The FDIC’s Potential Funding Shortfall

In the earlier post we discussed the health of the institutions insured by the Federal Deposit Insurance Corporation (FDIC), now let’s discuss the health of the FDIC itself:

(From the WSJ): “WASHINGTON — Federal Deposit Insurance Corp. Chairman Sheila Bair said Tuesday her agency might have to borrow money from the Treasury Department to see it through an expected wave of bank failures.

Ms. Bair said the borrowing could be needed to cover short-term cash-flow pressures caused by reimbursing depositors immediately after the failure of a bank. The borrowed money would be repaid once the assets of that failed bank are sold.

The last time the FDIC borrowed funds from Treasury came at the tail end of the savings-and-loan crisis in the early 1990s after thousands of banks were shuttered. That the agency is considering the option again, after the collapse of just nine banks this year, illustrates the concern among Washington regulators about the weakness of the U.S. banking system in the wake of the credit crisis.

“I would not rule out the possibility that at some point we may need to tap into [short-term] lines of credit with the Treasury for working capital, not to cover our losses, but just for short-term liquidity purposes,” Ms. Bair said in an interview. Ms. Bair said such a scenario was unlikely in the “near term.”

She said she did not expect the FDIC to take the more dramatic step of tapping a separate $30 billion credit line with Treasury, which has never been used.

In another move to bolster the insurance fund, Ms. Bair said the agency will propose in October charging higher premiums to thousands of U.S. banks. These contributions are one of the fund’s major sources of income. The FDIC has been wrestling with how much to raise the fees because the extra expense would put stress on already struggling financial institutions.

Ms. Bair said the agency could charge higher premiums to banks that rely on high-risk deposits to fuel growth or have an “excessive reliance” on secured funding, such as advances from one of the 12 federal home-loan banks. Banks with less risky profiles would still likely have to pay more, but she said their fees shouldn’t increase as much as high-risk banks.

“We should reward behavior that reduces our costs,” Ms. Bair said.”

Graphic courtesy of the WSJ

Stratifying the banks into categories that require the banks that engage in more risky behavior to pay higher fees is a good idea, but requiring those banks to have higher capitalization (and related) requirements would be an even better one. If banks are going to persist in engaging in risky behavior that can endanger the economy and potentially require tax payers to bail them out/minimize the impact, then it’s perfectly reasonably to require them to have higher capitalization requirements, pay higher fees to the FDIC, etc, in order to minimize the impact if they get into trouble.

Speaking of which, here is some additional data on the situation:

(WSJ Deal Journal): “ Banks didn’t pay much into the fund during the latest economic boom: By law, the money in the FDIC’s deposit insurance fund has to come from the banking industry. But the FDIC didn’t significantly raise premiums for the banks in the cash-rich times, and asking banks to fork over more now, when they are cash-strapped, would be difficult. “Would they have been wiser to stockpile more? It’s a Hobson’s Choice,” Comizio said. “You’re asking the banking industry during good times to cough up money that’s unnecessary for a time in the future that may not come when you may have more bank failures.” As of the second quarter, the FDIC’s decision not to raise insurance rates means its deposit insurance fund fell to only 1.01% of all insured deposits. That, in turn, means the FDIC has to create a five-year plan to recapitalize itself within the next few months. Of course, banks are setting aside more money to save themselves: as our colleague Damian Paletta reported, banks had set aside $50.2 billion in loan loss reserves by the end of June, compared with $11.4 billion at the same time last year.

If Treasury steps in with money, taxpayers foot the bill: We asked Comizio if the Treasury can keep forking out cash: Bear Stearns, potentially Fannie Mae and Freddie Mac, and now a little extra to the FDIC? “Treasury will come up with the money,” he said. “It’s a matter of how big the deficit and national debt you can run up.”

When I read the above I had to ask myself: “Why aren’t the premiums tied to a fixed % of profits, assets, based on a regular risk assessment, etc?”. If an individual trades in a Honda Civic for a Land Rover their insurance premiums go up, if the same individual takes his/her sports car to the track on weekends not only will their insurance premiums go up, but the track will require them to have extra safety equipment. Why aren’t we treating the banks the same way?

I understand that a healthy well-run institution doesn’t want to pay higher premiums that will be used to bail out a smaller and/or poorly run one, but banks paying smaller premiums that put the FDIC at risk of having to depend on tax payers just shouldn’t be an option.

You can read more here, and here.

Sources:

The WSJ: “FDIC Weights Tapping Treasury as Funds Run Low” — Damian Paletta and Jessica Holzer, August 27, 2008.

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

Posted in Categories: Contributor, Economy, External Research, USA.

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Comment by JasonK

2008-08-28 03:45:28

This is astonishing news. I can’t imagine the FDIC failing. Will the smaller banks suffer more now?

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