Banking

Banks Preparing for TAG Changes

With each new year, many people make changes in their lives that affect the way that they live. Starting January 1, 2013, banks are going to have to deal with a change: that of non-interest-bearing accounts losing the benefit of unlimited deposit insurance. Today, there is more than $1 trillion in these deposits in banks across the country. The expiration of the unlimited deposit insurance will affect banks in two ways: pressure on net interest margin as non-interest bearing deposits are shifted toward interest-bearing products or replaced with wholesale funding, and from liquidity pressures resulting from deposits leaving banks and being placed in alternative money market investments.

Evolution of TAG
The Transaction Account Guarantee Program (TAG) first became effective on October 14, 2008, as a part of the Temporary Liquidity Guarantee Program (TLGP) that was adopted by the Federal Deposit Insurance Corporation (FDIC). One of the purposes of the TLGP was to increase liquidity in the banking system so that lending by banks to consumers and businesses would normalize. TAG was one of the options under the TLGP in which full deposit insurance was given on all balances of non-interest- (or low-interest-) bearing transaction deposit accounts. Participation was optional for banks, and TAG was to continue until December 31, 2009.

In August 2009, TAG was extended for an additional six months, until June 30, 2010. It would be extended once more until year-end 2010. During this time, Section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed and provided similar transaction account insurance until December 31, 2012. This time, participation was mandatory for all banks.

Future of TAG
In early November, the FDIC sent letters to financial institutions with instructions to prepare themselves and customers for the expiration of TAG. There is still much debate about whether or not TAG will be extended. Advocacy groups are still hoping it will be extended and trying to attach such an extension to proposed legislation that may occur during the remainder of this year. There is also the chance that an extension will occur when the new Congress convenes in January.

No matter one's perspective on an extension to TAG, there are pros and cons. Many argue that TAG should expire on December 31, 2012, while liquidity within institutions is high and the cost of replacing any outflows is inexpensive. Others argue that TAG should be extended to ensure that deposit outflows do not occur at institutions while uncertainties, such as the so-called fiscal cliff, still exist in the markets. Some say that expiration of TAG benefits larger banks, since they are still viewed as too big to fail.

Finally, there is the thought that extending TAG just kicks the inevitable down the road and that it will add additional liquidity pressures on banks when the economy improves and loan growth is beginning to occur. Former FDIC Chair Sheila Bair has suggested that TAG could be brought to a more orderly expiration by ratcheting down the amounts that receive deposit insurance; for example, instead of going from unlimited insurance to coverage limited to $250,000, TAG could be reduced in tiers, going from unlimited amounts to $1 million, then $500,000, and then to $250,000. If Congress decides to extend TAG, perhaps such a proposal will receive consideration.

Implications of TAG expiration
Within the Sixth District, state member banks, and large non-member banks in which the holding company is monitored, have benefited greatly from TAG deposits. TAG deposits have increased 42 percent, from $39.4 billion to $56.1 billion, since the fourth quarter of 2010 (see the chart). Also, during the same period TAG deposits/total deposits increased from 11.36 percent to 14.18 percent.

As previously mentioned, the expiration of TAG will affect banks in two ways. The first way is through the net interest margin. Many of these deposits that remain in the banks will likely shift to areas such as repurchase agreements or interest-bearing deposit accounts. In some cases the deposits that leave will have to be replaced with wholesale funding sources. These situations will pressure the net interest margin. The good news is that the low interest rate environment mitigates a large impact to net interest margin. If all the TAG deposits in the Sixth District shift to interest-bearing products at a cost of 25 basis points, the impact to the total of the District net interest margin would be only 3 basis points.

Going forward
Banks will also be affected by TAG's expiration through liquidity pressures caused by some deposits leaving the bank. Some depositors will leave to diversify noninsured deposits across various institutions; others will move deposits for better investment opportunities. Many banks will be able to handle any deposit outflows through a reduction of balances kept at the Federal Reserve or fed funds sold. However, some institutions will have to replace portions, if not all, of the deposit outflows. Banks may also have to pledge securities to maintain public fund deposits. Most states require public funds to be either FDIC insured or collateralized with investment securities.

Bankers and examiners should understand the implications of the expiration of TAG. It is important for banks, through their forecasting processes, to capture any known outflows or deposits shifts to understand the impacts on both net interest margin and liquidity. Stress testing should be conducted for institutions to understand impacts of unexpected deposit outflows and to determine if actions, such as obtaining FHLB advances or brokered deposits, are warranted in advance of expiration to mitigate possible deposit outflows. Finally, it is important to carefully track any TAG deposit outflows to remain aware of the institution's liquidity position.

By Scott Williams, a senior examiner in the Atlanta Fed's supervision and regulation division

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