alan greenspan : federal deposit insurance reform testimony of mr alan greenspan, chairman of the board of governors of the us federal reserve system, before the committee on banking, housing, and urban affairs, u. s. senate, 23 april 2002. * * * chairman sarbanes, senator gramm, it is a pleasure to appear before this committee to present the views of the board of governors of the federal reserve system on deposit insurance reform. i will be addressing general reform issues, as proposed by the federal deposit insurance corporation ( fdic ) in the spring of 2001, rather than any specific bill. consequently, i will be expressing the broad views of the federal reserve board on the issues associated with modifications of deposit insurance. at the outset, i should note that last year's fdic report highlighted the significant issues and developed an integrated framework for addressing them. in broad terms, while the board opposes any increase in coverage, we support the framework for other reform issues that the fdic report constructed. benefits and costs of deposit insurance deposit insurance was adopted in this country as part of the legislative framework for limiting the impact of the great depression on the public. in the environment of the record number of bank failures of the time, deposit insurance in this country was designed mainly to protect the unsophisticated depositor with limited financial assets from the loss of their modest savings. references were made to the " rent money " and the initial 1934 limit placed on deposit insurance was $ 2, 500, promptly doubled to $ 5, 000, a level maintained for the next sixteen years. i should note that the $ 5, 000 of insurance coverage in 1934, consistent with the original intent of congress, is equal to less than $ 60, 000 today, based on the personal consumption deflator in the gdp accounts. despite its initial quite limited intent, the congress over the intervening decades has raised the maximum amount of coverage five times to its current $ 100, 000 level. the last increase, in 1980, was a more than doubling of the cap level and was clearly designed to let depository institutions, particularly thrifts, offer an insured deposit free of the then prevailing interest rate ceilings on such instruments, which applied only to deposits below $ 100, 000. insured deposits of exactly $ 100, 000 thus became fully insured instruments in 1980, but were not subject to an interest rate ceiling. the efforts of thrifts to use $ 100, 000 cds to stem their liquid

the bif and saif funds. because the charters and operations of banks and thrifts have become so similar, it makes no sense to continue the separate funds. separate funds reflect the past, but neither the present nor the future. merging the funds would diversify their risks, reduce administrative expenses, and widen the fund base behind an increasingly concentrated banking system. most importantly, the federally guaranteed insurance coverage provided to the two sets of institutions are identical, and thus the premiums need to be identical as well. under current arrangements, the premiums could differ significantly if one of the funds fell below the designated reserve ratio of 1. 25 percent of insured deposits and the other fund did not. should that occur, depository institutions would be induced to switch charter to obtain insurance from the fund with the lower premium. this could distort our depository structure. the federal government should not sell an identical service, like deposit insurance, at different prices. 2. statutory restrictions on premiums. current law requires the fdic to impose higher premiums on riskier banks and thrifts but prevents it from imposing any premium on well - capitalized and highly - rated institutions whenever the corresponding fund's reserves exceed 1. 25 percent of insured deposits. the board endorses the fdic recommendations that would eliminate the statutory restrictions on risk - based pricing and allow a premium to be imposed on every insured depository institution, no matter how well capitalized and well rated it may be or how high the fund's reserves. the current statutory requirement that free deposit insurance be provided to well - capitalized and well - rated banks when fdic reserves exceed a predetermined ratio maximizes the subsidy provided to these institutions and is inconsistent with efforts to avoid inducing moral hazard. put differently, the current rule requires the government to give away its valuable guarantee when fund reserves meet some ceiling level. this free guarantee is of value to banks and thrifts even when they themselves are in sound financial condition and when macroeconomic times are good. at the end of last year, 92 percent of banks and thrifts were paying no premium. included in this group were banks that have never paid any premium for their, in some cases substantial, coverage and fast - growing entities whose past premiums were extraordinarily small relative to their current coverage. we believe that these anomalies were never intended by the framers of the deposit insurance fund act of 1996 and should be addressed by