Financial Update (Second Quarter 2002)

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Atlanta Fed Examines Deposit Insurance Reform and FDICIA

Deposit Insurance Reform
Deposit insurance reform proposals center on basic issues such as the amount of deposit insurance premiums, the size of the insurance fund and the extent of coverage limits. But are these topics the most critical issues that should be debated? Not necessarily.

Mention the topics of deposit insurance or the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) nowadays and you’re likely to find someone involved in banking ready to give you an opinion. That’s because these topics have recently received quite a bit of attention as various interests and organizations have debated the merits of several deposit insurance reform proposals, including those proposals put forth by the FDIC.

These reform proposals center on basic issues such as the amount of deposit insurance premiums, the size of the insurance fund and the extent of coverage limits. But are these topics the most critical issues that should be debated? Not necessarily.

Exploring the real issues
A recent article in the Federal Reserve Bank of Atlanta’s Economic Review (First Quarter 2002) looks at various reform proposals now under discussion and suggests some other issues that should be considered in the deposit insurance reform debate.

The article was written by Robert A. Eisenbeis, the Atlanta Fed’s senior vice president and research director, and Larry D. Wall, a financial economist and policy adviser at the bank. The goal of the article, according to Eisenbeis and Wall, is to refocus attention on the policies needed to implement the original prompt corrective action provisions of FDICIA, many of which deal with limiting costs to the deposit insurance fund.

In the article, the authors explore FDIC’s basic proposals to reform FDICIA. These proposals include

  • levying insurance premiums on all banks regardless of their condition and the size of the insurance fund,
  • merging the Bank Insurance Fund and the Savings Associations Insurance Fund,
  • allowing the FDIC to issue credits against future premiums to all banks whenever the fund exceeds some target level,
  • giving the FDIC greater flexibility in setting the size of the insurance fund, and
  • indexing the current $100,000 limit on deposit coverage to a price index, with the first adjustment in 2005.

Unfortunately, according to Eisenbeis and Wall, these proposals focus on how to allocate losses from bank failures instead of trying to minimize losses in the first place. Minimizing losses, the authors say, should be the goal because that approach would reduce the social costs of bank failures and the potential for moral hazard problems in troubled banks. Further, by minimizing the losses from failed banks to the trivial levels envisioned by FDICIA, issues like how losses are allocated across depository banks, taxpayers and time become minor. The authors state that the large losses borne by the FDIC with some bank failures since FDICIA was enacted, including Superior Bank FSB, were due to supervisory forbearance — bank supervisors allowed banks to remain in business even when the institutions were not economically solvent.

Minimizing losses from bank failures, Eisenbeis and Wall say, should be the deposit insurance reform goal because that approach would reduce the social costs of bank failures and the potential for moral hazard problems in troubled banks.

The best approach
While acknowledging that they don’t have all the answers, Eisenbeis and Wall do recommend further consideration of several proposals to refocus attention on the original goals of FDICIA. For instance, the authors recommend developing and implementing market value–type disclosures of the value of banks’ assets and liabilities. This step, combined with a different approach to risk-based premiums and measures to strengthen market discipline, such as expanded use of subordinated debt, merit further consideration as potential partial solutions to the problem of implementing FDICIA, according to the authors.

For the complete text of the article, go to the Atlanta Fed’s Web site at www.frbatlanta.org and look under the Publications heading for the Economic Review.