In the recently passed legislation, the Dodd Frank Law, the FDIC is given the mandate to change the way it assesses deposit insurance premiums from banks, mostly based on risk. This will greatly impact small businesses, by limiting their access to capital through loans. Perhaps as much or more than the recent health care bill will.
First the Law
The law “defines a risk-based system as one based on an institution’s probability of causing a loss to the Deposit Insurance Fund (the Fund or the DIF) due to the composition and concentration of the institutions assets and liabilities, the likely amount of any such loss, and the revenue needs of the DIF. …allowing the FDIC to establish separate risk-based assessment systems for large and small members of the Deposit Insurance Fund.
“Over the long-term, institutions that pose higher long-term risk will pay higher assessments when they assume those risks. …should provide incentives for institutions to avoid excessive risk.” (the information quoted is found in the following paper about the new score card produced by the FDIC located at: http://www.denovostrategy.com/new-fdic-score-card/) The new assessments will be based on a performance score, which will be comprised of three main elements: 1) CAMELS Score, 30%; 2) Ability to withstand asset-related stress, 50%; and 3) Ability to withstand funding-related stress 20%. It is the asset-related stress that has the regulators concerned and if an institution has too much risk in that category, it will also affect the CAMELS rating, as the regulators will perceive that management is not doing their job – that of taking care of the bank.
The banker’s number one job now it to make sure that the bank never becomes a problem bank, that may cause the regulators to pay on deposits; everything else is now ancillary to that goal.
All small businesses are risk rated, based on their credit score, (or the owners credit score), which becomes the basis for easy or difficult access to credit at a financial institution. At times bankers make loans to small businesses, because they understand the business, the risk associated with the business and they know the owner, even though the credit may be simply o.k. (not great, but not terribly bad either).
This new way of assessing deposit insurance will now cause the banker to ask the question – how will this loan affect the bank’s portfolio and ultimately it’s DIF assessment? As bankers ask this question more loans will be turned down. This is not to say, that all loans should be written as applied for, but as the bell curve moves towards safety, it will certainly leave a larger percentage of good small business loans unfulfilled and business owners without the much needed capital to continue in business or to grow. And we all know that when small businesses don’t continue, or fail to grow, then lay-offs occur and unemployment lines increase.Did Congress and the regulators think this one through completely? Is there a better way to asses risk?