The FDIC's mission to maintain stability in the U.S. banking system is partially fulfilled by the deposit insurance program. The FDIC collects premiums from banking institutions to fund the deposit insurance; these premiums are calculated as a percentage of each bank's total deposits. Most banks today are paying out insurance premiums of about 5 to 7 cents for every $100 of domestic deposits.
The premiums, less operating costs, go into the Deposit Insurance Fund (DIF) which is used to cover the deposit losses of failed banks. Since the existence of a viable deposit insurance program is of critical importance in maintaining the public's faith in the banking system, the FDIC is continually assessing the risks of bank failures and projecting potential expenses that may be charged to the DIF.
Rising losses could signal rising fees
This year, the FDIC has been appointed the receiver for ten banks with total assets just over $40 billion. Not all of these assets translate to losses in the DIF however. Part of the FDIC's function as receiver is to sell off the assets of the failed banks, thus recouping losses to the DIF. It is estimated that the losses to the DIF associated with those ten bank failures will amount to $7.5 billion, meaning that more than 80 percent of the total assets should be recovered.
Even so, the FDIC's list of problem banks is growing. As of the end of the second quarter, there were 117 banks on the "problem" list, up from 90 at the end of the first quarter and 61 at the end of the second quarter of 2007. To address the rising number of at-risk banks, the FDIC increased its provisions for insurance losses by $10.2 billion during the second quarter; this was the largest factor behind the $7.6 billion decrease in the fund, which ended the quarter at $45.2 billion (unaudited). Since insured deposits only rose 0.5 percent in the same time period, the reserve ratio fell to 1.01 percent as of June 30, 2008. The reserve ratio has not been this low since 1995, when the combined Bank Insurance Fund (BIF) and Savings Account Insurance Fund (SAIF) was 0.98. The BIF and SAIF were merged in 2006.
When the reserve ratio dips below 1.15 percent, the FDIC is required by the Federal Deposit Insurance Reform Act of 2005 to create a fund restoration plan that will bring the ratio back up to 1.15 percent within five years. FDIC Chairman, Sheila C. Bair, has already stated publicly that the FDIC's restoration plan is likely to incorporate an increase in the premiums the banks pay into the fund. Bair has also indicated that the FDIC will propose changes in the rate structure to shift a greater share of the responsibility onto financial institutions that participate in higher-risk activities. The current credit crisis will likely result in premium increases across the board for all banks.
An increase in FDIC insurance premiums will put more strain on banks that are already grappling with rising credit losses. While this is bad news for existing banks, it is a necessary step in maintaining the public's confidence in the banking system. Should the FDIC develop an assessment system that provides rewards to banks that engage in safer activities, at least these institutions will have the option and incentive to take some of the risk out of their operations. De novo banks may end up with an advantage in this regard, because they can open the doors with a business strategy that complies with FDIC guidelines to keep premiums low and minimize risk going forward. De Novo Banks also open without a legacy portfolio that may have some high-risk loans. Very few de novo banks fail, which is a credit to the bankers and regulators working together in an effort to build a solid foundation for the new financial institution.
For banks with problem loans in its portfolio, the best solution is to get in and meet with the borrowers early (perhaps when the borrower misses the first payment, not the third). The sooner the problems are addressed the greater opportunity for success in recovery or improvement of the loan. This might mean meeting with all borrowers as a ‘check up' on their status. It is far better for the bank to find the problem loans than the examiners.
The bank insurance fund is a critical part of our country's economic engine and is a model for the world. The fund will be stressed during this credit crisis, but we have to maintain the faith in the system that has kept our banking system safe and in good health for the past 75 years.
By Wendell Brock, MBA, ChFC