In good times and in bad times, the
public can depend on federal deposit insurance. The men and women of the Federal Deposit
Insurance Corporation know that our mission is safeguarding Americas future. The
seal on the door of every FDIC-insured institution represents our pledge that federal
deposit insurance is one certainty in an uncertain world.
Deposit insurance has served America well. In
1999, the FDIC began a comprehensive review of the deposit insurance system to make sure
that it continues to serve America well and to explore ways that it might be
strengthened. For more than a year, we have analyzed the systems weaknesses and how
to address them. This Annual Report begins with an essay discussing the results of that
analysis and our recommendations for change, which we issued in April 2001. These
recommendations address a number of unintentional flaws in the current system.
For example, the way we price insurance now has a
potential procyclical bias that could undermine economic and financial stability. We
recommend changing the way we charge for insurance, not to raise revenue, but to
allocate costs more evenly over time, and more fairly among institutions, based on risk
and expected loss.
Bank failures are likely to come in waves, along
with serious downturns in the economy. Under our present system, however, banks are likely
to be faced with steep increases in deposit insurance premiums in an economic downturn
when their earnings are already depressed. Such premiums would divert billions of dollars
out of the banking system and would raise the cost of gathering deposits at a time when
credit would already be 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. By contrast, when the economy and the banking system are strong, as at the
present time, most banks are paying no premiums at all.
This anomaly results from existing legal
restrictions on insurance premiums tied to the size of the deposit insurance fund.
Currently, the FDIC is required to maintain its deposit insurance fund at a statutorily
designated reserve ratio of 1.25 percent of estimated insured deposits. When the fund is
at or above this ratio, the FDIC is constrained from charging premiums to most highly
rated, well-capitalized institutions. Currently, over 90 percent of the institutions pay
no premiums for deposit insurance. But when the fund is below 1.25 percent, the law
requires premiums to be increased sharply unless the fund would otherwise be restored to
the 1.25 percent level within one year.
Therefore, we are recommending that the FDIC have
greater flexibility in charging premiums over the business cycle to smooth premium swings
over time. In order not to distort incentives, these premiums should be priced as
accurately as possible to reflect expected loss, and should not be dependent on the size
of the fund. To avoid enormous growth of the deposit insurance fund during long stretches
of good years, it may be prudent to give rebates to insured institutions. Because basing
rebates on current deposit levels would exacerbate moral hazardthe faster you grow,
the larger the rebatewe are also recommending that rebates be based on the past
contributions of insured institutions to the fund.
The net effect of these recommendations is that
there would be billions of additional dollars available to the banking industry to help
fuel economic growth at the trough of the business cycle, and insurance premiums would
more closely reflect risk, ending subsidization of riskier institutions by safer ones.
Our recommendations could not come at a better
time, positioned as we are between a past of unprecedented prosperity and an uncertain
future. The past decade of economic expansion has contributed to a strong,
well-capitalized banking industry. Both the Bank Insurance Fund (BIF) and the Savings
Association Insurance Fund (SAIF) are fully capitalized. The numbers of troubled
institutions and of bank failures are very low by historical standards. Experience
teaches, however, that good times do not last forever. Andas the year 2000 drew to a
closesigns of stress in the economy were emerging, casting doubt on the ability of
banks to sustain recent growth rates in the face of softening loan demand. When bad times
return, more banks will fail. If banks fail in greater numbers, the BIF and the SAIF will
Our recommendations for deposit insurance reform
will eliminate inequities, making the deposit insurance system stronger and fairer. By
providing certainty and stability in the future, they will ensure that the system will
continue to serve the American public well.
To enjoy these benefits, however, we need to
reform the deposit insurance system while the industry is strong and the overwhelming
majority of institutions remain healthy. We have a good opportunity to act now. No one can
say how long that opportunity will remain open.
As the Commissioner for Financial Institutions
for the State of Hawaii, I saw runs on financial institutions. I witnessed how fragile
public confidence can be without the certainty that federal deposit insurance brings.
After nearly three years as FDIC Chairman, now
more than ever I am convinced of the importance of federal deposit insurance and the need
for the Corporation to advocate the recommendations we have proposed.
For me personally, it continues to be a great
honor and privilege to serve the public as FDIC Chairman, and to work shoulder to shoulder
with the men and women of the FDIC.
Aside from developing the most far reaching
proposals for deposit insurance reform since our founding, we worked together in 2000 to
address the risks of subprime lending by banks. We initiated important proposals to
address the problems of predatory and payday lending. We called for an early reexamination
of the Community Reinvestment Act. And we advanced the public debate on the need for
greater simplicity in bank capital regulationall this in addition to sounding the
appropriate safety and soundness alarms.
The Annual Reports of many organizations include
a recognition of how the success of the organization rests on the hard work and dedication
of its employees, but in no case is that truer than in our own. Many things set the FDIC
apart, but nothing stands out more than the commitment of our men and women to the
Corporations mission and their performance in accomplishing it, many times under
harsh conditions. Time and time again duty calls. Every time it does, the men and women of
the Corporation answer.
In my years as FDIC Chairman, nothing brought
greater pleasure and satisfaction than working with my colleagues on the Board and
throughout the Corporationand with so many leaders of the financial services
industry. I feel privileged and honored to have had that opportunity.
I also want to thank Andrew "Skip"
Hove, Jr., for the many years he gave to public service as Vice Chairman of the FDIC from
1990 until his retirement in January, 2001. During those years, Skip served as Acting
Chairman three times and he ably guided the Corporation through some of the more difficult
times it has faced. I salute Skip for all he has done on behalf of the FDIC and the
American people. In addition, I want to wish John Reich, FDIC Director, and Don Powell,
the nominee for FDIC Chairman, all the best as they take the reinsand the
futureof the Corporation into their hands. There is no better place to serve