Written Statement of

Thomas J. Sheehan, President

 Independent Community Bankers of America

Federal Deposit Insurance Corporation

Roundtable on Deposit Insurance Reform

April 25, 2000

The Independent Community Bankers of America is pleased to participate in the FDIC’s

Roundtable on Deposit Insurance Reform. The issues raised for discussion during the

Roundtable are timely and important. The ICBA commends Chairman Donna Tanoue

and the FDIC for undertaking this review of our nation’s deposit insurance system. A

well-functioning federal deposit insurance system is critical to maintaining stability and

depositor confidence in the banking and financial system.

Coverage Levels

Community bankers strongly support increasing the deposit insurance limit to $200,000

and indexing it for future inflation to adequately preserve the value of its protection for

depositors going forward. An increase is long overdue. Deposit insurance levels have

not been increased in 20 years, the longest period in history without an increase.

Following the “financial modernization” accomplished in the Gramm-Leach-Bliley Act, it

is now time to modernize the deposit insurance system.

The general level of income, prices and wealth in our nation has been on a steady

increase for decades. Yet, today’s deposit insurance limit is economically inadequate.

Inflation has eroded the value of deposit insurance nearly in half since it was last

increased in 1980. In fact, it is worth less today, in constant dollars, than it was in 1974

when it was raised to $40,000. If it were indexed for inflation since 1980, the coverage

amount would be $197,000. Looked at another way, in 1935, when federal deposit

insurance was established, the coverage level was ten times per capita annual income.

Today, it is only four times per capita income.

Raising coverage levels may not substantially elevate the risks to the FDIC funds. As

Chairman Tanoue has noted, this is because depositors already have the ability to

structure their accounts to achieve far greater coverage (although the ultimate effect will

depend on depositor behavior).
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Deposit insurance is vital to both depositor confidence in the banking system, and

community banks’ ability to attract core deposits which are used to support community

lending. Community banks are losing deposits to mutual funds, brokerage accounts,

the equities markets and “too-big-to-fail” banks. And we do not have ready access to

the capital markets for alternative funding. Easier access to the Federal Home Loan

Bank System will help. But alternative funding sources at competitive prices for

community banks other than deposits are scarce.

Large banks have an inherent funding and deposit gathering advantage over community

banks because of their “too-big-to-fail” status. Just the perception that “too-big-to-fail”

banks have governmental protection not available to other banks gives them “an

advantage in attracting depositors, other customers and investors,” as Kansas City

Federal Reserve Bank president Tom Hoenig has said.

And the consolidation of the banking and financial industries that will continue in the

wake of Gramm-Leach-Bliley will result in greater numbers of “too-big-to-fail” banks and

financial firms. “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,” Federal Reserve Governor

Larry Meyer has observed.

Thus, deposit insurance is more critical than ever to the vitality and competitiveness of

community banks. Core deposits are the primary source of funds for community

lending. A dwindling core deposit base in turn hurts the whole community.

Municipal Deposits

Community bankers support 100 percent deposit insurance protection for municipal

deposits. These are taxpayer funds that should not be put at risk. Many states require

institutions to collateralize municipal deposits. This makes it harder for community

banks to compete for these deposits. Many loaned-up community banks do not have

the available securities to use for collateral. Those that do must tie up assets in lower

yielding securities which affects their profitability and ability to compete. Collateralizing

municipal deposits take valuable resources away from other community development

and lending activities. Full deposit insurance coverage of 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 communities.

Both the BIF and SAIF currently have reserves well in excess of the required statutory

minimum level of 1.25 percent of estimated insured deposits. Both continue to grow,

due to low levels of bank and thrift failures and the interest earned on the reserves of

nearly $40 billion. Because of the strength and the growth of the deposit insurance

funds, we believe that insurance levels can be increased without impairing the full

capitalization of the funds.
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Deposit Insurance Premium/Pricing Structure

Recent events have highlighted some anomalies in the deposit insurance premium

system. The prime example is Merrill Lynch’s plan to move large sums of money (some

estimate up to $100 billion) in Cash Management Accounts from uninsured money

market funds into insured deposits in its two subsidiary banks. This results in new

deposits insured by the FDIC without any premiums having been paid. Significant

increases in the insured deposit base could impair the reserve ratio of the BIF/SAIF,

with the result that all banks and thrifts have to pay increased premiums, not just those

with rapid new deposit growth. Similarly, de novo banks have deposit insurance

coverage, but have never paid premiums. An equitable remedy for these situations is

worth exploring.

Community bankers generally support a risk-based premium system. Some observers

have criticized the current risk-based premium system, however, since the vast majority

of banks and thrifts (over 90 percent) currently pay no FDIC premiums since their

current very healthy condition places them in the highest-rated premium category.

Further distinctions among banks based on the risks they pose to the federal deposit

insurance system, it is argued, could address this situation. However, if the distinctions

become too fine, adequately defining these categories so that they reflect real

differences in risk profiles among banks, achieve consistent treatment across the

industry, and keep subjectivity to a minimum, becomes a real challenge. The costs of

implementing very fine distinctions between risk categories must be weighed against

the benefits that would be achieved.

Moreover, finer distinctions in risk categories among banks should not be used as an

excuse to collect more premiums from the industry, particularly when the BIF and SAIF

have reserves well in excess of the statutory minimum.

Maintaining the Funds: Rebates, Current Designated Reserve Ratio

Community bankers would welcome a rebate of excess reserves in the BIF and SAIF.

However, many feel that increasing levels of deposit insurance coverage would be more

beneficial to the long-term stability of their institutions—and their long-term ability to

meet the credit needs of their communities—than a rebate of excess reserves. Thus,

instituting a system for rebating reserves to the industry should not come before

adjustments in the coverage level are made.

Safeguards are currently in place to reduce the risk to the BIF/SAIF posed by bank

failures, including depositor preference, prompt corrective action, and least cost

resolution procedures in FDICIA that were designed to reduce the loss rates in the fund.

In addition, the FDIC has the authority to increase the designated reserve ratio for a

particular year when faced with a significant risk of substantial losses, and can levy

emergency special assessments. At the same time, the impact of industry consolidation

on the risk to the funds should be carefully monitored and addressed as appropriate.

But until there is clear evidence that the risk to the funds requires a higher reserve

requirement, the current designated reserve ratio should be maintained.