November 27, 2012 

MEMORANDUM TO: 	 The Board of Directors 

FROM: 	 Arthur J. Murton ~ 

. ~~ 

Director 

Division of Insurance and Research 

SUBJECT: 	 Designated Reserve Ratio for 2013 

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) and publish the 

designated reserve ratio, or DRR, before the beginning of each calendar year. 

1 On December 7, 

2011, the Board approved for publication a notice setting the DRR at 2 percent for 2012.2 The 

staff recommends maintaining the DRR at 2 percent for 2013 and requests that the Board 

authorize the 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: 

maintaining the DIF at a level that can withstand substantial losses, 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 ofthe DRR, which may change over time. Governing statutes do not direct the Board 

how to use the DRR. Based on current circumstances and historical analysis, staff continues to 

view the DRR as a long-range, minimum target for the reserve ratio, consistent with the 

comprehensive, long-range fund management plan contained in the proposed rulemaking in 

October 2010 to raise the DRR to 2 percent (October 2010 NPR). 

I 12 U.S.C. § 1817(b)(3)(A). 

2 76 FR 77229 (Dec. 12, 2011 ). The DRR is expressed as a percentage of estimated insured deposits. On December 

14,2010, the Board approved a fmal rule setting the DRR at 2 percent. See 75 FR 79286 (Dec. 20, 2010), codified 

at 12 C.F.R. § 327.4(g). 

3 12 U.S.C. § 1817(b)(3)(C). 

Concur: 
Background 

Governing statutes 

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

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

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

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

DRR (which was formerly capped at 1.5 percent) and consequently on the size ofthe fund; 4 (2) 

requires 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); 5 (3) requires the FDIC to offset the effect on 

institutions with less than $1 0 billion in total consolidated assets of increasing the reserve ratio 

from 1.15 percent to 1.35 percent;6 (4) eliminates the requirement that the FDIC provide 

dividends from the fund when the reserve ratio is between 1.35 percent and 1.5 percent; 7 and (5) 

continues the FDIC's authority to declare dividends when the reserve ratio is at least 1.5 percent, 

but grants the FDIC sole discretion in determining whether to suspend or limit the declaration or 

payment of dividends. 8 

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

DRR armually and, if changing the DRR, engage in notice-and-comment rulemaking before the 

beginning of the calendar year. 

9 

In effect, Dodd-Frank provides 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. 

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 

4 12 U.S.C. § 1817(b)(3)(B). 

5 12 U.S.C. § 1817(nt). 

6 12 U.S.C. § 1817(nt). Because the reserve ratio is not projected to reach 1.15 percent for several years, the Board 

has flexibility in the timing of the rulemaking to implement the offset requirement. Staff will continue to consider 

both the appropriate approach to and timing ofthe offset rulemaking. 

7 12 U.S.C. § 1817(e). 

8 12 U.S.C. § 1817(e)(2)(B). 

9 12 U.S.C. § 1817(b)(3)(B). 

2 

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. IO 

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. I I 

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

confidence in federal deposit insurance. Furthermore, although the FDIC has significant 

authority to borrow from the Treasury to cover losses when the fund balance approaches zero, 

the FDIC has viewed the Treasury line of credit as available to cover 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 

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. 

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. 

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 

10 75 FR 66262 (Oct. 27, 2010). 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 


66293 (Oct. 27, 2010). 


11 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/MediapodLibraryfindex.asp?library=pn I 00472 fdic RoundTable. 


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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. 12 

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. 13 The analysis that follows 

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

can withstand substantial losses, consistent with the FDIC's comprehensive, long-term fund 

management plan. 

Risk oflosses to the DIF 

As banking industry performance has improved in recent quarters, so has the condition of 

the insurance fund. The DIF balance has increased for eleven quarters in a row. following seven 

quarters of decline, and stood at $25.2 billion on September 30, 2012. Cumulatively, the DIF 

balance has risen by more than $46 billion from its negative $20.9 billion low point at the end of 

2009. Of the total increase in the DIF balance, $6.6 billion comes from fees previously set aside 

for debt guaranteed under the Temporary Liquidity Guarantee Program (TLGP), reflecting the 

wind-down ofthe program. 

14 Other factors contributing to the increase include assessment 

12 12 U.S.C. § 1817(nt). The updated analysis in the December 2010 fmal 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. 

13 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)(B). 

14 The TLGP was announced on October 14, 2008, as part of the federal government's coordinated response to the 

financial crisis. The TLGP was intended to promote financial stability by preserving confidence in the banking 

system and encouraging lending in the interbank credit market, thus facilitating lending to creditworthy businesses 

and consumers. The TLGP provided two limited guarantee programs: one that guaranteed newly-issued senior 

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income and a decline in the contingent loss reserve for anticipated bank failures. At September 

30, 2012, the contingent loss reserve was $3.6 billion, down from $7.2 billion one year earlier. 

Staff projects that the cost of failures for the five-year period from 2012 through 2016 

will be $10 billion, following estimated losses of$88 billion for banks that failed in 2008,2009, 

2010, and 2011. The projections are based on recently available information about banks 

expected to fail in the near term and on analyses of longer term prospects for troubled banks and 

trends in CAMELS ratings, failure rates, and loss rates. Beyond five years, the projections 

assume a low level of failures and associated losses. 

In staffs 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 current U.S. economic recovery has fallen short of previous recoveries, as evidenced 

by persistently high unemployment and relatively slow growth. Two key risks continue to weigh 

on the economic outlook. First, uncertain prospects for the European economy have increased 

volatility in global financial markets, which could trigger increased volatility in U.S. financial 

markets and adversely affect the U.S. economy. Second, the "fiscal cliff' at the start of2013­

the scheduled expiration of several tax cuts and the start of automatic federal spending cutsappears to be already affecting economic activity. 

Nevertheless, the slow but steady expansion of the U.S. economy should enable a 

continued gradual improvement ofthe condition of FDIC-insured depository institutions. Recent 

trends in banking industry perfonnance have, in fact, been generally positive. The third quarter 

of2012 was the eleventh consecutive quarter of aggregate positive net income. More than half 

of all insured institutions reported improvement in quarterly net income from one year earlier, 

and the number of unprofitable institutions declined from year-earlier levels in each of the last 

twelve quarters. Improving credit performance, leading to lower loan loss provisions, has been 

primarily responsible for most of the year-over-year improvement in earnings. Asset quality, as 

measured by the volume of noncurrent loans and leases, has improved for ten consecutive 

quarters. 

unsecured debt of insured depository institutions and their holding companies (the Debt Guarantee Program), and 

another that guaranteed certain transaction accounts at insured depository institutions (the Transaction Account 

Guarantee Program, or TAG). There are $1.7 billion in assets still set aside to pay TLGP claims. The TAG expired 

at the end of2010 and was replaced by a similar temporary program established under Dodd-Frank that is scheduled 

to expire on December 31, 2012. The last debt guarantees under the DGP also will expire on that date. 

5 

The total number of institutions on the FDIC's Problem Institution List fell to 694 at 

September 30, 2012 from 732 at June 30, 2012 and 844 at September 30, 2011. The number of 

problem banks has declined for six consecutive quarters and is now at its lowest level in three 

years. The improvement in the number of problem institutions reflects a decline during 2012 in 

the rate of supervisory rating downgrades from CAMELS ratings of 1 or 2 to CAMELS ratings 

of 3, 4, or 5, as well as an increase in the rate of supervisory rating upgrades. 

The rates at which 3-, 4-, or 5-rated institutions have failed, calculated over trailing 12­

month periods, have declined significantly since the spring of 2010, both in terms of institution 

numbers and assets. A total of 50 banks failed from January through November of2012, down 

from 90 for the same eleven-month period in 2011. The total assets of failures from January 

through November 2012 - $11.7 billion - were significantly less than the $3 5 billion in total 

assets of failures in the first eleven months of 2011. 

Although near-term economic prospects can inform the Board's decision on the DRR, 

they become less relevant in setting the DRR when the DIF balance is still recovering from the 

effects of the crisis. In this context, staffbelieves that the DRR should be viewed in a longerterm 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 

consequent large number of insured depository institution failures at high costs to the DIF. In 

staffs 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, since 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 rather than a 

final target 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 ofthe 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 substantia/losses 

Staff again recommends, as it did in 201 0 and 2011, 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. 

6 

Balancing the statutory factors 

In staffs view, the best way to balance all ofthe 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. 

Staff Contacts: 

Division of Insurance and Research: 

Munsell St. Clair 

Chief, Banking and Regulatory Policy Section 

(202) 898-8967 

Alan Deaton 

Acting Chief, Fund Analysis and Pricing Section 

(202) 898-3828 

Legal Division: 

Christopher Bellotto 

Counsel 

(202) 898-3801 

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