mr. Chairman, thank you and I want to thank the panel.

Senator JOHNSON. Thank you, Chairman Sarbanes.

Senator Bennett.

Senator BENNETT. Thank you very much, Mr. Chairman.

Let me do what you are not supposed to do—ask a question to

which I do not know the answer.

What happens to the extra money? Are we setting up another Social Security trust fund here where the money is beyond the 1.25

percent level or whenever it gets invested and earns interest, the

money that is not needed to run the FDIC? Does it just go into the

Treasury Department? Does anybody know?

Mr. HAGE. It stays in the insurance fund, Senator.

Senator BENNETT. What is it invested in?

Mr. HAGE. I do not know the investment portfolio. But that, I believe, is under the administration of FDIC.

Senator BENNETT. I understand that it stays in the portfolio. But

what is it invested in? Is it invested in Government bonds?

Mr. HAGE. We believe, yes.

Senator BENNETT. So from a cashflow standpoint, just like Social

Security, if you have a big run on the fund and people present

those bonds for payment, the Government has to come up with the

cash from some place else to pay off those bonds.

Mr. HAGE. Those bonds would have to be sold in a marketplace

environment. They would not be called by the FDIC against the

Government.

Senator BENNETT. I understand that.

Mr. PLAGGE. I guess I might add that it actually gets kind of to

the heart of some of the concerns of our bank members. It is really

the question of what doesn’t happen to it? Do we keep building the

fund up over and above and it takes money out of my institution

in Iowa, it takes money out of other banks around the country, especially in rural areas where liquidity is already tight and loan to

deposit ratios are high? How much do we keep putting into a fund

that appears to be, by all accounts, very safe and sound and meeting the needs of the insurance fund itself?

Senator BENNETT. If it becomes too tempting because the Government gets the revenue by selling the bonds, it becomes almost

a form of taxation to fund other governmental programs. And we

love that around here. But we are not sure that is the thing that

ought to be.

Mr. Plagge, institutions get rated as 1–A and therefore, they do

not have to pay anything into this fund. So in a very real sense,

that rating is worth something financially.

20

Mr. PLAGGE. Yes.

Senator BENNETT. And you are at the mercy of the bank examiner as to whether you get rated or not rated. So that just raises

the question of how objective is the bank examiner? Do you feel

good about the process that says, okay, this bank doesn’t have to

pay and this bank does? Or do you have some problems with it?

Mr. PLAGGE. Well, we have concerns, as you look at some of the

recommendations in the FDIC proposal of changing the assessment

system and changing the rating system. We are a national bank.

Both of our banks are national banks, so I strictly deal with OCC.

But I have been in a State bank before where I have had FDIC and

State regulators.

I like the system the way we have it. I think, again, congratulations to the designers. It has worked. It has put 92 percent of the

banks in the top category. I look at that as a good thing.

The incentive has been to be in the top-rated, well-capitalized

category, which is exactly where you want banks in any economic

downturn. It puts more capital behind the whole system, let alone

the $42 billion that is sitting in the fund. You have the $600 plus

billion that is sitting behind it in bank capital. I think the more

you try to break that down, when I see the assessment, the proposal where it is 1–A plus, 1–A, 1–A minus, 1–B, 1–C, and then

going down the ladder into the other categories, the subjectivity of

that is somewhat dazzling.

Bank regulators, and we have always had a good relationship

with our bank regulators, but they do have a lot of discretion.

There is a lot of subjectivity in that system, whether it is on the

overall rating or the individual ratings that make that up.

I guess I have not seen anything broke with the current system

that would dictate to me or suggest to me that we need to keep

breaking that down even further.

So, I think it trends into areas that would put, quite honestly,

a lot more pressure on the individual field examiners, let alone the

systems themselves. Again, I do not see that the system has broken

down in any fashion that would suggest we need to go that route.

Senator BENNETT. I see. Thank you. One final question.

You all talked about the free-riders, and nobody likes a freerider. But at the same time, the institutions that pay no premiums,

pay no premiums because they fall into the safest risk category.

And you just talked about the process by which a bank gets into

the safest-risk category. Should we change the category in order to

pick up the free-riders? Or are you saying that there should be an

entry fee to get into this business regardless of how safe you are?

Free-rider is almost a pejorative—it is a pejorative term. And it

may very well be an earned pejorative term. But when you look at

it from the standpoint of, well, the safest banks now do not pay

anything, how do you specifically propose that these institutions

coming in that are very, very safe should pay something? What

should the ticket to the dance be, or how should it be structured

in your view, any of you?

Mr. HAGE. Senator Bennett, I would suggest to you that freerider, as we would define it in our terminology, means those institutions that have paid no premium in the past, yet are dumping

huge sums of deposit money into the insurance fund.

21

Senator BENNETT. I understand that. But they come in dumping

this into the fund, as you say, and they have very, very safe capitalization.

Mr. HAGE. Yes. And what I was about to say is that, going forward, I do not think any of us are proposing that there would be

a category of membership or participation in the fund that would

pay no premium, but that there would appropriately be categories

or grades of premium paid based on the risk profile of individual

institutions. That risk profile or grading would be determined by

FDIC as a result of their examination process.

What is happened today in banking that is relatively new is that

balance sheets can today be constructed with different risk profiles

more in a broader range of business plans that have perhaps historically been true.

You asked about the impact of regulation and examination. I

think regulators have grown in their sophistication of being able to

understand these instruments as have managements of banks.

It is really critical that management in a bank understand the

risk profile that they are taking on into a balance sheet. That risk

profile is the investments and the loans that a bank makes. That

is where the risks come from, not the deposit.

When we talk about deposit insurance, we have to be careful that

we understand that difference. By and of itself, the amount of a deposit in a bank has meaning only as the basis for what we are insuring. But it is separated from the risk profile of the bank, which

is driven by the assets it has. So it is really important that we

measure the risk of the use of the deposits and have a premium

that reflects that risk on an ongoing basis.

That underscores what we are talking about in terms of the need

for flexibility. Over time, as, cumulatively, bank balance sheets

would change, the FDIC should have some flexibility to determine

whether 1.25 percent or some other number is the right minimum

threshold for coverage. And if we gave that flexibility, theoretically,

any way, there would be an opportunity to adjust premiums that

would be less dramatic than the all-or-nothing base that we have

today, all of 23 basis points or zero.

That is really the hard-core, not-working part of the premium

structure today. It is the all-or-nothing idea.

But the notion of having the ability over time to adjust the appropriate level of reserve ratio to be able to accelerate that in reasonable time frames, to be able to have a mix of premium assessments based on risk profiles of institutional members makes for a

much healthier, stronger system.

Senator BENNETT. Thank you.

Chairman SARBANES. The FDIC, as I understand it, at least is

proposing indirectly to address this issue by providing rebates that

would be based on what you had paid into the fund. So that at

least if you are an institution, over time, the very point you were

making earlier, as I understood it, which had paid into the fund,

you would get a rebate, and if you were an institution that had not

paid into the fund, you would not get a rebate.

Now that is addressing it at the other end, so to speak. But I

think it did reflect some sensitivity on their part.

Mr. Chairman, can I ask one question?

22

Senator JOHNSON. Yes, Chairman Sarbanes.

Chairman SARBANES. I am interested in the fact that 92 percent

of the institutions are well-capitalized. Now, if you heard about a

teacher who was giving 92 percent of the students in her class an

A, presumably, you would say, I do not know about that marking

system. I am not sure exactly what standard the teacher is using.

Senator BENNETT. Pretty smart class.

Chairman SARBANES. Yes. She needs to make more differentiations. I take it that is what the FDIC is perhaps searching to do

on this risk-based approach. So that you wouldn’t have all but 8

percent that passed the post, so to speak, and were in the same

risk category.

Mr. PLAGGE. I understand that as well. The incentive has been

placed where the regulation wants banks to be, and that is in the

well-capitalized area.

Breaking that down to the level that is being discussed, where

I looked at one chart where the potential premium charge for, I

think it was a 1–C bank, which is still in the well-capitalized area,

would essentially be the same as the premium requirement for one

that was in the low category. It would be the 3–A category.

It seems to me that the risk to the system is certainly much better protected when you still have that well-capitalized bank.

Again, to try to break that down and micromanage that at the

kind of levels that are being discussed to me, becomes very, very

subjective. And I think we should look at the positive side of that

and the fact again that the system was designed in a fashion that

has moved banks to be exactly where regulators hoped they would

be in the well-capitalized category.

Especially as we look at times like today, especially in agriculture and so forth, in the part of the country where we live.

It is good that banks are in that category. It does give them the

ability to stand the risk of a downturn and so forth, long before the

insurance fund would ever be tapped.

Chairman SARBANES. Mr. Chairman, thank you again for the

hearing. This has been a very thoughtful panel and we appreciate

their testimony very much.

I am not sure how far the statement that the system is working

gets us because you are talking about making changes in the system. Therefore, we have to consider what the consequences of those

changes should be. Again, I repeat the fact that we are at the end

of an extremely good economic period. We haven’t gone through the

stress and strain that we would experience in more difficult economic circumstances. And that is what we have to evaluate because that is why all these protections have been set up, to be able

to carry us through such a period.

But thank you very much and I very much appreciate the

thoughtfulness that is reflected in your statements and in your responses at the table.

Senator JOHNSON. Thank you, Mr. Chairman.

It is my ongoing effort to try to find consensus wherever we can

find it. I have a couple of questions I want to ask.

Let me start by asking the entire panel, from what I understand

from your testimony today, you all appear to support a significant

increase in coverage for retirement accounts, which, as you note,

23

are likely to exceed $100,000 in fairly short order and fairly commonly. Is it fair to say, at least on this panel, that there is an industry consensus that we should consider a significant increase on

retirement accounts independent of any disagreements that we

might have about a general coverage increase?

Mr. Plagge.

Mr. PLAGGE. We actually haven’t centered in on that. The one

concern that seemed to be expressed about increasing insurance in

general is the fact that it would attract hot money, and relating

back to the comments that were made during the S&L crisis.

I think the reason that bankers have talked about, well, at least

let’s look at the retirement funding, is because it falls out of that

category of hot money. It is stable funding for banks and so forth.

So as you look at the different areas where insurance could be

increased, whether it is municipal deposits or just insurance in

general, or IRA’s and retirement funds, it seems to be the one category that kind of deals directly with the hot money, concern that

resulted from the S&L crisis.

Senator JOHNSON. Mr. Hage.

Mr. HAGE. Senator Johnson, I think that when you look at the

public policy directions that are articulated increasingly today

where citizens of this country are asked and encouraged to be prepared to carry a larger amount of their retirement well-being, increasing deposit insurance coverage to those retirement accounts

makes all the sense in the world. It supports that philosophy.

The critical thing about when you reach the age of retirement,

I am told, although I am getting close, is that your tolerance for

risk, because you cannot replace funds lost, goes down.

I think we need to recognize that in the nature of how we encourage people to accumulate wealth and how we allow them to

protect its value. It makes a lot of sense to increase coverage specifically for retirement type of instruments to encourage people to

add to that saving. That also provides a stable base of funding for

community banks to continue to play the important role of providing growth through lending in our local communities.

Senator JOHNSON. Mr. Gulledge, of course, ICBA supports a generalized increase and catch-up with inflation. I would assume that,

obviously, a retirement component would be something that you

would support in the context of a larger comprehensive increase.

Let me ask you, Mr. Gulledge, obviously, we do have a bit less

consensus on this issue than on some of the others in FDIC reform.

And we have heard some observe that increasing the level from

$100,000 to $200,000 would create the potential for a moral hazard

of the kind last seen in the banking system during the savings and

loan crisis of the 1980’s.

The Fed and the Treasury, among others, have expressed to this

point adamant opposition to the concept of doubling because of the

risk issue. I wonder if you would share your observations on that

point.

Mr. GULLEDGE. Well, we do not agree that this would have a

great effect on the moral hazard issue. We feel that, for the increase and the doubling of coverage under the provisions of your

bill for individual coverage, we think that consolidation is bringing

24

about, is creating more risk to the FDIC fund than would be on an

individual raising of the coverages.

Senator JOHNSON. I appreciate your observation on that, Mr.

Gulledge.

In the brief amount of time that I have left on the clock for myself, let me ask Mr. Hage, because of your experience with the Federal Home Loan Bank System, the Treasury has suggested that

Federal Home Loan Bank advances and other secured capital be

considered in the deposit insurance assessment base. The FDIC’s

report said that a bank’s reliance on noncore funding, which may

include these advances, should be considered risky. How would you

respond to those recommendations?

Mr. HAGE. I would oppose the inclusion of the Federal Home

Loan Bank advances as a part of the deposit insurance premium

base. Federal Home Loan Bank advances are an alternative source

of funding. They are fully collateralized by other collateral that we

offer to offset that. They provide no risk to a consumer and there

is no direct benefit to a consumer. To include Federal Home Loan

Bank deposits would increase the cost of bank funding without any

economic value whatsoever.

So, to me, there is no correlation at all to including the Federal

Home Loan Bank advances with the deposit premium.

Senator JOHNSON. There is agreement from the ABA, Mr. Plagge.

Mr. PLAGGE. Yes. I can speak to a little different path on that.

As you know, in your State, and at least in Iowa, community

banks are using the Federal Home Loan Bank System pretty readily. With the new advances allowed for ag and small business

loans, it has become an important source of funding for us.

We just went through a regulatory exam in the last 4 or 5

months. I think the thing to keep in mind on that is the examiners

already take that into account. As they look at our liquidity, as

they look at our balance sheet, as they look at all the things that

they look over when they do an exam, they take that into account

in how we are structuring our balance sheet and how we are structuring our organization.

And so, I would hope and caution against that kind of stuff being

taken to equation because I think it really would have a pretty exasperating impact on community banks.

Senator JOHNSON. Mr. Gulledge, are you in concurrence?

Mr. GULLEDGE. First of all, I would like to say that we appreciate

very much the expansion of the membership in the Federal Home

Loan Bank System because it has been very meaningful to the

community banks in our country. It has helped in the liquidity

problems that we do have. And it is also true that the regulatory

agencies are warning us about over-use of advances from the Federal Home Loan Bank. And we understand some of this warning

because the rates are higher. It is creating a shrinking of net interest margins.

But we feel that the cure for that and the need for using these

lines is increased coverage so that we will have the liquidity that

we need and we do not have to go to the Home Loan Bank for these

advances.

Senator JOHNSON. Thank you. My time is expired.

Senator Reed.

25

COMMENTS OF SENATOR JACK REED

Senator REED. Thank you very much, Mr. Chairman.

Let me first commend you and the Ranking Member for holding

this hearing and beginning the careful deliberation about deposit

insurance reform. It has been an issue, as Senator Bennett said,

that has been with us for a long, long time. We hope, with your

leadership, that we can move forward and reach some type of satisfactory conclusion.

Let me also thank the witnesses for their excellent testimony.

I would just like to address initially a general question to all the

panelists. You have had the occasion to look at the FDIC’s proposals for reform. Is there any major element that they have neglected to leave out that you would suggest in terms of issues that

should be considered in a comprehensive reform package by the

Senate?

Mr. Hage.

Mr. HAGE. Senator Reed, as I have read that, I think it is a very

well-written report and reflects a lot of good, thorough study on the

part of the FDIC staff. I do not have anything excluded that I

would want to be included.

On behalf of ACB’s position, I would remind you that we think

that the three points of our position of getting those things done

urgently and quickly are important, not as an alternative of no additional reform, but simply get those done first, they are right now

urgent, continue the debate and the dialogue on the rest of the proposal, and then enact it appropriately.

Senator REED. Again, without pinning you down to an hour and

a day, how fast do you feel that this should be done in terms of

the continued soundness and safety of the banking system? And if

you say yesterday, I will understand.

[Laughter.]

Mr. HAGE. Well, since we all have a lot of money invested in

terms of prepaid premiums, yesterday would be a little sooner——

Senator REED. I have been listening to this discussion and I am

going to call my insurance agent because I believe I have lots of

prepaid premiums, also.

[Laughter.]

I have been behaving reasonably safely for years now.

[Laughter.]

But I appreciate your point.

Mr. HAGE. Senator Reed, they are only charging you a year in

advance. This is a multiyear prepayment.

Senator REED. All right.

[Laughter.]

Mr. Plagge.

Mr. PLAGGE. We agree as well. I think the FDIC has presented

a very good package. Obviously, we are not in agreement on all elements of it, but we feel it is good to have all those elements on the

table.

The only thing that we think maybe has been left out is giving

more of an independent nature to the FDIC board going back to the

three independent seats to make sure that there is continuity

through transition of parties and so forth. But, otherwise, we agree

26

that they have done a comprehensive look at things and hopefully,

we can find those areas that we can agree on.

Senator REED. Thank you very much.

Mr. Gulledge.

Mr. GULLEDGE. We too feel that the FDIC proposals were good.

They were well thought-out, very thoroughly put together. They established five areas or five points for consideration. We believe that

all of those are important.

Former FDIC Chairman Tanoue, I believe in her testimony previously, has stated, and the report indicates that it is not felt that

there should be a separation or a segregation of any of those

points. For comprehensive coverage, all of those should be taken

into consideration.

Senator REED. Thank you very much. The final point—related to

the size of the fund and the size of premiums is the effectiveness

of regulation. If we do not have effective regulation, then we are

going to need a lot of money in that fund because we would be paying lots of failed institutions.

And so I would just ask for your comments with respect to your

sense of, at this juncture, the adequacy of the regulation, the resources available for regulators, because I think that is inextricably

bound up in this whole discussion.

Mr. HAGE. Senator Reed, I think you are on to a very important

point. Effective regulation certainly is the base upon which any

system like this would ever work.

Again, observing from our personal experience, I think that the

sophistication of the regulators in terms of being able to model different financial instruments, getting more savvy about management’s preparedness and proactiveness in being able to model the

impact of different risk profiles that they might take has improved

significantly.

The system will never be 100 percent fail-safe. It is just the nature of our economy and the instruments themselves. But I think

the process has gotten much better.

Senator REED. Thank you.

Mr. Plagge.

Mr. PLAGGE. I agree with that as well. Again, we are a national

bank and we have gone through recent exams. In fact, I would say

the safety and soundness portion of the exams have stepped up,

which I consider positive. I think it is back to the basics.

The other thing that I would point out is that the regulators

have so much more authority to take actions than they used to

have, which I think makes the fund safer by its own nature. And

so, I feel good about the exam process that we currently have.

Senator REED. Mr. Gulledge.

Mr. GULLEDGE. Well, I am examined by the FDIC and I think

the FDIC is doing a very adequate job of examination. I hear no

complaint of that. I have no complaint of their assessment ratings,

the CAMEL ratings of the bank.

They are, however, saying that the current system is such that

they have some difficulty. And this goes back I think to the question earlier on the 92 percent of the banks that pay no premiums.

27

I believe it was not because of the capital, it was because of the

CAMEL ratings that exists. So that speaks to the strength of the

industry.

As relates to the capital, however, there is a requirement under

FDICIA that banks remain at certain capital levels, and I think

that speaks to those levels that we have today.

Senator REED. Thank you very much.

Thank you, Mr. Chairman.

Senator JOHNSON. Thank you, Senator Reed.

Senator Miller.

COMMENTS OF SENATOR ZEL MILLER

Senator MILLER. First, I apologize for not being here at the beginning of this hearing. I was presiding in the Senate. And I also

apologize if I am asking you something which you have already

covered.

I am curious about how you feel about this. Mr. Powell indicated

that perhaps all the FDIC-proposed reforms did not have to be all

in one package. I would like to know what any of you think would

be a must-have in the bill if you were making it up, and what

needs to be done most immediately.

Mr. PLAGGE. If it is okay, I will start with that.

Senator MILLER. All right.

Mr. PLAGGE. Actually one of our concerns is that if it is not a

comprehensive approach, maybe one or two things happen and

then the rest of it is never visited again. And so, we really feel that

it is the time. It is good public policy time. The fund is strong. It

is a great time to look at the whole package.

Obviously, there is a lot of things in that package, in the comprehensive bill, and we understand fully that something may come

out as a result of these discussions, that it probably won’t include

everything. But we will have to look at that at that particular time.

I guess we do caution that one or two things should not be picked

out of that and run through, with the rest of them set aside for a

later date, that unfortunately, may never come. We want to see the

comprehensive discussion, even if it goes on longer and takes

longer to reach consensus.

Senator MILLER. Do you feel the same way, Mr. Gulledge?

Mr. GULLEDGE. I surely do. I think that the FDIC comes with a

very good report and our association and our membership is very

supportive of all the provisions of that report.

We think it is also important to look at the whole package while

this is being done at this time. Frankly, we hope that Mr. Powell

will get a better view of this after he has come on board and has

been at the helm of the corporation for a period of time.

Senator MILLER. Mr. Hage.

Mr. HAGE. Senator Miller, ACB agrees with Mr. Powell, they do

not all have to be looked at at once. But I think, eventually, they

all should be looked at.

From my opening remarks, the first importance to us is the

merger of the BIF–SAIF funds. We think that ought to be done immediately. Second, give the FDIC appropriate flexibility to set the

correct premium levels in balance with the coverage ratio, so that

can be corrected on a smooth basis rather than a catastrophic, allVerDate 11-MAY-2000 07:09 Aug 15, 2002 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 81065.TXT SBANK4 PsN: SBANK4
28

or-nothing basis. Third, allow for the special premiums for the freeriders to rebalance and reset the appropriate funding for the deposits that have come into the system.

Senator MILLER. Thank you very much.

Senator JOHNSON. Senator Bennett, anything further?

Senator BENNETT. No, Senator.

Senator JOHNSON. Well, let me thank the panel again for what

I think has been excellent testimony. We have had good participation on the part of the Subcommittee as well. I am appreciative of

Senators Gramm and Sarbanes joining us for this, and obviously,

Senator Bennett’s good work with me on the Subcommittee.

We want to continue to move this issue forward. And as was

noted in Senator Miller’s last line of questioning, I acknowledge

that it may be that we cannot find consensus on every single issue

here. But, on the other hand, I think it is important that we begin

this debate as comprehensively as possible and recognize that a

balanced meal involves both the spinach and the dessert, and that

some of that is part of reality.

We will see what components we can move ahead with. But I do

want to see us work in conjunction with Representative Bachus on

the House side, with whom I met yesterday. I would like to see

what we can do to find bicameral and bipartisan consensus on

these issues. I think that our panel has contributed very significantly to our progress in that regard and again, I thank you for

your participation.

The Subcommittee hearing is adjourned.

[Whereupon, at 11:40 a.m., the hearing was adjourned.]

[Prepared statements, response to written questions, and additional material supplied for the record follow:]

29

PREPARED STATEMENT OF SENATOR TIM JOHNSON

Good morning. I am pleased to convene the first meeting of the Financial Institutions Subcommittee of my Chairmanship on a topic that has been of great interest

to me for many years. Federal deposit insurance is one of the cornerstones of our

banking and financial system. This insurance helps give depositors the confidence

they need to participate in America’s financial institutions. Since I began service in

Congress in 1987, we have seen some real ups and downs in the banking industry,

and it is a great privilege today to chair a hearing on a matter of such importance

to our Nation’s bankers, and indeed to our Nation as a whole.

I would first like to recognize Ranking Member Bennett, and thank him for his

participation at today’s hearing. It is a great pleasure to work with Senator Bennett

on banking issues. He has a very distinguished business background, and I value

his insights. I would also like to recognize Chairman Sarbanes, who conducts all his

hearings with such dignity and thought. I hope I can live up to the high standards

that he sets for the Senate Banking Committee.

As everyone in this room knows, or will surely find out in short order, comprehensive deposit insurance reform is enormously complex. I will resist the opportunity

to recite a history of banking reform, and steer clear of too many statistics—at least

until the question and answer period. While the body of literature on deposit insurance is vast, I would note that there appears to be more consensus than disagreement on potential reforms.

At today’s hearing, industry will respond to the FDIC’s recommendations for comprehensive reform of the Federal Deposit Insurance System. The FDIC, in my view,

has identified some significant weaknesses in the current system.

In particular, it is hard to argue with the FDIC’s observation that the current system is procyclical: that is, in good times, when the funds are above the designated

reserve ratio of 1.25 percent, 92 percent of the industry pays nothing for coverage;

but in bad times, institutions could be hit with potentially crushing premiums of

up to 23 basis points. I think most industry members agree that this so-called ‘‘hard

target’’ presents a real threat to their businesses.

Of course, this means that any movement in the funds down toward 1.25 increases the anxiety level of bankers and regulators alike, whether that movement

comes from fast growth of certain institutions, or from institutional failures like we

saw last Friday in the case of Superior Bank of Illinois. The numbers are still preliminary, but cost estimates of the failure start at $500 million, which could reduce

the SAIF ration by seven basis points. I say this not to be alarmist. But I would

urge caution against becoming complacent in good times, and resisting changes that

simply make sense over the long term and have the potential to enhance the stability of our system.

I am particularly interested in hearing from the witnesses about their positions

on premiums. I would note that there is unanimity among the Federal banking regulators that institutions should pay regular deposit insurance premiums, though not

with respect to how we should determine those premiums.

Now, I understand that 92 percent of the industry is free from current premium

payments, and it certainly presents an interesting psychological and political challenge to persuade folks to pay for something they currently get for free. On the

other hand, I am not the first to note that very few things in life are, in fact, free.

If you are getting something of value, eventually you have to pay for it. The question is not whether you will have to pay up; it is when and how much.

I am also interested in hearing comments about the erosion in value of deposit

insurance. My position is well known: I believe we need to increase, and index, coverage levels. Over the last 20 years, coverage values have decreased by more than

half, and previous increases were unpredictable both in terms of amount and timing. I expect to hear a spirited debate on this topic, and believe it should be included

in any discussion of comprehensive reform.

I would urge everyone involved in this debate to take a step back and recognize

that when we talk about deposit insurance, we are talking about the foundation of

our financial system. It is simply irresponsible to take a short-term approach, or to

politicize the issues. And while I am open to persuasion on just about any component of reform, I am firm in my belief that we all share the common goal of a safe

and sound banking system.

As many of you know, I am committed to ensuring that our small banks and

thrifts—which play such an important role in States like South Dakota—have the

tools they need to survive. I am also well aware of the value that our larger banks,

thrifts and bank holding companies bring to this country. I believe my strong support of financial modernization speaks for itself, and would simply add that I am

30

committed to finding a reform package that considers the needs and interests of all

members of our financial services community.

Now some might argue that it will be impossible to craft changes to our deposit

insurance system that will bring all the interested parties together. I reject this argument. First, every single bank and thrift in this country benefits from our worldclass deposit insurance system, and it is in everyone’s interest to find an acceptable

set of changes. Second, I believe that our witnesses will tell us that the industry

is, in fact, close together on many of the core reform issues. Finally, the regulators

themselves have said they are approaching consensus on many issues. I am optimistic that we will be able to develop a sound comprehensive reform policy.

I would like to hear what my colleagues and our witnesses have to say, and would

invite Ranking Member Bennett to make an opening statement.

—————

PREPARED STATEMENT OF SENATOR PAUL S. SARBANES

I thank Senator Johnson, Chairman of the Financial Institutions Subcommittee,

for holding this morning’s hearing on the important subject of possible Federal Deposit Insurance System reform. Any reform effort will demand a thorough analysis

of the issues and today’s hearing contributes to that effort.

On April 5, 2001, the FDIC published a report on reforming the deposit insurance

system. The FDIC recommended:

• Merging the Bank Insurance Fund (BIF) and Savings Association Insurance Fund

(SAIF) to reduce risk.

• Charging insurance premiums based on an institution’s risk to its insurance fund,

or ‘‘risk-based premiums.’’

• Shifting from a fixed reserve ratio of 1.25 percent of insured deposits to a target

range of reserve ratios to give FDIC flexibility and to eliminate sharp swings in

insurance premiums.

• Rebating premiums based on an institution’s historical contributions to an insurance fund when the fund grows above a target level.

• Indexing deposit insurance coverage levels by the amount of inflation.

Last week, the Treasury Department, Federal Reserve Board, Comptroller of the

Currency, and the Office of Thrift Supervision announced their views on the FDIC’s

recommendations. They all supported merging the funds. They also supported the

concept of giving the FDIC greater flexibility to allow a range of reserve ratios. The

Treasury Department, Fed, and Comptroller did not support raising the amount of

Federal deposit insurance coverage.

Today’s hearing is particularly timely in light of last Friday’s failure of a major

thrift, Superior Bank, FSB, of Illinois. The failed institution is projected to be the

11th most costly loss to the insurance fund in U.S. history. Reports suggest that the

failure may cost the SAIF $500 million. In addition, customers with uninsured deposits may lose over $40 million.

I am very concerned about this failure and have taken steps to inquire into its

causes. I have sent letters to the Comptroller General of the United States, Inspector General of the Treasury Department, which has authority over the Office of

Thrift Supervision, and the Inspector General of the FDIC and asked them to report

on the reasons for the failure with recommendations for preventing future losses.

I look forward to their responses.

I look forward to hearing the testimony from representatives of the banking and

the thrift industries on their views of the deposit insurance system and the FDIC’s

recommendations.

—————

PREPARED STATEMENT OF SENATOR JACK REED

First of all, I want to commend Senator Johnson for holding this hearing. This

is a very timely issue now, particularly with the House Financial Services Committee already holding several hearings on the subject. I am pleased that the Senate

Banking Committee, within the appropriate Subcommittee, now has an opportunity

to discuss the issue from our own perspective. I also understand from Senator Johnson that he intends to hold several hearings on this topic once Congress has returned from the August recess.

Second, I want to thank all of the witnesses who are appearing before us this

morning. I know that this is an important issue to all of you, and for those that

31

1 ICBA is the primary voice for the Nation’s community banks, representing 5,000 institutions

at nearly 17,000 locations nationwide. Community banks are independently owned and operated

and are characterized by attention to customer service, lower fees and small business, agricultural and consumer lending. ICBA’s members hold more than $486 billion in insured deposits,

$592 billion in assets and more than $355 billion in loans for consumers, small businesses, and

farms. They employ nearly 239,000 citizens in the communities they serve. For more information, visit www.icba.org.

you represent, so we are appreciative of your time and work in this effort, in order

to better explain your positions to us at this time.

Third, I want to just briefly speak of my feelings toward deposit insurance reform,

and the importance I believe it holds in the context of this Committee’s attention,

and possible future action.

The FDIC’s Options Paper that it produced in April provides much sound advice

on how Congress should proceed with reforming our deposit insurance system. Most

importantly I think, it needs to be done sooner rather than later, and I certainly

commend former FDIC Chairwoman Donna Tanoue for having the foresight to work

on this issue and produce such a worthy product for discussion.

It has been said many times before by others, including the distinguished Chairman of the Subcommittee, that the current system is procyclical and will harm the

banks it seeks to assist by charging higher premiums during more difficult economic

times. Therefore, it seems to behoove us to work together to enact a system that

will have the opposite effect. In other words, we should change the system now during strong and healthy economic times, by potentially charging minimal premiums

to institutions, based on their risk of course, and lessening the burden in the leaner

years.

Obviously, there are many complicated issues inherent in taking on a matter as

complex as our deposit insurance system, and there are many different sides to the

issue as well. That is why I am pleased that we are able to hear today from the

major banking trade associations, and that we will hear from other interested parties in the weeks to come. I also look forward to working with Senator Johnson and

others on the Committee on deposit insurance reform legislation in the near future.

We have a long road and task ahead of us, but I am confident that we will produce

thoughtful and comprehensive legislation at the end of the day.

Thank you, Mr. Chairman.

—————

PREPARED STATEMENT OF SENATOR WAYNE ALLARD

I want to thank Subcommittee Chairman Tim Johnson for holding this important

hearing. I am a cosponsor of his legislation to index deposit insurance and I look

forward to working on this and on the broader issue of deposit insurance reform.

I think we have some excellent witnesses here today and I am looking forward to

their testimony.

—————

PREPARED STATEMENT OF ROBERT I. GULLEDGE

CHAIRMAN, PRESIDENT & CHIEF EXECUTIVE OFFICER

CITIZENS BANK, INC., ROBERTSDALE, ALABAMA

CHAIRMAN OF THE INDEPENDENT COMMUNITY BANKERS OF AMERICA

ON BEHALF OF THE

INDEPENDENT COMMUNITY BANKERS OF AMERICA

AUGUST 2, 2001

Good morning, Chairman Johnson, Ranking Member Bennett, and Members of

the Subcommittee. My name is Robert I. Gulledge, and I am Chairman, President,

and CEO of Citizens Bank, a community bank with $75 million in assets, located

in Robertsdale, Alabama. I also serve as Chairman of the Independent Community

Bankers of America (ICBA) 1 on whose behalf I appear today. Thank you for this

opportunity to testify on the very important issue of deposit insurance reform.

I want to commend you, Chairman Johnson, for scheduling this hearing and giving this matter priority attention. Deposit insurance is of enormous importance to

community banks and their customers—and to the safety and the soundness of our

financial system.

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Few would dispute that Federal deposit insurance has been an enormously successful program, enhancing financial and macroeconomic stability by providing the

foundation for public confidence in our banking and financial system. It has done

what it was established to do—it has prevented bank runs and panics, and reduced

the number of bank failures. Even at the height of the S&L crisis, there was no

panic or loss of confidence in our financial system. The financial system and our

economy are stronger and less volatile because of Federal deposit insurance.

But it has now been more than 10 years since the last systematic Congressional

review of our deposit insurance system, and it should be modernized and strengthened. In the past two decades since deposit insurance levels were last increased, inflation has ravaged the value of this coverage. Inflation has eroded the real level

of deposit insurance coverage to less than half what it was in 1980. The less deposit

insurance is really worth due to inflation erosion, the less confidence Americans will

have in the protection of their money, and the soundness of the financial system

will be diminished. Rejecting an inflation adjustment to deposit insurance levels, as

the Federal Reserve and Treasury Department did in testimony last week before a

Subcommittee of the House Financial Services Committee, is a prescription for

weakening a vital and successful U.S. Government program.

The deposit insurance system currently remains strong, the industry is strong and

the overwhelming majority of institutions are healthy, but as the FDIC states in its

report ‘‘Keeping the Promise: Recommendations for Deposit Insurance Reform’’ (FDIC

Report), there are emerging problems and room for improvement.

Now while we can do it in a noncrisis atmosphere, is the time to consider comprehensive improvements to enhance the safety and the soundness of our Federal

Deposit Insurance System and ensure that the effectiveness of this key element of

the safety net is not undermined.

Emerging Issues

The major deposit insurance reform issues that have emerged and should be addressed in a comprehensive legislative package include:

• Preserving the value of FDIC protection and coverage for the future by substantially increasing coverage levels and indexing these new base levels for inflation.

• Establishing a pricing structure so that rapidly growing ‘‘free-riders’’ pay their

fair share into the deposit insurance funds (these free-riders like Merrill Lynch

and Salomon Smith Barney have also used multiple charters to offer coverage levels well beyond the reach of community banks).

• Smoothing out premiums to avoid wild swings caused by the hard target reserve

ratio (so banks do not pay unreasonably high premiums when they and the economy can least afford it).

• Providing appropriate rebates of excess fund reserves.

These issues, plus others addressed in the FDIC Report, are discussed below.

Deposit Insurance Coverage Has Been Eroded By Inflation and Should

Be Increased and Indexed for Inflation to Maintain Its Real Value

For community bankers, the issue of increased deposit insurance coverage has

been front and center in the deposit insurance reform debate. More coverage would

benefit their communities, and their consumer and small business customers. It

would help address the funding challenges and competitive inequities faced by community banks and ensure that they have lendable funds to support credit needs and

economic development in their communities. For community bankers, any reform

package will fall far short if it does not include a substantial increase in coverage

levels and indexation.

The ICBA strongly supports legislation introduced by Chairman Johnson and

Representative Joel Hefley (R–CO) to raise Federal deposit insurance coverage levels. Both bills (S. 128 and H.R. 746) would increase FDIC coverage levels to around

$200,000 and provide for automatic inflation adjustments (based on an IRS index)

every 3 years rounded up to the nearest thousand dollars. Both bills have garnered

substantial bipartisan support. Thirteen Senators are on the Johnson bill, 7 Democrats and 6 Republicans. Sixty-six Representatives have signed onto the Hefley bill,

including 28 Democrats, 37 Republicans, and one Independent.

Coverage Levels Ravaged By Inflation

The general level of income, prices, and wealth in the United States has been

steadily increasing for decades. As a consequence, inflation is severely eroding the

value of FDIC protection. The current deposit insurance limit is economically inadequate and unacceptable for today’s savings needs, particularly growing retirement

savings needs as the baby-boomer generation reaches retirement age.

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2The Gallup Organization conducted telephone interviews with a randomly selected, representative sample of 1,658 adults who identified themselves as the people most knowledgeable about

household finances age 18 or older, living in households with telephone service in the continental United States. The interview period ran from November 20 to December 23, 2000. The

margin of error is plus or minus 3 percent. 3 ‘‘Increasing Deposit Insurance Coverage: Implications for the Federal Insurance Funds and

for Bank Deposit Balances,’’ Mark J. Flannery, December 2000 (study was commissioned by the

ABA).

The real value of $100,000 coverage is only about half what it was in 1980 when

it was last increased. Chart 1, which is attached, shows that simply adjusting for inflation, the $100,000 limit set in 1980 represents only $46,564 in coverage today.

Worse yet, as Table 1 shows, today’s deposit insurance limit in real terms is worth $20,000 less than it was in 1974 when the deposit insurance limit was doubled to $40,000.

Looked at another way, in 1934, when Federal deposit insurance was established,

the coverage level was 10 times per capita annual income. Today, it is only four

times per capita income. During the last two decades, while deposit insurance levels

remained unchanged, financial asset holdings of American households have quadrupled, from $6.6 trillion in 1980 to $30 trillion in 1999.

Deposit insurance coverage levels have been increased six times since the program was created in 1934. But the increases have been made on an ad hoc basis

with no predictability either on timing or the size of the increase. We need to first

adjust coverage levels not touched in 20 years and move away from ad hoc increases

to a system that is predictable and grows automatically with inflation.

The ICBA strongly supports the FDIC proposal to increase coverage levels to

make up for inflation’s devaluing effects by automatically adjusting the levels based

on the Consumer Price Index. Using 1980 as the base year would raise coverage

levels to nearly $200,000 (see Chart 2 attached); using 1974 as the base year—the

year coverage levels were raised to $40,000—and would boost coverage to around $137,000 today.

Gallup Poll Shows Consumers Want Increase

A recent survey conducted by The Gallup Organization 2 on behalf of the FDIC

revealed that Federal deposit insurance coverage is a ‘‘significant factor’’ in investment decisions, especially to more risk-averse consumers and those making decisions in older and less affluent households. Fifty-seven percent of respondents said

deposit insurance is ‘‘very important’’ in determining where to invest.

Six in ten respondents said they would be likely to put more of their household’s

money into insured bank deposits if the coverage level of deposit insurance were

raised. Six in ten said they would move their money into insured accounts as they

neared retirement age or during a recession. The survey also showed that one in

eight households keep more than $100,000 in the bank, and about one-third of all

households reported having more than $100,000 in the bank at one time or another.

Importantly, the Gallup survey indicated that nearly four out of five (77 percent)

respondents thought deposit insurance coverage should keep pace with inflation.

Small Business Customers Support Increase

Small businesses are key customers of the community banks, which in turn are

premier providers of credit to these businesses. A recent study commissioned by the

American Bankers Association (ABA) 3 found that half of small business owners

think the current level of deposit insurance coverage is too low. When asked what

actions they would take if coverage were doubled, 42 percent said they would consolidate accounts now held in more than one bank; 25 percent would move money

to smaller banks; and 27 percent would move money from other investments into

banks.

Consumers and small businesses should not be forced to spread their money

around to many banks to get the coverage they deserve. As more and more institutions base pricing on the entire customer relationship, consolidating accounts enables customers to reap the benefits of pricing and convenience when holding more

of their financial ‘‘wallet’’ at one institution. For small businesses, especially, aggregating their business with one bank can enhance their banking relationship. And

equally important, customers should be able to support their local banks, and local

economies, with their deposits.

Increased Deposit Insurance Will Help Support Local Lending

An adequate level of deposit insurance coverage is vital to community banks’ ability to attract core deposits, the funding source for their community lending activities. Many community banks face growing liquidity problems and funding pressures.

34

4 In a speech before the National Bureau of Economic Research Conference on January 14,

2000, Federal Reserve Board Governor Laurence H. Meyer said, ‘‘. . . the growing scale and

complexity of our largest banking organizations . . . raises as never before the potential for systemic risk from a significant disruption in, let alone failure of, one of these institutions.’’ 5Thomas M. Hoenig, President of the Federal Reserve Bank of Kansas City, noted in a speech

on March 25, 1999, ‘‘To the extent that very large banks are perceived to receive governmental

protection not available to other banks, they will have an advantage in attracting depositors,

other customers and investors. This advantage could threaten the viability of smaller banks and

distort the allocation of credit.’’ 6 ‘‘The Changing Community of Banking,’’ 2000 Seventh Annual Survey of Community Bank

Executives, published by Grant Thornton LLP, March 2001.

It is hard to keep up with loan demand as community banks lose deposits to mutual

funds, brokerage accounts, the equities markets, and ‘‘too-big-to-fail’’ banks.

Deposit gathering is critical to community banks’ ability to lend because alternative funding sources are scarce. Due to their small size, unlike large banks, community banks have limited access to the capital markets for alternative sources of

funding. As a consequence, community banks must rely more heavily on core deposit

funding than large banks. To illustrate, at year end 1998, core deposits represented

72 percent of assets for banks of less than $1 billion in size, and only 43 percent

of assets for banks over $1 billion.

The Federal Reserve’s recent observation that small banks have enjoyed higher

rates of asset growth and uninsured deposit growth than large banks misses the

point. Since 1992, deposit growth has lagged the growth in bank loans by about

half—hence small banks are finding it harder to meet loan demand that supports

economic growth. Average loan-to-deposit ratios are at historical highs and the ratio

of core deposits to assets is declining as community banks fund a growing share of

their assets with noncore liabilities such as Federal Home Loan Bank advances and

other more volatile, less stable sources of funds such as brokered deposits. Federal

Home Loan Bank advances are not a substitute for deposits. Bankers must pay

higher rates for advances and other nontraditional funding than they do for deposits, putting pressure on net interest margins. Examiners are warning community

banks against over-reliance on FHLB advances and other noncore funding sources.

Some banks have seen a surge in deposit activity during the last two reported

quarters. The instability of the stock market has caused some weary investors to

pull out of the equities market and return to the safety and stability of banks. But

most observers believe this is an aberration that may not continue when the market

turns back up. Moreover, this phenomenon provides deposits to banks in a down

economy when loan demand is weakened; it does not help address the need for funding when loan demand is strong.

Large complex banking organizations (LCBO’s) are acknowledged as presenting

greater systemic risk to our financial system.4 The systemic risk exception to the

least cost resolution requirement in FDICIA has never been tested. It is our belief,

based on the historical record that LCBO’s will never be allowed to fail because of

this systemic risk factor. Government policy has fostered the establishment of everlarger financial institutions further concentrating our financial system. Uninsured

depositors in such institutions benefit from too-big-to-fail.5

The Federal Reserve spokesmen reject the notion that any bank is too-big-to-fail.

The historical record, however, is to the contrary. Notably, the Secretary of the

Treasury—not the Federal Reserve—has authority under FDICIA to make systemic

risk determinations (after consultation with the President).

In our judgment, the issue is not that FDICIA does not require that uninsured

depositors and other creditors be made whole, as the Federal Reserve testified last

week, but rather that the determination of systemic risk does permit all uninsured

depositors to be made whole—as they have been made whole during previous banking crises.

Increasing deposit insurance coverage would help level the playing field for community banks with large banks and large securities firms offering FDIC-insured

products, while protecting the funding needs of Main Street America.

According to Grant Thornton’s ‘‘Eighth Annual Survey of Community Bank Executives,’’ 6 77 percent of community bankers favor raising the insurance coverage

from its current level of $100,000 in order to make it easier to attract and retain

core deposits.

Full Coverage for Public Deposits

The ICBA also supports full deposit insurance coverage for public deposits. Most

States require banks to collateralize public deposits by pledging low-risk securities

to protect the portion of public deposits not insured by the FDIC. This makes it

harder for community banks to compete for these deposits with larger banks. Many

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7 In 1980, 14,000 banks with less than $500 million in assets accounted for about 50 percent

of total core deposits, and 11 banks with more than $20 billion in assets accounted for 15 percent of core deposits. By 1999, 7,800 banks with less than $500 million in assets accounted for

only 20 percent of core deposits and 46 banks with more than $20 billion in assets accounted

for 50 percent of core deposits.

community banks are so loaned-up that they do not have the available securities

to use as collateral. And those that do have to tie up assets in lower yielding securities which could affect their profitability and their ability to compete. In addition,

collateralizing public deposits takes valuable resources away from other community

development and lending activities.

As the FDIC noted in its report, ‘‘Raising the coverage level on public deposits

could provide banks with more latitude to invest in other assets, including loans.

Higher coverage levels might also help community banks compete for public deposits

and reduce administrative costs associated with securing these deposits.’’

Providing 100 percent coverage for public deposits would free up the investment

securities used as collateral, enable community banks to offer a more competitive

rate of interest in order to attract public deposits, and enable local governmental

units to keep deposits in their local banks as a valuable source of funding that can

be used for community lending purposes.

ICBA strongly supports legislation, S. 227 and H.R. 1899, introduced by Senator

Robert Torricelli (D–NJ) and Representative Paul Gillmor (R–OH) respectively, to

provide 100 percent coverage of public deposits.

Full Coverage for IRA’s and Retirement Accounts

Today’s retirement savings needs require a deposit insurance limit higher than

$100,000. Retirement accounts are long-term investments that over time can reach

relatively large balances that exceed the FDIC coverage limit. Today, accumulating

$100,000 in savings for education, retirement, or long-term care needs is not a

benchmark of the wealthy. With the graying of the population, safe savings opportunities are needed more than ever and an insured savings option is becoming even

more crucial now that budget surpluses are reducing the supply of Treasury securities. Thus, raising the coverage level on IRA’s and other long-term savings accounts

could encourage depositors to invest more of these savings in insured bank deposits.

FDICIA Reforms Minimize Taxpayer Exposure

Critics of proposals to substantially increase and index coverage levels contend

that the 1980 increase to $100,000 was unjustified and increased the resolution

costs of the S&L crisis. Overlooked, perhaps, is the fact that the Federal Reserve

Board advocated this increase at the very time its monetary policies were driving

the prime rate over 20 percent to wring inflation out of the economy and Congress

passed legislation deregulating interest paid on deposits. Also overlooked is the fact

that the new $100,000 coverage limit helped stem depositor panic as thousands of

the thrifts holding long-term, fixed-rate loans failed from the resulting severe asset

liability mismatch.

Higher coverage limits will not necessarily increase exposure to the FDIC or taxpayers as some fear. A variety of factors serve to minimize any increase in exposure

to the FDIC or taxpayers from bank failure losses due to an increase in deposit insurance coverage levels.

The reforms in bank failure resolutions instituted by the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)—including prompt corrective

action, least cost resolution, depositor preference, and a special assessment when a

systemic risk determination is made—are designed to reduce losses to the FDIC.

Prompt corrective action helps ensure that swift regulatory action when a bank

becomes critically undercapitalized so that losses do not increase while the bank’s

condition further deteriorates. Least cost resolution requires that—except in the

case where the systemic risk exception is invoked—the FDIC uses the least costly

method when a bank fails to meet its obligations to pay insured depositors only.

And depositor preference minimizes the FDIC’s losses by requiring that assets of the

failed institution are first used to pay depositors, including the FDIC standing in

the shoes of insured depositors, before other unsecured creditors are paid. And when

a systemic risk determination is made, the FDIC must charge all banks an emergency special assessment to repay the agency’s costs for the rescue.

It is ironic indeed to hear policymakers talk about the moral hazard of increasing

deposit insurance coverage to account for inflation when the trend of greater and

greater deposit concentration in fewer and fewer banks that are likely too-big-to-fail

because of systemic risk continues.7 The moral hazard, if any, created by inflationindexing coverage pales in comparison to that presented by the increased number

36

of LCBO’s whose failure could have serious adverse effects and thus trigger the systemic risk exception of FDICIA. Systemic risk presents much greater loss exposure

to the FDIC, and ultimately taxpayers, than does an increase in the coverage limit.

‘‘Free Riders’’ Must Pay Their Fair Share

Currently, the FDIC is restricted from charging premiums to well-capitalized,

highly rated banks so long as the reserve level remains above the 1.25 percent designated reserve ratio. As a result, 92 percent of the industry currently does not pay

premiums, rapidly growing institutions do not pay their fair share for deposit insurance coverage, and the more than 900 banks that were chartered within the last

5 years have never paid premiums. According to the FDIC, this system underprices

risk and does not adequately differentiate among banks according to risk.

By the end of the first quarter of 2001, Merrill Lynch and Salomon Smith Barney

had moved a total of $83 billion in deposits under the FDIC–BIF umbrella through

two banks that Merrill owns and six banks affiliated with Salomon Smith Barney,

without paying a penny in deposit insurance premiums. This dilutes the FDIC–

BIF’s reserve ratio, which is already lagging behind the FDIC–SAIF’s, which doesn’t

face a similar inflow problem. Every $100 billion of insured deposit inflows drops

the reserve ratio of the FDIC–BIF—which stood at 1.32 percent on March 31, 2001

(down from 1.35 percent on December 31, 2000)—about six basis points.

Once the 1.25 percent reserve ratio is breached, FDIC is required by law to assess

all banks a minimum average of 23 cents in premiums unless a lower premium

would recapitalize the fund within 1 year. How long it will be before the 1.25 percent designated reserve ratio is breached and premiums are triggered for all banks

is not known. But today, past assessments on banks are subsidizing the insurance

coverage for Merrill Lynch and Salomon Smith Barney! This inequitable situation

must be remedied.

Because Merrill Lynch and Salomon Smith Barney own multiple banks, they can

offer their customers more than $100,000 in insurance coverage. Merrill with two

banks can offer $200,000 in FDIC coverage, and Salomon Smith Barney is offering

each of its customers $600,000 in FDIC protection. This could have a significant

negative impact on the funding base of community banks. Most community banks

cannot offer their customers more than $100,000 in deposit insurance coverage in

this manner. Additionally, these huge institutions are too-big-to-fail, giving them

another advantage over community banks in gathering deposits.

If the FDIC were able to charge premiums to all banks, even when the reserve

level is above 1.25 percent, it could collect premiums from Merrill Lynch and

Salomon Smith Barney as they move deposits under the insurance umbrella. As it

now stands, the FDIC is prohibited from charging them anything. Furthermore, if

rapidly growing banks grew at a particularly fast rate, posing a greater risk, they

could be charged premiums at a higher rate.

Regular Premiums

The FDIC, Federal Reserve and Treasury have all recommended that the current

statutory restriction on the agency’s ability to charge risk-based premiums to all

institutions be eliminated, and that the FDIC be allowed to charge premiums, even

when the fund is above the 1.25 percent designated reserve ratio.

The recommendation to charge premiums to all banks, even when the fund is fully

capitalized, faces controversy in the industry. However, we believe that in a carefully

constructed, integrated reform package which includes substantial increases in deposit insurance coverage levels, bankers would be willing to pay a small, steady premium in exchange for increased coverage levels and less volatility in premiums. With

a small, steady premium, bankers will be better able to budget for insurance premiums and avoid being hit with an unexpectedly high premium assessment during

a downturn in the business cycle. Also the premium swings will be less volatile and

more predictable. It is also one way to extract some level of premiums from the free

riders and reduce the dilution of the reserve ratio.

Risk-Based Premium System Should Set Pricing Fairly

The current method of determining a bank’s risk category for premiums looks at

two criteria—capital levels and supervisory ratings. The FDIC argues that this riskweighting system is inadequate since it allows 92 percent of all banks to escape

paying premiums when the fund is fully capitalized. The FDIC says that it cannot

price risk appropriately under this method.

The FDIC has proposed a sample ‘‘scorecard’’ to charge premiums based on a

bank’s risk profile. The FDIC is quick to point out that this example is not etched

in stone, and the factors to be used to stratify banks by risk deserves more analysis

and discussion. But the model can be used as a starting point.

37

The FDIC proposes to disaggregate the highest-rated category of banks that currently do not pay insurance premiums (92 percent) into three separate risk categories based on a scorecard using examination ratings, financial ratios and, for

large banks, possibly certain market signals as inputs to assess risk.

Under this system, three premium subgroups would be created—42.7 percent of

the currently highest-rated institutions would pay a 1 cent premium, 26.5 percent

would pay 3 cents, while another 23 percent would pay a 6 cent premium. The 8

percent of institutions that are currently charged premiums under the current

system would fall into higher-risk categories and pay premiums ranging from 12 to

40 cents, as contrasted to the 3 to 27 cents they pay now. Under this example, the

FDIC would collect $1.4 billion in annual premiums for an industry average of 3.5

cents.

The Treasury Department and the OCC have cautioned against making the riskbased premium structure unduly complex at this time, both in terms of assigning

banks to risk categories and in setting premium rates for the various categories.

The ICBA and community bankers generally support a risk-based premium system. However, we believe more study is needed to determine the appropriate risk

factors, risk weighting, and complexity to be used in the matrix. Reaching consensus

on the factors to be used to stratify banks into risk categories and the premiums

to be charged in the various categories will take more thought and discussion.

We are concerned that under the FDIC proposal, nearly 50 percent of banks that

do not pay insurance premiums now would be paying either a 3 or 6 cent premium

(before rebates) during good times. We are also concerned about charging unduly

punitive premiums against weak institutions. We are concerned as well that this

system could create a reverse-moral hazard by encouraging banks to squeeze risk

out of their operations and in the process reduce the amount of lending they do in

their communities. Banking is not a risk-free enterprise.

We do recommend, however, that while it would be appropriate for Congress to

establish parameters or guidelines for the risk-based premium structure, the details

of the structure should be set by the FDIC through the rulemaking process with

notice and comment from the public. The FDIC is in a better position to judge the

relative health of the insurance funds and the industry and can react more quickly

to make changes in the premium structure as necessary.

Assessment Base

The Treasury Department has recommended that deposit insurance reform consider whether the existing assessment base, which is domestic deposits, be modified

to account for the effect of a bank’s liability structure on the FDIC’s expected losses.

The Treasury notes that in the event of bank failure, secured liabilities including

Federal Home Loan Bank advances have a higher claim than domestic deposits on

bank assets, and may increase the FDIC’s loss exposure.

If consideration is to be given to changing the assessment base at this time, then

Congress should look beyond assessing deposits and secured liabilities, which discriminates against community banks, and consider all liabilities (excluding capital

and subordinated debt). For years, community banks have paid assessments on

close to 90 percent of their liabilities, since domestic deposits are their primary

funding source, while the largest banks—the too-big-to-fail banks—pay on less than

40 percent of liabilities since their funding comes in large part from nondeposit

liabilities. Experience has shown that all nonassessed liabilities, not just deposits

and secured liabilities, have funded excess growth and troubled loans of banks that

subsequently failed. If the assessment base were to be expanded, it must be done

so equitably.

Premiums Should Be Smoothed Out and Volatility Reduced

The current statutory requirement of managing the funds to the hard 1.25 percent

DRR can lead to volatile premiums with wide swings in assessments. As noted

above, under the current system, well-capitalized and well-run banks cannot be

charged premiums so long as the reserve ratio is above the DRR of 1.25 percent.

However, when the reserve level falls below 1.25 percent, the law requires the FDIC

to charge an average of 23 cents in premiums unless the fund can be recapitalized

at a lower premium in 1 year.

This means there could be substantial fluctuations in premium assessments, depending on the extent of bank failure losses. The current system is dangerously

procyclical with premiums the highest when banks and the economy can least afford

it. Premiums could rise rapidly to 23 cents when economic conditions deteriorate,

potentially exacerbating the economic downturn, precipitating additional bank failures and reducing credit availability by removing lendable funds from banks.

38

The FDIC, Federal Reserve, and Treasury Department all recommend that the

1.25 percent hard target be eliminated, and the reserve ratio be allowed to fluctuate

within a given range. The FDIC argues that the deposit insurance system should

work to smooth economic cycles, not exacerbate them. For example, maintaining the

current DRR of 1.25 percent as a target, the reserve ratio could be allowed to fluctuate between 1.15 percent and 1.35 percent. Regular risk-based premiums would

be charged so long as the ratio is within that range.

However, in years when the ratio is below 1.15 percent, the FDIC suggests a ‘‘sur- charge,’’ for example, equal to 30 percent of the difference between the reserve ratio

and 1.15 percent. Alternatively, in years when the ratio is above 1.35 percent, there

would be a rebate equal to 30 percent of the difference between the reserve level

and 1.35 percent. This would ensure that premiums rise and fall more gradually

than under the current system.

The ICBA supports eliminating the hard 1.25 percent DRR and instituting a

range within which the funds can fluctuate without penalty or reward as part of

a comprehensive reform package. Under the current system, banks could be faced

with steep deposit insurance payments when earnings are already depressed. Such

premiums would divert billions of dollars from the banking system and raise the

cost of gathering deposits at a time when credit is already tight. This in turn could

cause a further cutback in credit, resulting in a further slowdown of economic activity at precisely the wrong time in the business cycle. The agency says it would be

preferable for the fund to absorb some losses and for premiums to adjust gradually,

both up and down, around a target range.

The FDIC also makes a strong case for maintaining 1.25 percent as the mid-point

of such a range. The FDIC report showed that under various loss scenarios (no loss,

moderate loss, and heavy loss), the fund never drops below .80 percent and it never

goes above 1.5 percent. Gradual surcharges and gradual rebates help to keep the

fund within this range.

Rebates

Pricing and rebates go hand-in-hand. If premiums are charged to all institutions

regardless of the fund’s size, rebates represent a critical safety valve to prevent the

fund from growing too large. The FDIC notes that in the best years, the rebate could

result in a bank receiving a net payment from the FDIC. In an economy as relatively strong as we have today, more than 40 percent of banks would receive a net

rebate.

Importantly, under the FDIC proposal, the rebates would be based on past contributions to the insurance fund, and not on the current assessment base. This

would have two advantages. It would not create a moral hazard that would encourage banks to grow just to get a higher rebate. And it would not unjustly enrich companies like Merrill Lynch and Salomon Smith Barney, which have transferred large

deposits under the insurance umbrella without paying any premiums.

We very strongly support this recommendation on rebates. It is only fair to those

institutions that have paid into the insurance fund for years. And it would prevent

free riders like Merrill Lynch and Salomon Smith Barney from earning rebates on

premiums they never paid.

Merge the BIF and SAIF As Part of the Comprehensive Reform Plan

Historically, banks and thrifts have had their own insurance funds. The BIF and

the SAIF offer identical products, but premiums are set separately. Since the S&L

crisis, when many banks acquired thrift deposits, many institutions now hold both

BIF- and SAIF-insured deposits. More than 40 percent of SAIF-insured deposits are

now held by banks.

The FDIC, Federal Reserve, and Treasury Department all recommend merging

the BIF and the SAIF as part of a deposit insurance reform package. They note that

the lines between S&L’s and banks have blurred to the point where it is difficult

to tell them apart. They argue that merging the two funds would make the combined fund stronger, more diversified, and better able to withstand industry

downturns than two separate reserve pools. The FDIC says costs also would go

down since it would not need to track separate funds.

The ICBA supports a merger of the BIF and the SAIF so long as it is part of a

comprehensive and integrated deposit insurance reform package that includes an

increase in coverage levels.

Conclusion

In summary, Mr. Chairman, the ICBA believes it is critical to review the Federal

Deposit Insurance System now in a noncrisis atmosphere. An ongoing strong deposit

insurance system is essential for future public confidence in the banking system and

to protect the safety and soundness of our financial system. The effectiveness of this

39

key Government agency should not be permitted to be undermined or eroded away

by a failure to preserve the value of its protection.

Deposit insurance is critical to the thousands of communities across America that

depend on their local community bank for their economic vitality. Without substantially increased deposit insurance coverage levels indexed for inflation, community

banks will find it increasingly difficult to meet the credit needs of their communities

and compete fairly for funding against the too-big-to-fail institutions and nonbank

providers.

We believe that deposit insurance reform should be comprehensive. The coverage

levels should be raised and indexed for inflation. The hard 1.25 percent designated

reserve ratio should be scrapped in favor of a flexible range. The statutory requirement that banks pay a 23 cent premium when the fund drops below the DRR should

be repealed. A pricing structure that fairly evaluates the relative risks of individual

banks without undue complexity should be instituted. Full deposit insurance coverage should be accorded to public deposits. And IRA’s, education savings and retirement accounts should be accorded higher coverage levels. We urge Congress to

adopt such an integrated reform package.

We commend you, Mr. Chairman, for moving the debate forward. The ICBA

pledges to work with you, the entire Committee, and our industry partners, to craft

a comprehensive and an integrated deposit insurance reform bill that can work and

can pass.

Thank you, Mr. Chairman, for the opportunity to express the views of our Nation’s community bankers.

40

41

PREPARED STATEMENT OF JEFF L. PLAGGE

PRESIDENT & CHIEF EXECUTIVE OFFICER

FIRST NATIONAL BANK OF WAVERLY, IOWA

ON BEHALF OF THE

AMERICAN BANKERS ASSOCIATION

AUGUST 2, 2001

Mr. Chairman, I am Jeff L. Plagge, President and CEO of First National Bank

of Waverly, Waverly, Iowa, and a member of the Government Relations Council of

the American Bankers Association (ABA). I am pleased to be here today on behalf

of the ABA. ABA brings together all elements of the banking community to best represent the interests of this rapidly changing industry. Its membership—which includes community, regional, and money center banks and holding companies, as well

as savings institutions, trust companies, and savings banks—makes ABA the largest

banking trade association in the country.

I would like to thank you, Mr. Chairman, for holding this hearing to examine

some key issues related to the Federal Deposit Insurance Corporation (FDIC). We

appreciate your long-held support of a strong banking and financial system, and in

particular, your concern for community banks. We also greatly appreciate your leadership and your openness to working with the banking industry to develop reforms

that enhance the deposit insurance system.

Assuring that the FDIC’s deposit insurance funds remain strong is of the utmost

importance to the banking industry. Over the past decade, commercial banks and

savings associations have gone to extraordinary lengths to rebuild the insurance

funds, contributing $36.5 billion to ensure that the insurance funds are well-capitalized. With the Bank Insurance Fund (BIF) exceeding $31 billion and the Savings

Association Insurance Fund (SAIF) at nearly $11 billion as of March 2001—rep- resenting over $42 billion in financial resources—it is safe to say that FDIC is extraordinarily healthy.

The outlook is also excellent. There have been few failures, and the interest income earned by BIF and SAIF (nearly $2.5 billion per year) is roughly three times

the FDIC’s cost of operation. As the current deposit growth rate moves back to the

recent norm, as we expect it will, this interest income will likely continue to move

the reserve ratio even further beyond the designated reserve ratio mandated by

Congress. Moreover, the banking industry is extremely well-capitalized, adequately

reserved for potential losses, and profitable.

With the deposit insurance funds so strong, now is an appropriate time to consider how we might improve the overall system. To this end, the ABA has held extensive discussions with commercial banks and savings institutions, as well as with

Members of Congress and their staffs and the FDIC, in order to facilitate the development of an approach that would both strengthen the system and be acceptable

to a broad range of parties.

Just this weekend, this issue was discussed in detail at ABA’s Summer Meeting,

which brings together our Board, Government Relations Council, the leadership of

all the State Bankers Associations, and others. This testimony reflects the conclusions reached during that meeting.

The FDIC has done an excellent job developing an approach that addresses many

of the key issues. While we do not agree with everything in the FDIC’s April 2001

report—and are particularly concerned about the possibility of increasing premiums—we believe it provides a basis for serious discussion.

The ABA has stated for the past year and a half that a bill to strengthen the

FDIC is likely to be enacted only if an industry consensus in support of such legislation can be developed. As you will see, while some differences remain, the positions

of the ABA, America’s Community Bankers, and The Independent Community

Bankers of America are very similar. Our three associations have agreed that we

should discuss the issues together on an ongoing basis and work together to develop

legislation that would have broad support.

I would add that while there is a general belief among most bankers that we

should work with Congress to strengthen the FDIC, there is also deep concern that

such legislation could evolve to increase banks’ costs or to become a vehicle for extraneous amendments. If that were to be the case, we have no doubt that support

would quickly dissipate and turn to opposition. Indeed, our Summer Meeting discussion emphasized that the ABA will have to oppose any FDIC reform legislation that

results in a increase in premiums when the insurance funds (or a merged fund) are

above the 1.25 percent designated reserve ratio, as they are today. Fortunately, we

also believe working together, we can see a consensus bill develop that can have

broad bipartisan support.

42

1See Apprendix A for details of these significant safeguards under current law that protect

the FDIC funds.

In my testimony today, I would like to make several key points:

• Today’s system is strong and effective, but some improvements could be made. It

is the position of the ABA that we have a workable deposit insurance system that

has the confidence of depositors and banks. However, there are areas that can be

improved. Any reform should strengthen and improve the deposit insurance system, enhance the safety and the soundness of the banking system, and improve

economic growth.

• A comprehensive approach is required. Because deposit insurance issues are intrinsically interwoven, any changes must consider the overall system. We are

pleased that all the issues we believe should be considered are on the table now.

We recognize that any final bill may not cover in full all of the issues given political realities, but the Congress is engaging in a thoughtful comprehensive process,

which we appreciate.

• Changes should only be adopted if they do not create new costs to the industry.

The ABA will work to develop and support a consensus position, but ABA will oppose deposit insurance legislation that imposes new insurance costs or contains

negative add-on amendments not related to deposit insurance reform.

I would like to discuss these points more fully, and in the process, discuss a few

specific issues.

Today’s System is Strong and Effective, But Improvements Could Be Made

For over 65 years, the deposit insurance system has assured depositors that their

money is safe in banks. The financial strength of the FDIC funds is buttressed by

strong laws and regulations including prompt corrective action, least cost resolution,

risk-based capital, risk-based premiums, depositor preference, regular exams and

audits, enhanced enforcement powers and civil money penalties. Many of these provisions were added in the Financial Institutions Reform, Recovery and Enforcement

Act of 1989 (FIRREA) and the FDIC Improvement Act of 1991 (FDICIA).1 Taken

together, these provisions should reduce the number of bank failures, lower the

costs of those that do fail, and ensure that the FDIC will be able to handle any contingency. Even more important is that the banking industry has an unfailing obligation—to meet the financial needs of the insurance fund.

Simply put, the system we have today is strong, well-capitalized and poised to handle any challenges that it may encounter for decades to come. As with any system,

there is room for improvement. We would propose three litmus tests for any reform:

(1) it should strengthen and improve the deposit insurance system; (2) enhance the

safety and soundness of the banking system; and (3) improve economic growth.

A Comprehensive Approach is Required

The ABA firmly believes that any approach to reforming the FDIC should be done

in a comprehensive manner. Since last year, support for a comprehensive approach

has clearly grown. We are pleased that the FDIC’s proposal released in April 2001

is comprehensive and basically has put most of the relevant issues on the table for

discussion. In this section of my testimony, I want to give you ABA’s perspective

on what constitutes a comprehensive approach. Again, we recognize that any final

bill may not cover in full all of the issues discussed below, but we respectfully suggest that all of them should be on the table.

MUTUAL APPROACH

The ABA believes consideration should be given to the concept of including the

current insurance program elements of a mutual approach in which banks are provided with some type of ownership interest. Under such an approach, dividends

would be paid based on the ownership interest. This approach will help address the

issue of new and fast growing institutions paying no premiums, since such institutions will not have the same dividend stream. A great deal more work needs to be

done to develop a specific proposal. We believe, however, that when the fund reaches

a designated cap (discussed below), dividends should be paid to banks and savings

institutions based on a measure of their historic payments to the FDIC. The FDIC

says it can track such payments and develop such a system. A dividend system

based on previous contributions is fair because it is the accumulated interest income

on those very contributions that boosted the fund beyond the cap. Thus, this represents a return on the significant sacrifices that were made to more than fully capitalize the insurance funds.

43

2The full study is available at aba.com.

DEPOSIT INSURANCE LIMIT

As ABA stated last year, the current $100,000 insurance limit—set in 1980—has

lost over half its value when adjusted for inflation. As a consequence, it is more difficult, particularly for smaller institutions, to raise sufficient amounts of funds to

meet loan demand in their communities. For many banks, a source of funding is

the number one issue. Recent increases in loan-to-deposit ratios demonstrate that

many community banks are searching for funds to support loan demand. In discussing this issue, three items deserve consideration: (1) indexing the insurance

limit to account for inflation; (2) raising the insurance limit above the current

$100,000; and (3) providing additional coverage to IRA’s and other retirement accounts held at banks. Let me briefly discuss each in turn.

Indexing

There is general, although not unanimous, support within the banking industry

for permanently indexing the level of deposit insurance coverage. Under an indexing

system, the insurance limit would be automatically adjusted from time-to-time,

based on changes in an appropriate index. These changes should be in level increments—that is, $5,000—to avoid consumer confusion. Without indexing, the

insurance level constantly falls behind inflation, as Congress cannot be expected to

regularly pass increases.

Base for Indexing

There has been a great deal of discussion within the banking industry, as well

as in the Congress and the regulatory agencies, about the appropriate year to use

as the base for beginning any inflation adjustment. For example, as the FDIC has

pointed out, if the base chosen were 1980 (when the limit increased from $40,000

to $100,000), the insurance level would be approximately $200,000 today to account

for inflation; if 1974 were chosen (when the limit was increased from $20,000 to

$40,000), the new limit would be approximately $140,000.

In discussions with bankers over the last year on this topic, two questions have

emerged about increasing the coverage level: (1) what are the potential economic

costs; and (2) how many new deposits might flow into the banking system? To help

answer these questions, ABA hired Professor Mark Flannery of the University of

Florida. Dr. Flannery’s study was extremely helpful in understanding the potential

economic benefits and costs of various increases in the deposit insurance level.

The study concluded—based on research conducted separately with bankers, individuals, and small business owners—that doubling coverage could result in net new

deposits to the banking industry of between 4 percent and 13 percent of current domestic deposits, with the lower end of the range more likely, in Flannery’s opinion.

Obviously, the amount of any increase would vary among individual banks, depending on their markets and business strategies. These hypothetical new deposits, plus

the added protection that existing deposits (between $100,000 and $200,000) would

receive, would lower the BIF–SAIF reserve ratio below the required 1.25 percent. This would eliminate the $3.2 billion cushion that exists today and would, under

current law, require a 3–13 basis point assessment on all domestic deposits to return the ratio to 1.25 percent.2

This study—the first attempt to assign real numbers to a complicated and theoretical concept—stimulated considerable discussion in the banking industry. Several

points of view emerged: First, there are many bankers who strongly believe a significant increase to $200,000 is important to improve their access to funding and

that the benefit would exceed the potential cost. Second, there are also many bankers who are very concerned about the loss of the current buffer above the 1.25 percent reserve ratio and the potential for premium increases that would accompany

a significant increase of the insurance limit. Third, there are bankers who expressed

concerns about the acceptability of such an increase to Members of Congress, the

Treasury, the Federal Reserve, and others.

While there are differences of opinions in the industry, we believe that Congress

should consider an increase in the current limit to the maximum possible that can

be achieved without incurring significant costs that would outweigh the value of the

increase. We appreciate your efforts, Mr. Chairman, to focus on this issue and the

importance of attracting additional deposits into the banking industry to meet the

credit needs of our communities. Of course, the bottom line is that we need to develop a comprehensive bill that addresses the key issues outlined in this statement

that can also be enacted. We recognize that this is a controversial issue and therefore want to work with you to see what approach can be developed that can have

the support necessary to be enacted.

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3See Appendix A for details of additional FDIC powers and authorities.

Retirement Savings

The ABA believes Congress should also consider the possibility of a higher level

of insurance for long-term savings vehicles, such as IRA’s, Keoghs, and any future

private Social Security accounts if enacted. These are long-term investments that

tend to grow considerably over time, frequently exceeding the current $100,000

limit. For example, at an interest rate of 6 percent, even an annual deposit of $2,000

in an IRA would grow with compounding to over $110,000 in 25 years. And because

stock market volatility may be particularly worrisome to retirees, the security of

insured deposits is very appealing. Moreover, these deposits represent a very important, stable funding source for bank lending.

A differential for retirement savings accounts is not a new concept. In fact, in

1978, the Congress passed the Financial Institutions Regulatory and Interest Rate

Act that provided IRA and Keogh accounts coverage up to $100,000—two-and-a-half

times the $40,000 limit that was in place at that time. The Senate Banking Committee Report on the Act supported the differential coverage in this way: ‘‘The Committee believes that an individual should not have to fear for the safety of funds

being saved for retirement purposes.’’ Such a concern is as important today as it

was then.

We also note that some of the concern, expressed by some Members of Congress

and others, about a general increase in the $100,000 limit is based on the problem

of ‘‘hot money’’ moving to weak institutions, as occurred in the 1980’s. However, this

concern would not seem to apply to retirement savings, which are very clearly more

stable.

CAPPING THE INSURANCE FUND AND EXPANDING THE REBATE AUTHORITY

The ABA has long advocated that the insurance fund should be capped and the

rebate authority expanded. Not only are the BIF and SAIF currently fully capitalized, they are $3.2 billion over the 1.25 percent designated reserve ratio (DRR) set

by Congress following the difficulties in the 1980’s. Moreover, with interest income

exceeding the FDIC’s operating expense by $1.5 billion a year, it is highly likely that

the insurance funds will continue to grow, after deposit growth rates return to their

norm, as we expect. The compounding effect will mean even greater rates of growth

in the future. We believe the FDIC’s proposal on this point—which for the first time

acknowledges the importance of rebates as a check on excessive growth of the fund—

is a tremendous step forward. While in the past we have advocated direct rebates,

a dividend approach, based on historic payments into the funds, accomplishes the

same purpose and ABA supports that approach. The Federal Reserve and Treasury

Department, in testimony before a House Financial Services Subcommittee last

week, supported such an approach.

The funds held in excess of the DRR are not necessary to ensure the soundness

of the deposit insurance system. As I mentioned above, the FDIC has the authority

to adjust premium levels and has significant regulatory powers over depository institutions to ensure that the FDIC can meet any funding contingency. Importantly,

the FDIC also has the authority to set aside a reserve to cover anticipated future

losses. The power of this reserve was clearly demonstrated in the early 1990’s when

the FDIC reserved $16 billion for future losses, $13 billion of which was never

needed. Because this reserve is subtracted out of the funds’ balances, the reserve

ratios were dramatically understated at that time. This extra, and often overlooked,

cushion provides an important tool for managing the funds resources. Perhaps most

importantly, the banking industry is legally obligated to meet the financial needs of

the insurance fund. Simply put, limiting the size of the fund and expanding the rebate or dividend authority will not affect the FDIC’s ability to meet any future obligations to insured depositors.3

The cost of FDIC holding excess reserves is very high. It represents a significant

loss of lendable funds for banks in the communities they serve. I can tell you as

a banker that I certainly can put rebates to good use in my community providing

loans and services to my customers. This will have a far greater positive impact on

economic conditions in Waverly, Iowa, than if that money sits in the Government’s

coffers in Washington.

As noted above, we believe that viewing the FDIC more as a mutual insurer will

naturally lend itself to a rebate system, through the payment of dividends. While

the details of a cap and dividend system need to be worked out, we believe the 1.40

percent cap proposed in S. 2293 (as introduced in the last Congress) and H.R. 4082

is a reasonable point at which to cap the funds. We thank Senator Santorum for

his leadership on this issue.

45

There is a precedent for this type of system. The National Credit Union Administration has provided over $500 million over the last 5 years in dividends to credit

unions. The dividend payment is designed to keep the National Credit Union Share

Insurance Fund at 1.30 percent of insured deposits.

PREMIUMS FROM FAST GROWING INSTITUTIONS

Bankers believe there is an inherent unfairness in the current system that allows

fast growing institutions to pay no premiums, even though their growth materially

dilutes the coverage reserve ratio of the insurance funds. For many bankers this has

become a top priority in FDIC reform. The problem of fast growing institutions can

be addressed through a combination of a dividend/rebate system under the mutual

approach and granting the authority to the FDIC to charge premiums in cases

where institutions are growing by a defined percentage over average growth at

banks.

MUNICIPAL DEPOSITS

In a number of States municipal deposits are a significant source of funding, particularly for community banks. However, collateral requirements for municipal deposits often entail a costly administrative burden and have a very large opportunity

cost by tying up funds in securities that could otherwise be used for additional lending in the community. This situation varies by State. The ABA will continue to work

on suggestions for addressing collateral requirements.

A number of bankers advocate a 100 percent insurance on municipal deposits, or

at least on local municipal deposits. They point to the huge administrative burden

required to pledge bonds to collateralize these deposits, as well as the lost opportunities from holding excess bonds rather than making more loans. The ABA recognizes that 100 percent has raised economic and political concerns with some

Members of Congress due to ‘‘moral hazard’’ questions, and there is, frankly, no consensus within the industry on this issue at this point. There is, it is worth noting,

precedent under current deposit insurance practices for a differentiation between

municipal and other deposits. Therefore, we believe further work needs to be done

on this issue. For example, consideration could be given to providing broader coverage or perhaps granting banks the option to purchase additional insurance for

municipal deposits. Any such additional insurance should be limited to some definition of local deposits, and the cost of such additional insurance should fully cover

any additional risk to the insurance fund.

TOO-BIG-TO-FAIL

The ABA has long opposed the too-big-to-fail doctrine and worked with the Congress and regulators to include the limits on its use contained in FIRREA and

FDICIA. Nevertheless, important aspects of this doctrine continue to exist. Deposit

insurance reform provides an opportunity to revisit the too-big-to-fail doctrine, and

hopefully, eliminate it fully.

MERGER OF THE FUNDS

In the context of comprehensive reform, a merger of the SAIF and BIF would be

appropriate.

SMOOTHING OUT PREMIUMS

The FDIC is recommending that the ‘‘hard’’ 1.25 percent ‘‘Designated Reserve

Ratio’’ (DRR) trigger be softened so that the industry would not be charged very

high premiums all at once if the fund falls significantly below the 1.25 percent level.

The ABA believes there is merit to smoothing premiums by eliminating the so-called

‘‘23-cent cliff’’ as long as it does not result in additional net premium payments over

the long run. The current system is, in effect, a major tax increase in a recession.

It is procyclical and would undermine any economic recovery.

We are, however, troubled by the suggestion in the FDIC’s proposal that a band

around the 1.25 DRR be established under which no rebate (if over-funded) or surcharge (if under-funded) would be provided. The FDIC would still charge regular

premiums within this band. If the goal is always to return to the DRR level, then

there should be no band around that level. Since the majority of the time there are

few failures and losses, the fund will generally be above the upper level of the band.

In effect, the broad approach would set a new de facto reserve level above 1.25 percent and would ignore the billions of dollars in lost lending opportunities of overfunding the FDIC.

INDEPENDENT FDIC BOARD

Consideration should be given to changing the FDIC Board to make sure it is

truly independent, as it is designed to be. The most direct way to do that would

46

be to have three independent board members. Since the board was expanded to five

members in FIRREA, more often than not, there have been vacancies on the board.

The vacancies tend to be the ‘‘outside’’ seats because the seats held by the Comptroller of the Currency and the head of the Office of Thrift Supervision are always

filled (either by the Comptroller or the head of OTS or acting directors of those organizations). Thus the Administration has generally had half of the Directors. Such

an imbalance threatens the independence of the FDIC and could politicize decisions.

Returning to a three-member independent board—which served the FDIC for well

over 50 years—should be considered as part of a comprehensive approach to reform.

Changes Should Only Be Adopted If They Do Not Create

New Costs To The Industry

We must emphasize that we cannot support, and would oppose, any new approach

that results in additional premium costs to those banks which are currently paying

no premiums and which grow at normal rates. The example of a new premium

structure used by the FDIC in its report would, for example, result in unacceptable

premium increases for many banks. We see no justification for such increases when

the insurance funds are above the required reserve ratio.

There are several arguments made for charging premiums to at least some banks

that now pay no premiums. First, it is argued that to charge no premiums means

these banks are not paying for their insurance. We could not disagree more. Banks

have paid for their insurance—they prepaid it. The billions of dollars in the BIF and

SAIF are the result of premiums and interest on premiums. The fact that the FDIC

is now self-funded is an extraordinary achievement.

Moreover, banks are obligated to maintain the fund at 1.25 percent of insured deposits. If the fund falls below this level, all institutions pay to recapitalize the fund.

This assures adequate funding of the insurance fund. Even more important is that

the banking industry has an unfailing obligation—set in law—to meet the financial

needs of the insurance fund. This means that the entire capital of the industry—

over $600 billion—stands behind the FDIC funds.

It is also worth noting that the commercial banks and savings banks are paying

nearly $800 million each year to cover FICO and interest payments; despite the fact

that these institutions had nothing to do with the crisis that led to the issuance of

the FICO bonds. Therefore, we have fully paid up our insurance and more. We must

remind Congress that the current premium system was a carefully negotiated compromise with our industry in exchange for the picking up of the FICO interest payments. We see no justification for Congresses’ unilaterally reworking that ‘‘agreement’’ with our industry when the funds remain above the 1.25 percent reserve

ratio.

A second argument is that there must be gradations of risk in the upper category

of banks. We are not at all persuaded that these gradations are significant or that

the FDIC or anyone else has a system that can really make that differentiation with

any degree of confidence. Furthermore, we believe there is a sort of ‘‘grade on the

curve’’ implicit in this argument. The upper category is just that. Banks have

worked hard to become stronger institutions, with strong capital; these banks are

in the top category because they deserve to be there, as would be clearly shown by

an historical perspective. We see no justification for changing the system now by

arguing that there are too many banks in that category, after they have done what

it takes to be strong, well-managed and well-capitalized.

Of utmost importance, bank premiums are funds that otherwise could be lent and

invested in local communities. Charging new premiums takes that money out of

communities, undermining economic growth.

Another potential cost that could severely impact bank lending would be a change

in the assessment base related to Federal Home Loan Bank advances and other secured liabilities. This change was suggested in testimony last week by the Treasury

Department. We believe that such actions are directly counter to the intent of

Gramm–Leach–Bliley, which recognized the need for additional sources of funding

for community banks, and the appropriate role that the Federal Home Loan Banks

could play in filling that need. To alter the assessment base to now include Federal

Home Loan Bank advances and other secured liabilities will hamper the ability of

banks to fund themselves and their communities.

We would also note that changing the risk-based premium system may trigger

other problems and costs. For example, the scoring system suggested by the FDIC

could impose additional regulatory burdens and may conflict with examination ratings of the OCC, the Federal Reserve, and State banking departments. The Federal

Reserve, in testimony last week before a House Financial Institutions Subcommittee, raised questions about how this new system might work. The Treasury DepartVerDate 11-MAY-2000 07:09 Aug 15, 2002 Jkt 000000 PO 00000 Frm 00050 Fmt 6621 Sfmt 6621 81065.TXT SBANK4 PsN: SBANK4
47

ment noted in the same hearing that the approach was complicated and suggested

it not be included in this legislation.

Conclusion

Mr. Chairman, we greatly appreciate the speed with which you have moved to

hearings on this issue. We are prepared to work with you and the Members of this

Subcommittee to find the best solution to these critical issues. We think this is an

excellent time to begin that process—with the industry and the FDIC in excellent

health. We sense there is a growing consensus on issues to be addressed and approaches to these issues. We look forward to working with you to see if we can develop and enact legislation to make the FDIC insurance system even stronger.

Appendix A

Capping the insurance fund and providing rebates will not limit the FDIC’s ability

to meet any contingency. The FDIC has great flexibility to manage the funds to

maximize effectiveness, and there are many existing laws that help protect the

funds. For example, consider:

RESERVES FOR FUTURE LOSSES: FDIC has great flexibility to adjust reserves for

future losses. This reserve fund is subtracted from the fund balance when calculating whether the fund is fully capitalized—for example, if the fund balance is at

least 1.25 percent of insured deposits. Obviously, the larger the reserve for future

losses, the smaller the fund balance. Once the fund balance falls below 1.25 percent

of insured deposits, premiums must be charged by the FDIC to fully capitalize the

fund. Thus, if FDIC anticipates greater potential losses, it can merely set aside reserves, potentially creating a situation where banks would have to pay premiums

to maintain the capitalization level of the fund. The FDIC has suggested that this

‘‘hard’’ target of 1.25 percent be ‘‘softened’’ allowing a slower recapitalization than

possible under current law. It is important to note that even with such a change,

the FDIC still would be able to set aside reserves for future losses, thereby affecting

the level of the fund relative to the 1.25 percent level.

AUTHORITY TO RAISE THE DESIGNATED RESERVE RATIO (DRR): The FDIC has the

authority to raise the DRR if it can document that it is justified for that year ‘‘by

circumstances raising a significant risk of substantial future losses to the fund.’’ By

raising the DRR, the FDIC would likely be raising the assessments necessary to

maintain that new higher level. Thus, if the FDIC foresees problems, it has this

additional authority to easily deal with the situation.

RISK-BASED PREMIUMS: Risk-based premiums were authorized in 1991 by the

Congress and implemented in 1993. Several important points should be made: First,

the risk-based system provides an automatic self-correcting mechanism. If industry

conditions deteriorate and the banks’ capital falls or supervisory concerns arise, a

higher risk-premium is charged and more income is received in the fund. The FDIC

has been critical of the fact that nearly 92 percent of the industry falls in the toprated category and therefore pays no premiums. On the contrary, the incentives are

such that nearly all banks want to be in this top category, and given the economic

performance of the economy and the banking industry over the last decade, it is no

wonder that such a high percentage enjoys the benefits of such a rating.

Second, the FDIC has made additional changes to the risk-based system designed

to identify patterns that signal future problems for individual banks. This should

serve to improve the sensitivity of the risk-based system to changes, and build in

the automatic adjustments sooner than would otherwise have been the case.

MANDATORY RECAPITALIZATION: If the reserve ratio falls below the DRR, the banking industry must immediately rebuild the fund back to the DRR. If the rebuilding

is expected to take longer than one year, a mandatory recapitalization plan at very

high assessment rates (minimum 23 basis points of domestic deposits) must be established. Thus, if the industry continues to grow, the practical impact is that the

fund balance will never fall below 1.25 percent of insured deposits for any length

of time. In dollar terms, the fund would therefore always be over $35 billion. We

agree with the FDIC that, in times of stress, the high premiums that would be

required to maintain the DRR may be counterproductive. Moreover, a ‘‘hard’’ 1.25

percent level means that the benefits of such a large fund cushioning the shock of

bank failure losses is lost. While maintaining a level of capitalization is important

to preserving depositor confidence, proposals that would require a slower rebuilding

would be beneficial to maintaining credit availability during difficult economic

times. Again, it is worth noting that the reserves of future losses, mentioned above,

provide a cushioning effect and should mitigate large upward swings in premiums.

48

4There is a ‘‘systemic risk’’ exception to advance funds if needed to prevent a severe economic

effect (upon a determination by the Secretary of the Treasury, in consultation with the President

and written recommendation from the FDIC and the Fed). Any costs would be an obligation of

the banking industry on a broader base of assets minus tangible capital and sub debt. Also, the

Federal Reserve is restricted from providing discount window lending to ‘‘undercapitalized’’ institutions or those with CAMEL 5 ratings. This has the effect of preventing delays that would

allow large, uninsured deposits to run before the bank was closed. This provision also extends

discount window lending to other nonbank firms for emergencies. 1 ACB represents the Nation’s community banks of all charter types and sizes. ACB members

pursue progressive, entrepreneurial, and service-oriented strategies in providing financial

services to benefit their customers and communities.

Additional Authorities That Protect FDIC

Beyond the flexibility to adjust the deposit insurance funds to meet any contingency, there are other important laws and regulations that have fundamentally

changed the operating environment for FDIC. Taken together, these provisions lower

the probability of banks failing and they reduce the cost to the FDIC from those that

do fail.

• PROMPT CORRECTIVE ACTION: This established mandatory regulatory actions as

capital levels fall below the minimum requirements.

• CRITICALLY UNDERCAPITALIZED INSTITUTIONS: This requires mandatory conservatorship or receivership of institutions with capital less than 2 percent. Theoretically, if receivership takes place, the FDIC should suffer no losses on the institution at all.

• HOLDING COMPANY GUARANTEES/CROSS GUARANTEES: This requires the holding

company to guarantee compliance with recapitalization plans of the bank and

puts losses on sister banking institutions of a holding company in the event that

one bank subsidiary fails. By expanding the obligation to cover losses, the FDIC

effectively reduces its loss exposure.

• DEPOSITOR PREFERENCE: This law elevates the FDIC’s claim above general creditors (standing in place of the insured depositors that it has made whole) in the

receivership of any failed bank. This superior claimant position will certainly

lower resolution costs to the FDIC.

• RULES RESTRICTING TOO-BIG-TO-FAIL: FDIC may not take any action, directly or

indirectly, that causes a loss to the insurance fund by protecting depositors for

more than the insured portion of deposits or by protecting creditors other than

depositors.4

• EMERGENCY SPECIAL ASSESSMENT AUTHORITY: This authority requires the industry to repay any borrowing by FDIC and for any other purpose deemed necessary.

• ‘‘LEAST-COST RULE:’’ This requires the FDIC to resolve failures in the least costly

manner of all alternatives.

• LINE OF CREDIT EXPANDED: The 1989 law increased the FDIC’s line of credit to

the Treasury from $5 billion to $30 billion and made it mandatory for the industry to repay any borrowing.

Simply put, limits on the size of the insurance fund and expanding the rebate authority poses no concern to the FDIC funds—existing laws and regulations provide

the needed flexibility to meet any financial obligation that may arise.

—————

PREPARED STATEMENT OF CURTIS L. HAGE

CHAIRMAN, PRESIDENT, & CHIEF EXECUTIVE OFFICER

HOME FEDERAL BANK, SIOUX FALLS, SOUTH DAKOTA

FIRST VICE CHAIRMAN, AMERICA’S COMMUNITY BANKERS

ON BEHALF OF

AMERICA’S COMMUNITY BANKERS

AUGUST 2, 2001

Chairman and Members of the Committee, I am Curtis Hage, Chairman, President, and CEO of Home Federal Bank in Sioux Falls, South Dakota. I am here

today representing America’s Community Bankers (ACB) 1 as their First Vice Chairman. ACB is pleased to have this opportunity to discuss with the Committee reform

of the deposit insurance system. While the system is still healthy, rapid growth of

insured deposits is highlighting the problems caused by an overly rigid statute that

could result in damage to the banking system and the Nation’s economy.

49

2Speech, May 10, 2001 (p. 2).

Rapid growth is diluting the insurance funds as they stretch to cover more deposits. And inevitably, the FDIC must sometimes use those funds to protect depositors.

As a result of a failure last week, the FDIC’s Savings Association Insurance Fund

(SAIF) will reportedly lose $500 million—5 percent of the total in the fund. A loss

that size would reduce the SAIF’s reserve ratio from 1.43 percent of insured deposits

to 1.36 percent. The Bank Insurance Fund (BIF) had already fallen to 1.32 percent

through a combination of rapid growth in insured deposits and similar losses.

Both funds are still well above the statutory minimum of 1.25 percent of insured

deposits. However, under a statutory requirement imposed in 1989, if a fund falls

below the 1.25 percent reserve requirement, the FDIC must impose premiums. If

a fund is projected to take over a year to exceed 1.25 percent, the FDIC must impose

a statutorily mandated 23 basis point premium on all institutions in that fund. For

a community bank with $100 million in deposits, that equals $230,000. This premium would be like a targeted tax increase, threatening to drag the economy closer

to recession, and inhibiting community bankers’ ability to help their customers.

Fortunately, there is a ready solution to this problem. The Deposit Insurance Stabilization Act (H.R. 1293), introduced by Representatives Bob Ney and Stephanie

Tubbs Jones, would eliminate the arbitrary 23 basis-point requirement. Eliminating

the 23 basis-point premium would give the FDIC flexibility to recapitalize the fund

under a more reasonable schedule. The bill would also do what everyone agrees

should be done, merge BIF and SAIF. A merged fund is stronger and would be less

affected by either rapid growth or losses from failures. The bill would also permit

the FDIC to impose a special premium on excessive deposit growth.

ACB strongly recommends that Congress act on the Deposit Insurance Stabilization Act this fall, before either BIF or SAIF might fall below 1.25 percent. We agree

with incoming FDIC Chairman Don Powell that Congress need not deal with all

deposit insurance issues at once. Our position does not rule out adding additional

provisions. If Congress can quickly develop a consensus on other issues, such as capping the fund, providing for rebates, and modestly indexing coverage, ACB would

endorse an expanded bill.

On the coverage issue, ACB believes that Congress should focus on increasing protection for retirement savings. We strongly urge you to provide substantially more

coverage for retirement savings than for other accounts, as was done before 1980.

This is needed to provide adequate coverage for the variety of tax-advantaged savings accounts that have grown substantially over the years, as well as prepare for

any Social Security reform, including self-directed accounts should Congress adopt

that concept.

While ACB believes the FDIC should reform the risk-based premium system, we

strongly oppose the agency’s proposal to impose a premium on all insured institutions when the funds are over the statutory reserve ratio. Healthy institutions that

are not paying a premium today paid extraordinary premiums in the 1990’s—in

effect prepaying for today’s coverage. Despite the rhetoric being used, they are not

getting free coverage.

Congress should not let the objective of comprehensive reform be the enemy of the

necessary—stabilizing the deposit insurance system.

The Most Urgent Issue

The most urgent deposit insurance issue that we face today stems, in part, from

the strength of the system. Since both the BIF and SAIF are above their statutorily

required 1.25 percent ratio, the FDIC does not currently charge a premium to

healthy institutions. A few companies are taking advantage of that situation by

shifting tens of billions from outside the banking system into insured accounts at

banks they control. Unfortunately, the magnitude of these deposit shifts dilutes the

deposit insurance funds and reduces the designated reserve ratio. The problem is

not that the FDIC is holding too few dollars—earnings have kept BIF and SAIF balances relatively stable—but that those dollars are being asked to cover a rapidly

rising amount of deposits in a few institutions. As former FDIC Chairman Tanoue

said, ‘‘other banks can rightly say that they are subsidizing insurance costs for these

and other fast-growing banks.’’ 2

As last week’s failure demonstrated, this situation could worsen very quickly. A

combination of rapid growth and just a few failures could trigger a 23 basis point

premium. For my bank the cost of such a premium would be $1.4 million annually.

For all banks in South Dakota the cost would be $31 million. That much capital

can support over $300 million in lending. These premiums could come at the worst

possible time—when the national economy and some local economies are shifting to

50

3 12 U.S.C. 1815(d)(1)(A).

a different pace. Whenever they might come, they would divert resources from communities and shift them to Washington.

How large is this free-rider problem? In 2000, Merrill Lynch swept $36.5 billion

from its Cash Management Accounts into insured accounts at its two affiliated

banks, effectively reducing the BIF reserve ratio by 2.15 basis points. Merrill has

swept an additional $11 billion into those banks this year.

Another major firm, Solomon Smith Barney has swept a total of $17 billion into

its six BIF- and SAIF-insured affiliates this year, making this program especially

attractive to large investors. The FDIC now estimates that all of this activity has

lowered BIF’s reserve ratio by at least 3 basis points.

ACB does not object to growth in insured deposits. These firms’ activities are permissible under the current law, which never anticipated the current scenario. But

two companies’ growth plans are diluting the funds and reducing the designated reserve ratio at the possible expense of all insured banks. Without this dilution, the

BIF reserve ratio would have increased, rather than fallen. And the FDIC is faced

with a statutory prohibition on assessing for this growth.

Because of these high-growth programs, institutions in every State could be forced

to pay premiums. These institutions collectively paid billions into the FDIC in the

late 1980’s and the 1990’s. In the early 1990’s, all FDIC-insured institutions paid

approximately 23 basis points each year—again, $230,000 for each $100 million in

deposits—$900,000 annually for my bank. And in 1996 SAIF-insured institutions

paid an additional 66 basis points—a total of $4.5 billion. My bank’s share was $2.6

million. Those substantial payments brought the FDIC back to health. Now these

premiums are being used, in effect to cover new deposits at a few rapidly growing

institutions.

To correct this situation, Congress should quickly pass H.R. 1293, or similar legislation. The bill does three things:

• PERMITS THE FDIC TO IMPOSE A FEE ON EXISTING INSTITUTIONS FOR EXCESSIVE DEPOSIT GROWTH SO THAT THE REQUIRED RESERVE RATIO CAN BE MAINTAINED. Currently, the FDIC may impose an excessive deposit growth fee on new institutions

or new branches. By allowing the FDIC to impose fees on existing institutions,

H.R. 1293 would address the current ‘‘free-rider’’ problem.

• MERGES THE BIF AND THE SAIF. According to the FDIC, merging the BIF and

the SAIF would create a more stable, actuarially stronger deposit insurance fund.

A single, larger fund would be less affected by either rapid growth or losses from

failures.

• ALLOWS FOR FLEXIBLE RECAPITALIZATION OF THE DEPOSIT INSURANCE FUND. If the

reserve ratio of the merged fund falls below the required level of 1.25 percent, the

bill would give the FDIC flexibility in recapitalizing the fund over a reasonable

period of time. By repealing the automatic assessment of 23 basis points,

H.R. 1293 would give the FDIC authority to use a laser beam approach, rather

than a sledgehammer, to recapitalize the insurance fund.

ACB believes that Congress should act quickly on this legislation to help ensure

the continued strength of the FDIC and prevent the unnecessary diversion of billions of dollars away from community lending to homeowners, consumers, and small

businesses.

How the Excess Growth Premium Would Operate

Ironically, Congress permits the FDIC to impose special assessments on de novo

institutions.3 Congress recognized that these institutions can be expected to grow

at rates that exceed the industry average and impose other risks. However, because

of their relatively small size, they cannot be expected to dilute a multibillion dollar

deposit insurance fund. The same thing cannot be said about an existing institution—now effectively exempt from premiums—that embarks on a new business plan

that could add tens of billions to the insured deposit base. So the law correctly

recognizes that de novo institutions are relatively risky. However, the law forces the

FDIC to ignore the risk to the institution and to the insurance fund posed by

an existing institution that begins growing at a rate significantly above the industry

average.

A growth premium would avoid dilution of the fund by making the fund whole

with respect to any excess growth, preventing the imposition of unnecessary premium costs on other institutions. The special growth premium would apply only to

those institutions whose growth imposed a material impact on the fund. It would

also not apply to growth through merger or acquisition. By definition, these deposits

51

4The Deposit Insurance System: What Reforms Make Sense?; Ricki Helfer, December 4, 2000;

Address to America’s Community Bankers, pp. 9–10 (Helfer, December 4, 2000).

are already included in the insured deposit base, so shifting them from one institution to another does not dilute the fund.

Assessing a special premium only on significant growth would allow premium-free

growth by an ordinary institution that had developed a particularly successful business plan. But it would address the case of, for example, a diversified financial firm

that was simply transferring significant amounts of uninsured funds under its effective control into its insured bank.

ACB believes that the special premium should compensate the fund at the thencurrent reserve ratio to avoid dilution of the fund. The FDIC should have the

flexibility to collect this premium over a reasonable period to avoid imposing an

undue shock on the affected institutions. While the premium might be collected over

time, it should be booked immediately as a receivable in the fund to maintain its

coverage ratio.

Additional Provisions

While ACB urges you to take immediate action on legislation to deal with the

free-rider issue and eliminate the 23 basis point ‘‘cliff,’’ we welcome consideration

of some additional reforms to the deposit insurance system. Our positions on these

issues are discussed in detail in our comprehensive report to the FDIC, which we

released in January. A copy of that report was distributed to you along with this

testimony. What follows is a summary of ACB’s position on issues on which a

prompt consensus might emerge.

Coverage

The industry has a mixed reaction to proposals to change deposit insurance coverage levels. Most ACB members are skeptical that increases in general deposit

insurance coverage levels would significantly increase funding. Former FDIC Chairman Helfer is even more skeptical. Last year, she said, ‘‘There is very little evidence

that doubling the coverage limits will expand the deposit base of smaller banks.

Community bankers that I have talked to think that very little benefit will result

from a significant increase in coverage limits.’’ 4 Depositors with large sums may

shift insured deposits from one bank to another to consolidate balances or take advantage of higher interest rates. But one bank’s gain may well be another bank’s

loss.

A better approach would focus on increasing coverage for retirement savings, such

as IRA and 401(k) accounts. Coverage should be increased to an amount substantially above the general coverage level. This is not a new concept; in 1978 Congress

provided for $100,000 coverage for retirement savings accounts, two and one-half

times the then-current level for regular savings. Higher retirement account coverage

would provide a stable funding source for community lending and is extremely important to retirees and those nearing retirement.

Additional retirement account coverage would help implement an important national policy. Congress has just provided substantially enhanced tax incentives to

encourage individuals to accumulate retirement savings. These individual savings

are often replacing resources that employers previously provided through definedbenefit pension plans. This shift in retirement funding has increased the burden on

individuals to manage their own assets. As individuals respond to tax incentives,

their retirement assets often exceed by substantial amounts the current $100,000

coverage limit. Since planners generally recommend that individuals shift these

savings into more secure and stable investments as they approach retirement, a

substantial increase in deposit insurance coverage for retirement savings would be

particularly helpful. These plans could be easily defined by requiring that they meet

the standards of the Internal Revenue Code. The increased coverage would also be

useful if Congress adopts some version of private accounts under the Social Security

System.

In addition to a substantial increase in retirement coverage, to help maintain the

role of deposit insurance in the Nation’s financial system ACB supports indexing

coverage levels. Congress should use as a base the last time it adjusted coverage

primarily for inflation, which was done in 1974. At that time, it increased coverage

to $40,000. According to the FDIC, if adjusted for inflation since that time, the current coverage limit would be approximately $135,000.

As long as the fund is above its statutory minimum of 1.25 percent of insured

deposits, a modest increase in coverage should not require an additional minimal

premium. If unacceptable premium increases are a condition for an immediate inVerDate 11-MAY-2000 07:09 Aug 15, 2002 Jkt 000000 PO 00000 Frm 00055 Fmt 6621 Sfmt 6621 81065.TXT SBANK4 PsN: SBANK4
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5FDIC Options Paper, August 2000, p. 44.

6 60 Fed. Reg. 42680 (August 16, 1995). 7 Helfer, December 4, 2000, p. 12.

8S. 2293 and H.R. 3278.

crease in coverage, Congress should at least index coverage from the current

$100,000 level.

Indexing on a going-forward basis would certainly not justify any premium increase. However, it would maintain ‘‘the same relative importance of deposit insurance in the economy over time. . . .’’ 5 Indexing using the current level would also

end the debate over what year and level should be the basis for indexing. Depository

institutions and the economy have adjusted to the current level of coverage. Indexing would effectively maintain that level without the need for more Congressional

action.

To simplify and reduce the cost of implementation, as well as to promote consumer understanding, we recommend that any increases be instituted only in

$10,000 increments. Some ACB members are especially concerned that frequent

small adjustments and accompanying disclosures would be more costly than any

benefit they might realize from increased deposit funding.

Congress Should Set a Ceiling on the Fund

ACB recommends that Congress set a ceiling on the deposit insurance fund’s designated reserve ratio (DRR), giving the FDIC the ability to adjust that ceiling using

well-defined standards after following full notice and comment procedures. In deciding the actual ceiling amount, ACB recommends that Congress ask the FDIC to provide it with a firm recommendation on where it should set a statutory ceiling. The

agency has already done considerable historical analysis on the level of the funds

and income needed to maintain them.6 Clearly, the agency could adapt that analysis

to determine a reasonable ceiling to recommend to Congress.

ACB agrees with Former FDIC Chairman Helfer’s comment:

I believe it is possible for the FDIC to develop analytical tools that will

permit it to identify a ceiling on the funding needs of the deposit insurance

system at any particular time—a DRR that would change as circumstances

change. . . . The purpose of establishing a ceiling DRR is so that insurance

funds will not grow beyond a size that can be justified on the basis of the

needs of the deposit insurance system, thereby withdrawing capital from

banks who could have contributed to economic growth by leveraging those

funds to meet the economic needs of their communities. Amounts accumulated in the system over and above the DRR ceiling should be rebated to

banks to facilitate economic activity, which benefits every one.7

Before increasing the ceiling, the FDIC should be required to find that a higher

level is needed to meet a substantial and identifiable risk to the fund or the financial system. In addition, Congress should require the FDIC to follow a full notice

and comment process under the Administrative Procedure Act before making any

change to the ceiling.

Excess Reserves Should Be Returned to Institutions That Paid Premiums

Reserves in the fund that exceed the ceiling should be returned to insured institutions based on their average assessment base measured over a reasonable period

and based on premiums paid in the past. Rebatable premiums would include the

1996 SAIF special assessment, but not the high-growth special assessments.

During the 106th Congress, ACB supported legislation introduced by Senators

Rick Santorum (R–PA) and John Edwards (D–NC) and Reps. Frank Lucas (R–OK)

and Mel Watt (D–NC) that would have set a 1.4 percent ceiling and used the excess

to pay interest on FICO bonds.8 After the FICO bonds mature, excess funds above

the ceiling would be rebated. The bill would have given the FDIC authority to

change the ceiling. Reps. Lucas and Watt have reintroduced that legislation in the

current Congress (H.R. 557).

ACB continues to believe that this is a constructive solution to a serious potential

problem that could be caused by a substantially overcapitalized insurance fund.

However, a broader approach could lead to full rebates more promptly than provided

in the Lucas/Watt bill.

The FDIC should also consider risk factors when calculating any rebate. This

would allow the FDIC to provide a risk-based incentive to institutions without imposing a premium on the healthy institutions. Under a broader rebate program,

these incentives could come into play before the FICO obligation ends. The riskiest

institutions would get no rebates, while the safest institutions would get higher

than average rebates. Those in between could expect average rebates. These difVerDate 11-MAY-2000 07:09 Aug 15, 2002 Jkt 000000 PO 00000 Frm 00056 Fmt 6621 Sfmt 6621 81065.TXT SBANK4 PsN: SBANK4
53

ferential rebates would provide the same risk-reduction incentive as variations in

premiums. All institutions would know that as the fund approached the ceiling, they

could expect to benefit by operating in a less risky manner.

Whatever the mechanism Congress provides, resources not needed for reasonably

foreseeable deposit insurance purposes should not remain in Washington.

Risk-Based Premiums

Just as ACB urges Congress to prevent the imposition of a 23 basis point premium, we also support the current statutory language that prevents the FDIC from

imposing premiums on well-capitalized and well-run institutions when reserves are

above required levels. The FDIC and others have recommended that the Congress

repeal this policy, contending that institutions are getting ‘‘free’’ deposit insurance

coverage. This is like contending that a single-premium annuity policy is free.

Look at the numbers: From 1992 through 1996, BIF-insured banks paid a total

of $19.9 billion, while SAIF-insured institutions paid over $8.4 billion. In 5 years,

the total paid was a staggering $28.3 billion. During that period, a $100 million deposit SAIF-insured institution paid $1.8 million in premiums. A comparable BIF

institution paid $810,000. Those payments would cover 36 years of premiums for a

SAIF institution and 16 years for a BIF institution if they paid the average premium assessed between 1950 and 1990.

The industry stepped up to the plate to recapitalize their funds. As a result, the

FDIC got the money over a 5 year period, gaining the opportunity to earn substantial interest that built up the funds. That is just the way a single premium annuity

works. An insurance company charges less in nominal dollars than it expects to pay

out, making up the difference and earning a profit by investing.

Conclusion

ACB appreciates this opportunity to present our views on the significant deposit

insurance issues before you today. The deposit insurance system is still strong, but

could be made even stronger. We urge you to move quickly to give the FDIC the

flexibility that it needs to deal with the strains imposed by extraordinary growth

in insured deposits at a few institutions. Prompt passage of legislation like the Ney/

Tubbs Jones bill (H.R. 1293) will strengthen and stabilize the system.

In addition, Congress may wish to seek an early consensus on additional issues

that could be added to this legislation. Indexing coverage, providing for increased

coverage of retirement accounts, capping the size of the fund and providing for the

rebates could result in comprehensive reform that would substantially improve the

system.

Deposit insurance is an essential part of our banking system. While a variety of

opinions exist within the industry regarding what reforms, if any, should be enacted, general consensus exists that any reform should leave the FDIC stronger. It

should continue and strengthen the original mission of the FDIC to protect depositors. America’s Community Bankers is committed to working with you and your

Committee, and others in the industry to help forge a bill that can move expeditiously through Congress.

54

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER

FROM ROBERT I. GULLEDGE

Q.1. Some of the past concern about raising the deposit insurance level above $100,000 was the moral hazard of putting the American

taxpayer at risk if financial institutions fail. Give me your thoughts

as to why we should raise the deposit insurance level above

$100,000 and place the American taxpayer at risk.

A.1. The reasons for raising the insurance level above $100,000 are

covered in detail in my written statement submitted for the hearing record, but I will summarize them below. The ICBA does not

agree that raising the deposit insurance level above $100,000 will

materially increase the risk to the American taxpayer. This is more

fully described in my written statement, and also summarized

below.

Higher deposit insurance coverage levels would benefit communities, consumers, and small businesses. It would help address the

funding challenges and competitive inequities faced by community

banks and ensure that they have lendable funds to support their

communities.

Inflation has severely eroded the real value of FDIC coverage,

which has been a bulwark of consumer confidence in our financial

system, in the two decades since it was last adjusted. The current

limit is inadequate for today’s savings needs, particularly growing

retirement savings needs.

Higher coverage would benefit consumers. A recent Gallup consumer survey conducted for the FDIC showed that: 57 percent of

respondents cited Federal deposit insurance as ‘‘very important’’ in

determining where to invest; one in eight households keep more

than $100,000 in the bank; one-third of all households reported

having more than $100,000 in the bank at one time or another; and

nearly four out of five (77 percent) respondents thought deposit insurance coverage should keep pace with inflation.

Reports of the 816 uninsured depositors at the recently failed Superior Bank, FSB demonstrate well the need for increased coverage. Some of those who will lose substantial sums include an injured worker who deposited a $145,000 disability settlement the

day before the thrift failed; and a woman who deposited $120,000

in proceeds from the sale of her deceased mother’s home days before the thrift failed. Many of the uninsured had their retirement

savings at the thrift, including one person with $3 million in an

IRA. The ICBA supports substantially higher coverage levels for retirement savings.

These stories demonstrate that depositors with more than the

coverage limit are not necessarily wealthy or capable of exercising

‘‘depositor discipline’’ by scrutinizing their banks. If Federal bank

regulators can be surprised by the true financial condition of a

bank (as in the case of both the Superior and Keystone National

Bank failures), then how can we expect the ordinary depositor to

exercise ‘‘depositor discipline’’?

Higher coverage would benefit small businesses. A recent ABA

survey of small business owners found that half think the current

level of deposit insurance coverage is too low. If the coverage were

doubled, 42 percent said they would consolidate accounts now held

in more than one bank; 25 percent would move money to smaller

55

banks; and 27 percent would move money from other investments

into banks.

Higher coverage would benefit our communities. Consumers and

small businesses shouldn’t be forced to spread their money around

to many banks to get the coverage they deserve. Customers should

be able to support their local banks, and local economies, with their

deposits.

Higher coverage levels are needed to enable community banks to

maintain sufficient core deposits to meet community lending needs

as they lose deposits to mutual funds, brokerage accounts, the equities markets and too-big-to-fail banks. Since 1992, deposit growth

has lagged the growth in bank loans by about half—hence small

banks are finding it harder to meet loan demand that supports

economic growth. And because of their small size, the community

banks lack access to the capital markets for alternative sources of

funding.

Community bankers in agricultural and rural markets are particularly faced with these difficulties. As the Federal Reserve Board

noted in the attached July 27 letter to Representative Spencer

Bachus (R–AL), who Chairs the Financial Institutions Subcommittee (House Financial Services), asset and deposit growth at small

banks in agricultural and rural areas (see lines 6 and 7 of accompanying chart) between 1995 and 2000 has failed to keep pace with

asset and deposit growth for small banks in metropolitan areas (see

line 8).

Also, growth of uninsured deposits at agricultural banks (far

right column of line 6) greatly lags growth of uninsured deposits

at all other banks for this period, averaging 3.9 percent annually

compared to double-digit percentage annual increases at all other

institutions. And other Federal Reserve data shows deposit growth

for all small banks is lagging loan growth. We believe this to be

direct evidence of the difficulties many community bankers face in

attracting and maintaining core deposits to meet loan demand.

FDICIA reforms minimize taxpayer exposure. Higher coverage

limits will not necessarily increase exposure to the FDIC or the

taxpayers. A variety of factors serve to minimize any increase in

exposure to the FDIC or the taxpayers from bank failure losses due

to an increase in deposit insurance coverage levels.

The reforms in bank failure resolutions instituted by the Federal

Deposit Insurance Corporation Improvement Act of 1991 FDICIA—

including prompt corrective action, least cost resolution, depositor

preference, and a special assessment when a systemic risk determination is made—are all designed to reduce losses to the FDIC.

It is ironic to talk about the moral hazard of increasing deposit

insurance coverage to account for inflation when the trend of

greater and greater deposit concentration in fewer and fewer banks

that are likely too-big-to-fail continues. This deposit concentration,

not an increase in coverage levels, presents the greatest systemic

risk and ‘‘moral hazard’’ in our financial system and to the loss exposure of the FDIC and the taxpayer. And even if an emergency

determination of systemic risk is made by the Secretary of the

Treasury, and if all depositors—and creditors—at Large Complex

Banking Organizations (LCBO’s) are again made whole, a special

56

assessment on all banks will be levied to recover all of these bailout costs.

Q.2.a. Mr. Plagge’s testimony says ‘‘there is general, although not

unanimous, support with the banking industry for permanently indexing the level of deposit insurance coverage.’’ What percentage of

your membership supports indexing the level of deposit insurance

coverage? What percentage of your membership supports covering

municipal deposits? What percentage of your membership supports

covering IRA’s, and other retirement accounts? What percentage of

your membership would be willing to pay a small, steady premium?

A.2.a. While we have not conducted a formal, membership-wide

survey of community banker support for indexing coverage, covering municipal deposits, IRA’s and other retirement accounts, and

paying a small, steady premium, the ICBA strongly supports all of

these proposals as part of a comprehensive approach to deposit insurance reform.

On the procedural level, the ICBA formulates its public policy positions through a multifaceted input and review process involving

the organization’s banker-elected and banker-composed Executive

Committee, Board of Directors (composed of over 100 bank and

thrift executives from 48 States), 13 separate issue committees

(e.g., Federal Legislation, Policy Development, Regulation Review),

as well as consulting with individual community bankers and State

community banking trade associations affiliated with the ICBA.

In addition to being approved and ratified by the ICBA’s Policy

Development Committee, Executive Committee and Board of Directors, our current policy resolutions were ratified by unanimous

voice vote of the 1,300 community banker delegates to the ICBA

Annual Convention held in Las Vegas, Nevada in March 2001. Our

policy resolutions on ‘‘Deposit Insurance’’ and ‘‘Community Bank

Funding and Liquidity’’ are attached.

Our stance in strong support for comprehensive deposit insurance reform, including provisions to both substantially increase

current coverage levels and index this new base for future inflation,

is the result of community-banker deliberations over the course of

the last several years. This process was intensified in March 2000

following former FDIC Chairman Donna Tanoue’s announcement

at the ICBA Annual Convention in San Antonio, Texas that her

agency would be undertaking a thorough review of and make recommendations on Federal deposit insurance reform. Chairman

Tanoue’s speech mentioning proposals to increase and index coverage levels for inflation since 1980 drew a standing ovation from

the community banker delegates at the convention.

Throughout this process, all of the above-noted issues (and other

possible reforms) have been considered, and often reconsidered, by

various ICBA committees and ultimately our Executive Committee

and Board of Directors. This process has provided our banker membership with extensive and repeated opportunities to weigh in on

the issues under consideration and formulate the trade association’s positions and advocacy strategies.

With regard to paying a small, steady premium, I would reiterate

my testimony at the August 2 hearing that the ICBA believes ‘‘that

in a carefully constructed, integrated reform package which inVerDate 11-MAY-2000 07:09 Aug 15, 2002 Jkt 000000 PO 00000 Frm 00060 Fmt 6602 Sfmt 6602 81065.TXT SBANK4 PsN: SBANK4
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cludes substantial increases in deposit insurance coverage levels,

bankers would be willing to pay a small, steady premium in exchange for increased coverage levels and less volatility in premiums.’’ This will enable bankers to better budget for premiums

and will help avoid unexpectedly high premiums during economic

downturns. In addition, we believe premium swings would be less

volatile and more predictable, and it would also result in ‘‘free riders,’’ like Merrill Lynch and Salomon Smith Barney which have

now pumped upward of $100 billion into insured deposits, paying

some level of premiums and thereby reduce further dilution of the

insurance fund(s) reserve ratio.

Q.2.b. Mr. Plagge’s testimony also discusses a study which shows

that ‘‘doubling coverage could result in net new deposits to the

banking industry of between 4 percent and 13 percent of current

domestic deposits, with the lower end of the range more likely.’’

Also doing this ‘‘would lower the BIF–SAIF reserve ratio below the

required 1.25 percent.’’ Is this worth the potential cost? Is it worth

the potential for premium increases that would accompany a significant increase of the insurance limit?

A.2.b. The premium costs of an increase in deposit insurance coverage must be considered in the context of comprehensive reform.

The ICBA believes that community bankers are willing to pay a

small, steady, fairly priced premium as part of a comprehensive

package that includes a substantial coverage increase. In a comprehensive package, the hard target 1.25 percent reserve ratio

would likely be replaced by a flexible range in order to reduce premium volatility. Premiums would remain steady as long as the reserve ratio stayed within the range. Thus, a dip in the reserve ratio

below 1.25 percent in such a scenario would not result in increased

premiums.

Q.2.c. What do you think of Mr. Hage’s proposed bill to merge the

BIF and the SAIF, allow for flexible recapitalization of the deposit

insurance fund and permit the FDIC to impose a fee on existing

institutions for excessive growth?

A.2.c. We believe Mr. Hage’s proposed bill is too narrow. Instead,

the ICBA supports a comprehensive approach to deposit insurance

reform as more fully described in our answer below to Question 3.

Q.3.a. Mr. Powell indicated that perhaps all the FDIC proposed reforms did not have to be in one package. What would be on your

‘‘must have in the bill’’ list if you were making one?

A.3.a. The ICBA’s preference, as noted in Answer 2 above, would

be comprehensive legislation that: (1) substantially raises coverage

levels and indexes the new base for future inflation; (2) increases

coverage for public deposits and retirement products; (3) removes

the current hard 1.25 percent designated reserve ratio in favor of

a flexible range, with rebates, based on past contributions, when

the fund exceeds the upper end of the range; (4) repeals the current

statutory requirement that banks pay a 23 cent premium when the

fund(s) drop below the DRR; and (5) institutes a pricing structure

that fairly evaluates the risks of individual banks without undue

complexity or cost, including the payment of a small, steady premium. Also, in the context of a comprehensive bill, the ICBA would

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not oppose merger of the BIF and the SAIF into a single insurance

fund.

The ICBA’s bottom line on deposit insurance reform remains that

we cannot support any legislative proposals that do not substantially increase current coverage levels and index the new base for

future inflation.

Q.3.b. Should these reforms be done now?

A.3.b. Yes. The ICBA fully shares the view stated in the FDIC’s

recent report ‘‘Keeping the Promise: Recommendations for Deposit

Insurance Reform’’ that the time for comprehensive action is now

in a noncrisis atmosphere. Indeed, the recent Superior Bank, FSB

failure should serve as a catalyst for action. Delay in dealing with

the S&L crisis of the late 1980’s not only prolonged the problem,

but also greatly increased the costs of the bailout.

The ICBA is also concerned that a piecemeal approach to deposit

insurance reform will not result in all the important issues being

addressed adequately, or possibly at all. Should Congress move on

a limited package this year, as some suggest, momentum for action

on other critical topics could well be lost. That would be unfortunate, as the ICBA joins the Senate Banking Committee’s Financial

Institutions Subcommittee Chairman Tim Johnson (D–SD), Representative Bachus, and others who believe the best way to deal

with this complex situation is to face all the issues directly in a

proactive fashion. To do otherwise could be an invitation to larger

obstacles down the road.

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2001 ICBA POLICY RESOLUTIONS

[Excerpts]

DEPOSIT INSURANCE

A strong and well-functioning Federal Deposit Insurance System is the foundation

on which consumer confidence in our banking and financial system rests. That confidence in turn plays a pivotal role in maintaining stability during difficult economic

times. The Federal Deposit Insurance System has worked well for more than 65

years, but following the ‘‘financial modernization’’ accomplished in the Gramm–

Leach–Bliley Act, it is now time to review and modernize our Federal Deposit Insurance System as well.

Increased Coverage Levels

ICBA strongly supports increasing deposit insurance levels and regularly indexing

them for inflation to adequately preserve the value of its protection going forward.

Deposit insurance coverage levels have not been increased in 20 years—the longest

period in FDIC history without an increase. Deposit protection has been eroded in

half due to inflation since 1980 and is inadequate for today’s savings needs, particularly growing retirement savings needs. The less deposit insurance coverage is really

worth due to inflation erosion, the less confidence Americans will have in the protection of their money, and the soundness of the financial system will be diminished.

Adequate deposit insurance levels are also critical to community banks’ ability to

attract core deposits to support community lending as they lose deposits to mutual

funds, brokerage accounts, the equities markets, and ‘‘too-big-to-fail’’ banks. Increased coverage levels will help local communities by enabling depositors to keep

more of their money in local banks, where it can be reinvested for community

projects and local lending.

The ICBA also supports full deposit insurance coverage for in-market municipal

(public) deposits—taxpayer funds that should not be put at risk. State deposit

collateralization requirements make it harder for community banks to compete for

these deposits with larger banks. Many loaned-up community banks do not have securities available to use for collateral. Those that do must tie up assets in loweryielding securities affecting their profitability and ability to compete. Full deposit

insurance coverage of in-market municipal deposits would free up the investment

securities used as collateral, enable community banks to offer a more competitive

rate of interest to attract municipal deposits, and enable local governmental units

to keep deposits in their local banks and communities.

Other Deposit Insurance Reform Issues

The FDIC has undertaken a timely and a comprehensive review of the Federal

Deposit Insurance System. In addition to the issue of coverage levels, the FDIC is

reviewing two other key issues: Fairness in deposit insurance pricing and funding

insurance losses over time. The ICBA supports this comprehensive review and—in

conjunction with an increase in the coverage level—supports efforts to reform the

system to:

• Adequately assess deposit growth at rapidly growing institutions—which currently pay no insurance premiums to offset the dilution in the reserve ratio

caused by their deposit growth (‘‘free rider’’ problem).

• Appropriately differentiate pricing for individual institutions based on risk.

• Reduce premium volatility by smoothing out premium payments to remedy the

current procyclical nature of deposit insurance premiums—with premiums lowest

when the industry is healthiest and highest when the industry is weakest and can

least afford to pay—caused by the hard target reserve ratio.

• Provide appropriate options for rebate of excess fund reserves to the industry.

• More equitably apportion the costs of systemic risk protection, recognizing that

the benefits of a stable financial system goes beyond the banking system alone.

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COMMUNITY BANK FUNDING AND LIQUIDITY

[Priority]

Community banks are facing serious funding and liquidity challenges as they find

it harder and harder to attract and maintain core deposits to match asset growth

and support community lending. According to the FDIC, deposits increased by only

4.1 percent in 1999, the smallest annual increase since 1993, while bank lending

increased 7.8 percent. Community banks continue to see disintermediation of deposits to mutual funds, brokerage accounts, the equities markets, tax-free credit unions

and ‘‘too-big-to-fail’’ banks. Alternative sources of funds at competitive prices for

community banks are scarce because community banks lack ready and efficient access to the capital markets. By contrast, large commercial banks can access the capital markets for funds and use securitization to supplement deposits. High tax rates

on traditional saving instruments such as certificates of deposit further encourage

investment in higher risk investments and drain community bank core deposits.

Deposit Insurance Coverage Levels

To stem the deposit flight out of local communities and enable community banks

to better compete with the emerging financial conglomerates, the ICBA urges that

Federal deposit insurance coverage levels be increased, and indexed for inflation

going forward.

Deposit insurance coverage has been frozen at $100,000 since 1980. Inflation

alone has cut the real value of deposit insurance protection in half. The ICBA

strongly supports an increase in deposit insurance coverage levels in order to help

community banks attract additional core deposits. Improved access to Federal Home

Loan Bank advances will help (see below), but more is needed as advances are not

a complete substitute for deposits. Increased coverage levels will allow depositors to

keep more of their money in local banks, thus boosting the supply of lendable funds

at community banks and providing funds to keep local economies prosperous.

While community banks now have more alternative funding sources, these sources

cannot be relied on as a complete replacement for deposits. Community bankers recognize this and their examiners caution against too great a reliance on nontraditional funding sources. Community banks need to offer higher levels of deposit

insurance to avoid overdependence on Federal Home Loan Bank advances.

Federal Home Loan Bank Access

Federal Home Loan Bank System modernization provisions included in the

Gramm–Leach–Bliley Act of 1999 represented a significant step in addressing community bank funding problems by providing Community Financial Institutions (insured depository institutions with less than $500 million in assets) greatly enhanced

access to the Federal Home Loan Banks for long-term fixed-rate funding.

The ICBA will continue its work to expand eligibility for direct access to longerterm funding sources as these provisions are implemented. The ICBA strongly encourages the FHLB’s to move forward to implement their expanded collateral options available for Community Financial Institutions (CFI’s) as rapidly as possible

without jeopardizing safety and soundness. We urge the FHLB’s to develop the

products and programs to support their CFI members lending to agriculture and

small businesses as envisioned by the legislation.

Other Sources

ICBA will continue to work to improve community bank access to other longerterm funding from sources including the Farm Credit System, Farmer Mac and the

Federal Reserve banks in order to be better able to meet their local lending demand.

We call upon the Federal Reserve to review the operations of its discount window

as a potential new long-term funding window for community banks.

ICBA will continue to interface with banking regulators on the growing importance of community bank use of nondeposit sources of liquidity. ICBA will work to

educate its members about funding alternatives and the asset/liability management

challenges that arise with their use.

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RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER

FROM JEFF L. PLAGGE

Q.1. Some of the past concern about raising the deposit insurance level above $100,000 was the moral hazard of putting the American

taxpayer at risk if financial institutions fail. Give me your thoughts

as to why we should raise the deposit insurance level above

$100,000 and place the American taxpayer more at risk?

A.1. The severe effect of inflation over the last 21 years has cut the real value of the $100,000 insurance limit in half. Thus, the

coverage that individuals and importantly, small businesses, have

received has diminished significantly over time. The importance of

deposit insurance to maintaining the confidence of our system requires very careful consideration of the real value of the protection

provided.

A very important part of your question is what risk this poses

to taxpayers. A critical provision, enacted in the FDIC Improvement Act of 1991, makes banks entirely responsible for any losses

or other expenses of the FDIC. In effect, this means that the entire

capital of the banking industry stands behind the funds. Therefore,

the taxpayer risk is extremely small under our current system and

an increase of the insurance limit would have no appreciable effect

on this.

Some observers have commented that the increase of the insurance limit from $40,000 to $100,000 in 1980 contributed to the

losses in the S&L crisis. While this increase may have made it

easier for some high-flying S&L’s to fund their risky activities, the

failure on the part of the S&L’s regulator to close insolvent institutions was the primary cause of the significant losses. This, of

course, was exacerbated by poor accounting methods, insufficient

capital and lack of prompt regulatory action to prevent abuses from

taking place or becoming worse. With such lax regulatory oversight, those high-flying S&L’s could have raised any level of funding regardless of whether the limit were $40,000 or $100,000.

Q.2.a. Mr. Plagge, your testimony says ‘‘there is general, although

not unanimous, support with the banking industry for permanently

indexing the level of deposit insurance coverage.’’ What percentage

of your membership supports indexing the level of deposit insurance coverage?

A.2.a. While it would be impossible to say with any precision what

percentage of our membership supports indexing, it is fair to say

that the vast majority believes that indexing the fund going forward—whether the fund is indexed from $100,000 or some higher

base level—would be appropriate. As I said in my statement, support is not unanimous. There are some institutions that believe

that no change—either increasing the current base of $100,000 or

indexing going forward—should be undertaken. We base our response on discussions within our Government Relations Council

(about 130 bankers from every State and all bank sizes), but also

discussions held in numerous forums and meetings throughout the

country over the last 18 months.

It is very important to remember that as the real value of the

insurance limit has fallen with inflation, it becomes increasingly

difficult, particularly for smaller institutions, to raise sufficient

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amounts of funds to meet loan demand in their communities. For

many banks, a source of funding is the number one issue. Recent

increases in loan-to-deposit ratios demonstrate that many community banks are searching for funds to support loan demand. Thus,

there is an important public policy issue that underlies the need

to keep the insurance coverage limit revised to reflect inflation.

Q.2.b. What percentage of your membership supports covering municipal deposits?

A.2.b. It would be difficult to estimate a percentage with any precision as there are varying opinions on increasing coverage for municipal deposits, and frankly, there is not a consensus within the

industry. Some of our members support full coverage on municipal

deposits. They believe that there is no economic difference to the

municipality whether the deposits are fully secured or fully insured

by the FDIC, yet there is a big difference in the management of

the collateral, which is costly and time-consuming to administer

and often absorbs resources that would have otherwise been used

for lending. There are also other bankers who support a system

that would allow them to purchase additional insurance from the

FDIC to cover these deposits, perhaps at limits to $5 million or $10

million (reflecting the level of deposits that are often associated

with these deposits). As the collateral rules are dependent on State

law and regulation, the opinions on the importance of coverage

vary from State-to-State. There are also bankers who want no

change. ABA believes that the issue should be under consideration

as legislation is developed. It is worth noting that there is precedent under current deposit insurance practices for a differentiation

between municipal and other deposits.

Q.2.c. What percentage of your membership supports covering the

IRA’s, and other retirement accounts?

A.2.c. The vast majority of bankers support a differential coverage

limit on IRA’s, Keoghs, and other retirement accounts. Again, there

are some institutions that are opposed to any increase of any sort

in the level. As noted in ABA’s testimony, there is precedent for

differential coverage: Between 1978 and 1980, the coverage for

IRA’s and Keoghs was two-and-a-half times ($100,000) the limit at

that time ($40,000). The recent failure of Superior Bank has highlighted the fact that many people have retirement savings that exceed the insurance limit. This is not ‘‘hot’’ money and well-deserves

special consideration. Moreover, the retirees are hardly the source

of market-discipline that would constrain risk-taking at financial

institutions.

Q.2.d. What percentage of your membership would be willing to

pay a small, steady premium?

A.2.d. Increasingly bankers have become concerned about the potential costs that a revised risk-based assessment system would

involve. Thus, there is very strong and near universal opposition to

any reform that would entail additional costs to the industry. The

ABA strongly opposes this concept when the fund is above 1.25 percent of insured deposits. The industry does recognize that there is

potential for the fund to fall below the 1.25 percent level and that

costs would arise at that time. Moreover, changes such as increasVerDate 11-MAY-2000 07:09 Aug 15, 2002 Jkt 000000 PO 00000 Frm 00069 Fmt 6602 Sfmt 6602 81065.TXT SBANK4 PsN: SBANK4
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ing the insurance limit above $100,000 might move the reserve

ratio closer to the 1.25 percent designated reserve level and increase the likelihood that new premium payments would have to

be made. However, those potential costs are far different than the

immediate increase in premiums for approximately 4,500 banks

that has been suggested in examples presented by the FDIC. These

banks, among the 92 percent of the industry currently in the 1A

risk-category, pay no premiums. The prospect of paying higher premiums when the fund has over $3 billion in excess capital is very

disturbing for the industry. In this regard, I attach a letter, recently sent by ABA President Donald Mengedoth to the House Financial Services Committee, which addresses this issue in detail.

Q.2.e. Is it worth the potential for premium increases that would

accompany a significant increase of the insurance limit?

A.2.e. There were many bankers, particularly community bankers,

who had expressed a willingness to pay some small premium if the

insurance limit was raised to $200,000. They believe they would

benefit from new deposits flowing into their banks from such a

change. They recognized that the current reserve ratio would decline and thus might run the risk of paying some small premium

in the future. As political opposition to doubling the insurance limit

has increased and as the realities of the potential costs of greater

premiums due to the reduction of the reserve ratio, the acceptability of paying any new costs has fallen dramatically. The concern over paying greater costs has also risen as the suggestions

about splitting up the top-rated category has made it clear that

some institutions that pay no premiums today would be required

to pay something if these changes were adopted.

It is important to differentiate between the two types of additional costs. Under the current premium structure, any increase in

the insurance level, even indexing, would raise the potential for additional premiums because the insurance funds would move closer

to the 1.25 percent designated reserve ratio. That loss of cushion

is acceptable to most, but not all, banks in this context. The second

costs—asking banks not currently paying premiums to pay when

the fund is above 1.25 percent—is completely unacceptable to the

great majority of our members and to ABA.

Q.2.f. What do you think of Mr. Hage’s proposed bill to merge the

BIF and the SAIF; allow for flexible recapitalization of the deposit

insurance fund and permit the FDIC to impose a fee on existing

institutions for excessive deposit growth?

A.2.f. We believe it is too narrow. The provisions in Mr. Hage’s bill

provide a reasonable starting point for any reform. As ABA pointed

out in our testimony, there are other very important considerations—including capping the funds, providing rebates and adjusting insurance levels for inflation—that should be considered as

part of any comprehensive plan. We are pleased that the FDIC and

the other banking regulators recognize the need for a comprehensive approach to reforming the deposit insurance system.

Q.3. Mr. Powell indicated that perhaps all the FDIC proposed reforms did not have to be in one package. (a) What would be on your

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‘‘must have in the bill’’ list if you were making one? (b) Should

these reforms be done now?

A.3. We have serious doubts about proceeding in stages, frankly

because we doubt there would be a second stage. In our written

statement we have laid out the many issues that should be considered as part of any comprehensive reform of the FDIC. We believe

that any narrowing of the list or prioritizing would tend to limit

the possibility that a complete review of the issues be undertaken.

From our discussions at our large Summer Planning Meeting two

messages were heard loud and clear: First, that industry would be

opposed to any reform that would raise the cost of the system to

the banking industry; and second, that any reform package should

include a cap on the fund and a rebate or dividend system.

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RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER

FROM CURTIS L. HAGE

Q.1. Some of the past concern about raising the deposit insurance levels above $100,000 was the moral hazard of putting the American taxpayer at risk if financial institutions fail. Give me your

thoughts as to why we should raise the deposit insurance level

above $100,000 and place the American taxpayer more at risk?

A.1. ACB supports a modest increase in general coverage levels in- dexed from the $40,000 level Congress set in 1974, since that was

the last time coverage was adjusted solely to account for inflation.

Depending on the index used, that would result in coverage of approximately $135,000. We also support indexing coverage to account for future inflation. We do not believe such an increase in

coverage would pose additional risk to the taxpayers because the

‘‘real,’’ or inflation-adjusted level of coverage would be unchanged.

Moreover, the deposit insurance funds remain strong and banking

industry capital—the first line of defense against losses—remains

at historically high levels.

Nevertheless, ACB would not an advocate an increase in general

coverage levels if it were accompanied by unacceptable increases in

costs or if debate over the issue threatened to delay action on more

urgent deposit insurance reform issues.

ACB believes Congress should act quickly to deal with the rapid

growth in deposits at a few ‘‘free rider’’ institutions. As I said in

our testimony, ACB urges Congress to act this year on a bill to

merge the Bank Insurance Fund (BIF) and the Savings Association

Insurance Fund (SAIF), eliminate the mandatory 23-basis-point

premium, and give the FDIC authority to impose premiums on excess deposit growth.

ACB does not believe that a modest increase in coverage levels

or indexing would greatly increase the total amount of insured deposits. Frankly, our members believe that there would be some

shuffling of deposits among insured institutions, but no major infusion of deposits from outside the system. Since there would be only

a modest increase in total insured deposits, a premium increase

would not be justified.

However, we agree with the FDIC that indexing coverage would

be helpful to maintain the relative position of deposit insurance in

the Nation’s economy. Indexing would allow an individual to maintain the same relative level of coverage without opening multiple,

additional accounts at different institutions.

While ACB does not advocate a substantial increase in general

coverage levels, we strongly support providing a substantial increase in retirement account coverage. As I said in our testimony

to the Committee, Americans are increasingly responsible for managing their own retirement funds and need a safe haven for these

important assets. In the recently passed tax legislation, Congress

encouraged even greater growth in these accounts. Clearly, substantially increased deposit insurance coverage would help implement this public policy.

Q.2.a. Mr. Plagge’s testimony says ‘‘there is general, although not

unanimous, support within the banking industry for permanently

indexing the level of deposit insurance coverage.’’ What percentage

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of your membership supports indexing the level of deposit insurance coverage?

A.2.a. ACB has not surveyed our membership on this question explicitly. However, in the fall of 2000, we formed a deposit insurance

team of 32 members to comprehensively examine the FDIC’s deposit insurance options paper, which raised the possibility of indexing. The team’s consensus was that if it was not possible to obtain

modest increases in coverage in the short run, the Congress should

at least index coverage going forward. That would maintain the relative role of deposit insurance in the Nation’s economy without

adding significant new risk to the FDIC. This conclusion (as well

as the Team’s other recommendations) was later endorsed unanimously by the 70 members of ACB’s Government Affairs Steering

Committee and Board of Directors.

Q.2.b. What percentage of your membership supports covering the

municipal deposits?

A.2.b. ACB members hold differing views on increased coverage for

municipal deposits. This generally reflects differences in State and

local practices. For example, in Minnesota local governments have

joined together to form mutual funds, effectively by-passing insured

depository institutions. In other States, not all depository institutions are eligible to accept municipal deposits. On the other hand,

some minority owned institutions believe they might benefit from

increased coverage for these deposits. In sum, ACB believes that

policymakers should avoid imposing an across-the-board premium

for increased coverage that would not benefit all institutions.

Q.2.c. What percentage of your membership supports covering the

IRA’s and other retirement accounts?

A.2.c. As indicated in my reply to question 1, ACB strongly supports a substantial increase in coverage for retirement accounts.

ACB’s deposit insurance team believes that this has a solid basis

in public policy and would be a major benefit to the Nation’s retirees and those approaching retirement. In addition, these deposits

would be a major boost to community lending by providing a stable

base of long-term funding.

Q.2.d. What percentage of your membership would be willing to

pay a small, steady premium?

A.2.d. ACB strongly supports maintaining the current statutory

language preventing the FDIC from imposing premiums on wellcapitalized and well-run institutions when FDIC reserves are above

the required levels. We reject the notion that by not paying premiums currently, these institutions are getting ‘‘free’’ deposit insurance coverage. My bank and thousands of others have already paid

for our coverage. From 1992 through 1996, insured institutions

paid a total of $28.3 billion into the insurance funds. That is a

large majority of the approximately $42 billion now available in

BIF and SAIF. Much of the additional amount is the interest

earned on the money we paid in.

Q.2.e. Mr. Plagge’s testimony also discusses a study which shows

that ‘‘doubling coverage could result in net new deposits to the

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banking industry of between 4 percent and 13 percent of current

domestic deposits, with the lower end of the range more likely.’’

Also doing this ‘‘would lower the BIF–SAIF reserve ratio below the

required 1.25 percent.’’ Is this worth the potential cost?

A.2.e. ACB does not believe that doubling deposit insurance coverage—which could reduce the reserve ratio below the required

1.25 percent—would be worth the potential cost. As I indicated in

response to question 1, we would expect only a very modest increase in deposits as a result of doubling coverage. ACB believes

that prompt action on legislation to permit banks to pay interest

on business checking accounts would do far more to improve banks’

ability to attract deposits. We strongly urge the Senate to act on

this proposal, which has already passed the House as H.R. 974.

Q.2.f. Is it worth the potential for premium increases that would

accompany a significant increase of the insurance limit?

A.2.f. As indicated in my answers to other questions, ACB does not

support a significant increase in general coverage limits in large

part because they would likely be accompanied by unacceptable

premiums.

Q.3.a. Mr. Powell has indicated that perhaps all of the FDIC-proposed reforms did not have to be in one package. What would be

on your ‘‘must have in the bill’’ list if you were making one?

A.3.a. ACB’s ‘‘must have in the bill’’ proposals are contained in

H.R. 1293, the Deposit Insurance Stabilization Act, introduced by

Representatives Bob Ney (R–Ohio) and Stephanie Tubbs Jones (D–

Ohio). That bill fully addresses the concern that one or both of the

deposit insurance funds could fall below the 1.25 percent ratio, triggering a damaging 23 basis point premium. H.R. 1293 contains

three elements:

• Permits the FDIC to impose a fee on existing institutions for deposit growth that materially dilutes the insurance funds, so that

the required reserve ratio can be maintained. Currently, the

FDIC may impose an excessive deposit growth fee on new institutions or new branches. By allowing the FDIC to impose fees on

existing institutions, H.R. 1293 would address the current ‘‘freerider’’ problem.

• Merges the BIF and the SAIF. According to the FDIC, merging

the BIF and the SAIF would create a more stable, actuarially

stronger deposit insurance fund. A single, larger fund would be

less affected by either rapid deposit growth at a few institutions

or losses from failures.

• Allows for flexible recapitalization of the deposit insurance fund.

If the reserve ratio of the merged fund falls below the required

level of 1.25 percent, the bill would give the FDIC flexibility in

recapitalizing the fund over a reasonable period of time. By repealing the automatic assessment of 23 basis points, H.R. 1293

would give the FDIC authority to use a laser beam approach,

rather than a sledgehammer, to recapitalize the insurance fund.

ACB believes that Congress should act quickly on this legislation

to help ensure the continued strength of the FDIC and prevent the

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potential diversion of billions of dollars away from community lending to homeowners, consumers, and small businesses.

Q.3.b. Should these reforms be done now?

A.3.b. ACB strongly urges the Congress to act this year on the

proposals contained in H.R. 1293. We would welcome action on

other issues—such as providing for rebates and substantially increasing coverage for retirement accounts. However, if the list of

comprehensive reform proposals is too long for the Congress to pass

this year, we ask that you set priorities, enact what you can this

year, and return to the rest next year.

Further large transfers from uninsured money market funds into

insured deposits, accompanied by just a few costly failures, could

easily trigger large premium assessments across the country. There

is no way to predict those events with any accuracy. But unless

Congress acts now, the matter will be outside your control. That is

a risk we should not take and one we can avoid.

RESPONSE TO ORAL QUESTION OF SENATOR JOHNSON

FROM CURTIS L. HAGE

I would like to take this opportunity to supplement my response

to Chairman Johnson’s question on this topic.

Q.1. Senator Johnson asked for responses to a Treasury Department suggestion ‘‘that Federal Home Loan Bank advances and

other secured capital be considered in the deposit insurance assessment base. The FDIC’s report said that a bank’s reliance on

noncore funding, which may include these advances, should be considered risky.’’

A.1. My bank has relied for years on Federal Home Loan Bank advances; they are a core part of my funding. Advances are a stable

and reliable supplement to my core deposit base. With these options, I do not have to rely on other funding sources, such as the

higher-cost brokered deposits. The FHLBank advances are overcollateralized as required by regulation and they add strength to a

properly run depository institution as an alternative source of funding. My use of advances makes my institution more stable, reducing the likelihood that the FDIC would suffer any loss associated

with our insured deposits.

It is true that a bank might use advances, or any other funding

source, to finance risky operations. However, the risk-based premium structure is in place precisely to impose appropriate costs on

more risky activities. If the FDIC finds that certain types of lending or other activities increase the risk of failure, then it should impose a premium to reflect that risk. The additional risk would stem

from the activity, not how that activity is funded, especially when

the funding source is as stable as advances from the Federal Home

Loan Bank System.

While it is true that the collateral supporting advances stands

ahead of the FDIC in the event of an institution failure and resolution, appropriately used advances provide necessary funding flexibility, helping ensure that depository institutions remain healthy.

Adding advances as a risk factor would unnecessarily raise costs to

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the detriment of consumers and businesses that ultimately benefit

from the responsible use of advances.

Now that the System is more fully open to the commercial banks,

advances are becoming more important to community lending

throughout the country. Given the shortage of deposits in many

communities, it would not make sense to artificially discourage depository institutions use of Federal Home Loan Bank advances for

housing and community development.