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Financial Institution Letter

Deposit Insurance Assessments

TO: CHIEF EXECUTIVE OFFICER 
SUBJECT: Enhancements to the Risk-Related Premium System 

The Federal Deposit Insurance Corporation (FDIC) is refining the Risk-Related Premium System (RRPS) to provide a more flexible, forward-looking system that keeps pace with new and emerging risks. The refinements are intended to identify institutions with atypically high-risk profiles among those in the best-rated premium category, and to determine whether there are unresolved supervisory concerns regarding the risk-management practices of these institutions. Where such concerns are present, the institutions will be given an opportunity to address the cited deficiencies with risk-management practices before higher premiums are assessed. It is expected that very few institutions will fall into this category.

The refinements are effective immediately. Six institutions face possible reclassification for the second semiannual assessment period of 2000 and will be notified shortly of the specific risk-management concerns to be addressed. The FDIC will determine a notified institution's risk classification for the second assessment period of 2000 after consulting with the primary federal regulator. These consultations will take place in June, based on information gathered through the normal supervisory process.

Background 

During the banking crises in the 1980s, a small percentage of institutions that were well- capitalized with good earnings when the economy was strong, subsequently experienced problems, and in many cases failed, when the economy softened. Many of these institutions exhibited common characteristics including rapid asset growth and risky lending concentrations. A recent review of institutions that experienced significant problems in 1998 and early 1999 revealed similar common characteristics including rapid growth often centered in potentially risky, high-yielding lending areas, significant concentrations in high-risk assets, and recent changes in business mix. These potentially risky traits, accompanied by inadequate management systems and controls, can lead to a deteriorating financial condition even when economic conditions are favorable.

In the existing semiannual review process for the risk-based premium system, an offsite model is employed that uses quarterly financial data to predict the composite examination rating for each institution based on historical relationships. The existing process does not focus on institutions with characteristics most similar to those that recently have become troubled, and such institutions are not systematically identified for review. More broadly, the existing process does not focus on newly emerging risk characteristics. Additional screening will be used for this purpose so that institutions flagged by the supplementary screens are given additional incentives to address any weaknesses in risk-management practices that have not yet been adequately addressed.

Two-Step Process 

As a result, the FDIC is implementing the following two-step process.

Step One: Two-part test 

  • Supplementary Screens : Institutions in the best-rated supervisory category are screened to identify outliers (extreme values) in terms of combinations of rapid growth, concentrations, high yields on the loan portfolio, and rapid changes in business mix.
  • Supervisory Validation : For the flagged institutions, supervisors are asked whether there are concerns regarding risk-management practices that have been communicated to the institutions.

Step Two: Notification and response 

  • Those institutions with risk-management concerns are notified that unless the concerns are adequately addressed prior to the next semiannual assessment period, the FDIC may charge them higher premiums. FDIC decisions to notify institutions will be made in consultation with the primary regulator.
  • Prior to the next assessment period, notified institutions will indicate to their primary federal regulator the extent to which the concerns have been addressed. The primary regulator will then share this information and discuss its own evaluation of the institution's progress with the FDIC. The FDIC will consider the recommendation of the primary regulator and then determine whether to reclassify the institution. Reclassified institutions always have the right to appeal the decision through the existing assessment appeals process.

Description of Supplementary Screens 

The supplementary screens being implemented by the FDIC involve a combination of the financial characteristics discussed above-rapid loan growth, high-yielding loan portfolios, concentrations in high-risk assets, and recent changes in business mix. Examination component ratings are also used to reduce the number of screened institutions by focusing on those most likely to have weaknesses already identified by the supervisory process. A grouping methodology was used to compare institutions with similar asset composition and to identify outliers within each group in terms of their risk profiles. These groupings were employed in the development of screens for the review process. Percentile cut-off points for identifying outliers were selected to achieve a reasonable balance between the benefits of additional review of institutions with characteristics that may reflect an atypically high-risk profile and the resource costs of conducting such reviews.

The screens will be reviewed on an ongoing basis and will be refined or replaced as needed to ensure that new and emerging risks to the insurance funds are reflected in the review process for assigning deposit insurance premiums. The FDIC's intent is to use all available offsite tools to identify institutions in the best-rated supervisory category with atypically high-risk profiles.

Screening Results 

Call Report data as of June 30, 1999, were used for the supplementary screens during the fall 1999 review process. The screens flagged 193 institutions for review. Summary statistics by bank grouping, asset size, screening criterion and other categories are presented in the attachment.

After review and consultation with the primary federal regulators regarding the risk-management practices of the flagged institutions, the FDIC has elected to notify six institutions of a possible reclassification for the next semiannual assessment period (second half of 2000). The proportion of flagged institutions that are notified will vary going forward, as conditions change and screens are modified, but it is expected that this proportion will remain small.

Timing of Notification and Responses to Certify Progress 

Institutions will be notified shortly that they may be reclassified for the second semiannual assessment period of 2000 unless concerns regarding risk-management practices are adequately addressed. The FDIC will consult with the primary federal regulator before deciding whether to reclassify an institution, using information gathered through existing supervisory channels, and these consultations will take place in June.

The dates above reflect the off-cycle timing of the start-up for these premium system enhancements. Going forward, the timing of notification and responses will line up with the normal assessment cycle. Institutions that are candidates for reclassification can expect to be notified by year-end and midyear of the respective assessment cycles, and the primary regulator will be consulted regarding the progress of notified institutions by the following June 1 and December 1. These time frames will be indicated in the notices to individual institutions.

For further information, please call 1-800-759-6596 (select Option 1) or contact Richard Jones, Chief, Assessment Implementation Section, Division of Insurance, on 202-898-6592.

Arthur J. Murton

Director

 

Attachment: HTML Format PDF Format (20 Kb - PDF help or hard copy

Distribution: All FDIC-insured Institutions 

NOTE: Paper copies of FDIC financial institutions letters may be obtained through the FDIC's Public Information Center, 801 17th Street, NW, Room 100, Washington, DC 20434 (800-276-6003 or (703) 562-2200). 

FIL-7-2000

Last Updated: February 4, 2000