Federal Deposit Insurance Corporation

55017th Street NW, Washington, D.C. 20429-9990 Division of Insurance and Research

October 6, 2015

MEMORANDUM TO

FROM:

SUBJECT:

The Board of Directors

Diane Ellis ~~"`'~,,.~, 5,~~~ -,

Director `

Division of Insurance and Research

Designated Reserve Ratio for 2016

Summary and Recommendation

The Federal Deposit Insurance Act (FDI Act) requires that the FDIC Board of Directors

(Board) designate a reserve ratio for the Deposit Insurance Fund (DIF or fund) and publish the

designated reserve ratio, or DRR, before the beginning of each calendar year.l On October 18,

2014, the Board approved for publication a notice setting the DRR at 2 percent for 2015.2 Staff

recommends maintaining the DRR at 2 percent for 2016 and requests that the Board authorize

staff to publish the attached notice to that effect in the Federal Register.

The Board must set the DRR in accordance with its analysis of certain statutory factors:

risk of losses to the DIF; economic conditions generally affecting insured depository institutions;

preventing sharp swings in assessment rates; and any other factors that the Board determines to

be appropriate.3 Staff has identified one "other factor" for the Board's consideration: viewing

the DRR as a minimum goal that will allow the fund to grow sufficiently large in good times to

increase the likelihood of the DIF remaining positive during bad times, consistent with the

FDIC's comprehensive, long-term fund management plan.

The manner in which the Board evaluates the statutory factors may depend on its view of

the role of the DRR. Governing statutes do not direct the Board on how to use the DRR. Based

on current circumstances and historical analysis, staff continues to view the DRR as a long-

' 12 U.S.C. § 1817(b)(3)(A).

2 Similarly, on October 8, 2013, the Board approved for publication a notice setting the DRR at 2 percent for 2014.

78 FR 62633 (Oct. 22, 2013). The DRR was first set at 2 percent in a final rule approved by the Board on December

14, 2010. See 75 FR 79286 (Dec. 20, 2010), codified at 12 C.F.R. § 327.4(g). The DRR is expressed as a

percentage of estimated insured deposits.

3 12 U.S.C. § 1817(b)(3)(C).

Concur:

Charles Y

General Counsel
2

range, minimum target for the reserve ratio, consistent with the comprehensive, long-range fund 

management plan contained in the October 2010 proposed rulemaking to raise the DRR to 2 

percent (October 2010 NPR).4

 

Background 

Governing statutes 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which 

was enacted on July 21, 2010, gave the FDIC much greater discretion to manage the DIF, 

including where to set the DRR. Among other things, Dodd-Frank: (1) raised the minimum 

DRR to 1.35 percent (from the former minimum of 1.15 percent) and removed the upper limit on 

the DRR (which was formerly capped at 1.5 percent) and consequently on the size of the fund;5

(2) eliminated the requirement that the FDIC provide dividends from the fund when the reserve 

ratio is between 1.35 percent and 1.5 percent;6

 and (3) continued the FDIC’s authority to declare 

dividends when the reserve ratio is at least 1.5 percent, but granted the FDIC sole discretion in 

determining whether to suspend or limit the declaration or payment of dividends.7, 8, 9

The FDI Act continues to require that the Board consider the appropriate level for the 

DRR annually and, if the Board is changing the DRR, to engage in notice-and-comment 

rulemaking before the beginning of the calendar year.10 

In effect, Dodd-Frank provided the Board with broad discretion to set the DRR in 

consideration of specified factors and other factors that the Board determines are appropriate, so 

long as it is set no lower than 1.35 percent. Neither the FDI Act nor the amendments under 

Dodd-Frank establish a statutory role for the DRR as a trigger, whether for assessment rate 

determination, recapitalization of the fund, or dividends. 

 

4

 75 FR 66272 (Oct. 27, 2010). 

5

 12 U.S.C. § 1817(b)(3)(B). 

6

 12 U.S.C. § 1817(e). 

7

 12 U.S.C. § 1817(e)(2)(B). 

8

 Dodd-Frank also required that the fund reserve ratio reach 1.35 percent by September 30, 2020 (rather than 1.15 

percent by the end of 2016, as formerly required) and that the FDIC offset the effect of increasing the reserve ratio 

from 1.15 percent to 1.35 percent on institutions with less than $10 billion in total consolidated assets. 12 U.S.C. § 

1817(nt). 

9

 Dodd-Frank also made permanent the increase in the standard maximum deposit insurance amount (SMDIA) from 

$100,000 to $250,000. See 12 U.S.C. 1821(a)(1)(E). The SMDIA is subject to an inflation adjustment under 12 

U.S.C. 1821(a)(1)(F), and beginning April 1, 2010, and every five years thereafter, the FDIC is required to consider 

certain factors and determine whether an inflation adjustment is appropriate. For 2015, the FDIC has considered the 

factors and determined that the inflation adjustment will not affect the level of the SMDIA in the foreseeable future 

because it will not take effect until the value of $100,000, inflation adjusted since 2005, exceeds the current SMDIA 

of $250,000. 

10 12 U.S.C. § 1817(b)(3)(A). 
3

Comprehensive, long-range management plan for the DIF 

The October 2010 NPR proposed raising the DRR to 2 percent. After consideration of 

comments received, a final rule adopted by the Board in December 2010 set the DRR at 2 

percent. 

The October 2010 NPR also set out a comprehensive, long-range management plan for 

the DIF that was designed to: (1) reduce pro-cyclicality in the risk-based assessment system by 

allowing moderate, steady assessment rates throughout economic and credit cycles; and (2) 

maintain a positive fund balance even during a banking crisis by setting an appropriate target 

fund size and a strategy for assessment rates and dividends.11 

During an economic and banking downturn, insured institutions can least afford to pay 

high deposit insurance assessment rates. Moreover, high assessment rates during a downturn 

reduce the amount that banks can lend when the economy most needs new lending. For these 

reasons, it is important to reduce pro-cyclicality in the assessment system and allow moderate, 

steady assessment rates throughout economic and credit cycles.12 

It is also important that the fund not decline to a level that could risk undermining public 

confidence in federal deposit insurance. Although the FDIC has significant authority to borrow 

from the Treasury to cover losses, the FDIC has viewed the Treasury line of credit as appropriate 

for covering unforeseen losses, not as a source of financing projected losses. 

A 2 percent DRR is an integral part of the FDIC’s comprehensive, long-range 

management plan for the DIF. A fund that is sufficiently large is a necessary precondition to 

maintaining a positive fund balance during a banking crisis and allowing for long-term, steady 

assessment rates. 

In developing the long-range management plan, staff analyzed historical fund losses and 

income data from 1950 to 2010 to determine how high the reserve ratio would have to have been 

before the onset of the two banking crises that occurred during this period to maintain a positive 

fund balance and stable assessment rates. The analysis, which was detailed in the October 2010 

NPR, concluded that moderate, long-term average industry assessment rates, combined with an 

appropriate dividend or assessment rate reduction policy, would have been sufficient to prevent 

 

11 75 FR at 66272. Pursuant to the comprehensive plan, the FDIC also adopted a new Restoration Plan to ensure that 

the DIF reserve ratio reaches 1.35 percent by September 30, 2020, as required by Dodd-Frank. 75 FR at 66293. 

12 At a September 24, 2010 roundtable organized by the FDIC, bank executives and industry trade group 

representatives uniformly favored steady, predictable assessments and found high assessment rates during crises 

objectionable. The proceedings of the roundtable can be viewed in their entirety at: 

http://www.vodium.com/MediapodLibrary/index.asp?library=pn100472_fdic_RoundTable. 
4

the fund from becoming negative during the crises. Staff also found that the fund reserve ratio 

would have had to exceed 2 percent before the onset of the crises to achieve these results.13

Staff views the 2 percent DRR as the minimum level needed to withstand a future crisis of 

the magnitude of past crises. Because analysis shows that a reserve ratio higher than 2 percent 

increases the chance that the fund will remain positive during such a crisis, the 2 percent DRR 

should not be treated as a cap on the size of the fund. 

Analysis of Statutory Factors 

As discussed above, Dodd-Frank retains the requirement that the Board set and publish 

the DRR annually in accordance with its analysis of statutory factors.14 The analysis that follows 

considers each statutory factor, including one "other factor": maintaining the DIF at a level that 

can withstand substantial losses and allowing it to grow sufficiently large in good times to 

increase the likelihood of the DIF remaining positive during bad times, consistent with the 

FDIC’s comprehensive, long-term fund management plan. 

Risk of losses to the DIF 

The DIF balance has increased for 51⁄2 years and stood at $67.6 billion as of June 30, 

2015. Cumulatively, the DIF balance has risen by more than $88 billion from its negative $21 

 

13 The analysis set out in the October 2010 NPR sought to determine what assessment rates would have been needed 

to maintain a positive fund balance during the last two crises. This analysis used an assessment base derived from 

domestic deposits to calculate assessment income. Dodd-Frank, however, required the FDIC to change the 

assessment base to average consolidated total assets minus average tangible equity. In the December 2010 final rule 

establishing a 2 percent DRR, staff undertook additional analysis to determine how the results of the original 

analysis would change had the new assessment base been in place from 1950 to 2010. Both the analyses in the 

October 2010 NPR and the December 2010 final rule show that the fund reserve ratio would have needed to be 

approximately 2 percent or more before the onset of the crises to maintain both a positive fund balance and stable 

assessment rates. The updated analysis in the December 2010 final rule, like the analysis in the October 2010 NPR, 

assumed, in lieu of dividends, that the long-term industry average nominal assessment rate would be reduced by 25 

percent when the reserve ratio reached 2 percent, and by 50 percent when the reserve ratio reached 2.5 percent. 

Eliminating dividends and reducing rates successfully limits rate volatility whichever assessment base is used. See 

75 FR at 79288. 

14 Specifically, in setting the DRR for any year, the Board must consider the following factors: 

(1) The risk of losses to the DIF in the current and future years, including historic experience and potential 

and estimated losses from insured depository institutions. 

(2) Economic conditions generally affecting insured depository institutions so as to allow the DRR to 

increase during more favorable economic conditions and to decrease during less favorable economic 

conditions, notwithstanding the increased risks of loss that may exist during such less favorable conditions, 

as the Board determines to be appropriate. 

(3) That sharp swings in assessment rates for insured depository institutions should be prevented. 

(4) Other factors as the FDIC’s Board may deem appropriate, consistent with the requirements of the 

Reform Act. 

12 U.S.C. § 1817(b)(3)(C). 
5

billion low point at the end of 2009. Primary factors contributing to the cumulative increase in 

the fund balance since 2009 include assessment income and a reduction in estimated losses 

associated with past and anticipated failures. At June 30, 2015, the contingent loss reserve for 

anticipated failures was $684 million, down from $1.5 billion one year earlier. 

The increase in the DIF balance reflects improvements in banking industry performance 

and condition. The second quarter of 2015 marked the 21st time in the past 24 quarters in which 

banking industry earnings posted a year-over-year increase. Almost three-fifths (59 percent) of 

institutions reported year-over-year earnings growth while less than 6 percent were unprofitable 

– the lowest proportion of unprofitable institutions since the second quarter of 2005. Asset 

quality, as measured by the volume of noncurrent loans and leases, has improved for 21 

consecutive quarters. The total number of institutions on the FDIC’s Problem Institution List fell 

to 228 at June 30, 2015 from 354 at June 30, 2014. The number of problem banks has declined 

for 17 consecutive quarters and is now at its lowest level since third quarter 2008. 

The rates at which 3-, 4-, or 5-rated institutions have failed, and their costs, have declined 

significantly since the spring of 2010. A total of 6 banks failed from January through September 

of 2015, down from 14 failures for the same period in 2014. 

 

Although the banking industry’s financial condition has improved since the most recent 

crisis, challenges remain. Revenue growth is modest, reflecting narrow margins. The average 

net interest margin for the industry declined by 70 basis points since second quarter 2010 to 3.06 

percent in the second quarter of 2015. The prolonged low interest rate environment has created 

incentives for institutions to reach for yield by increasing the share of longer-term assets on their 

balance sheets. This reach for yield has helped average asset yields, but it has left banks more 

vulnerable to interest rate risk as rates rise. 

In staff’s view, high deposit insurance fund losses incurred during the crisis of the 1980s 

and early 1990s and during the more recent crisis suggest that the Board should set a DRR at a 

level that would have maintained a positive fund balance during both crises. Adoption of this 

long-range, minimum goal would improve the DIF’s ability to handle losses during any future 

periods of severe industry stress and reduce the possibility of increased deposit insurance 

assessment rates during a banking downturn. 

Economic conditions affecting FDIC-insured institutions 

The economy has grown slowly over the past six years since the financial crisis. Recent 

U.S. economic indicators have been positive on net. The labor market continues to improve with 

steady payroll gains and a declining unemployment rate, although weaknesses remain. Inflation 

has been subdued for several quarters, with oil prices down from a year ago and a stronger 

dollar. On the other hand, the crisis in Greece and the decline in China’s equity market, among 

other international developments, have contributed to volatility in financial markets and added 

economic uncertainty. 
6

Key risks weigh on the U.S. economic outlook. These risks include the impact of 

increases in interest rates on economic growth; the risk of higher inflation from prolonged low 

interest rates; fiscal challenges at federal, state, and local levels; and global economic risks, such 

as a slowdown in key advanced and emerging market economies. A slowdown in the U.S. 

economic recovery could result in more bank failures than projected and a decline in the value of 

failed-bank assets. 

Although near-term economic prospects and recent trends in banking industry 

performance can inform the Board’s decision on the DRR, staff believes that the DRR should be 

viewed in a longer-term perspective. Twice within the past 30 years, serious economic 

dislocations have resulted in a significant deterioration in the condition of many insured 

depository institutions and in a large number of insured depository institution failures at high 

cost to the DIF. In staff’s view, the DRR should, therefore, be viewed as a minimum goal 

needed to achieve a reserve ratio that can withstand these periodic economic downturns and their 

attendant insured depository institution failures. Taking these longer-term economic realities 

into account, a prudent and consistent policy would set the DRR at a minimum of 2 percent, 

because that is the lowest level that would have prevented a negative fund balance at any time 

since 1950 without raising assessment rates during the crises. 

Preventing sharp swings in assessment rates 

Current law directs the Board to consider preventing sharp swings in assessment rates for 

insured depository institutions. Setting the DRR at 2 percent as a minimum goal would signal 

that the Board plans for the DIF to grow in good times so that funds are available to handle 

multiple bank failures in bad times. This plan would help prevent sharp fluctuations in deposit 

insurance premiums over the course of the business cycle. In particular, it would help reduce the 

risk of large rate increases during crises, when insured depository institutions can least afford an 

increase. 

Maintaining the DIF at a level that can withstand substantial losses 

Staff again recommends, as it did in 2010 and every year since, that the Board consider 

one additional factor when setting the DRR: viewing the DRR as a minimum goal that will allow 

the fund to grow sufficiently large in good times to increase the likelihood of the DIF remaining 

positive during bad times. This aim is consistent with the FDIC’s comprehensive, long-term 

fund management plan. Having adequate funds available when entering a financial crisis should 

reduce the likelihood that the fund will become negative or that the FDIC will need to increase 

assessment rates, levy special assessments on the industry, or borrow from the U.S. Treasury. 

Balancing the statutory factors 

In staff’s view, the best way to balance all of the statutory factors (including the 

additional factor identified above) is to maintain the DRR at 2 percent. Based on the analysis 

described above, staff continues to recommend viewing a 2 percent DRR as a long-range, 

minimum target. 
7

 

Staff Contacts: 

 

Division of Insurance and Research: 

Munsell St. Clair 

Chief, Banking and Regulatory Policy Section 

(202) 898-8967 

Robert Grohal 

Chief, Fund Analysis and Pricing Section 

(202) 898-6939 

Legal Division: 

Nefretete Smith 

Senior Attorney 

(202) 898-6851