Tuesday, July 13, 2010

The Dodd-Frank Bill's Consequences for Community Banks: FDIC

In the previous post, I discussed the many regulatory burdens the Dodd-Frank bill imposes on community banks. The crushing weight of this bill extends beyond just regulatory compliance, and imposes many concerning changes to the structure and use of the FDIC and Deposit Insurance Fund. As the entire industry - large and small banks - shoulder the costs of the FDIC, these changes impact all banks.

Community Banks' Savings From the Broadened Assessment Base May Be Short-lived
By expanding the assessment base (from total domestic deposits to total assets less tangible capital) the cost of non-deposit funding rises. The banks that face the higher assessments will change their business plans, which will inevitably lead to a shift away from non-deposit funding sources toward deposit funding. Competition for deposits is likely to intensify, pushing deposit rates higher. Should that competition lead to a mere 5 basis point rise in deposit rates, the “static” savings for the typical community bank disappears. It also affects the availability and pricing of home loan bank advances as these are now subject to FDIC assessments. Thus, while the appeal of this change is understandable, the unintended consequences have the very real potential to lower or even eliminate the promised savings.

No Limit on Size of FDIC Insurance Fund
The Dodd-Frank Act eliminates dividends whenever the deposit insurance fund (DIF) exceeds 1.35% of insured deposits and eliminates the hard cap (of 1.50%) on the size of the fund. It also gives the FDIC unrestricted authority to set a new “designated reserve ratio” or long-term target ratio above 1.50%. The bill raises the minimum level for the DIF to 1.35%, and does benefit banks under $10 billion by requiring larger banks to make up the gap from the old minimum of 1.15% to the new minimum of 1.35%. Smaller banks would continue to pay premiums, however, how this provision will be implemented is unknown. All banks would be required to keep the fund above the minimum and at the new designated reserve ratio wherever that is set.

Additional Cost of Higher Insurance Limits
The Dodd-Frank Act does increase permanently the insurance limit to $250,000 and does extend the Transaction Account Guarantee (TAG) for two years. The permanent increase in the $250,000 coverage level, however, means that the reserve ratio of the fund (which is equal to the fund divided by insured deposits) is lower. Thus, the cost to attain even the old minimum of 1.15% is greater and the pace of the recapitalization is longer (unless the FDIC raises all premium rates to maintain the same schedule). The Congressional Budget Office “scored” this increase in premium income at $8.8 billion. How the FDIC will price the TAG program (which protects depositors in all institutions) is also unknown.

Precedent for Using the FDIC as a Government Revenue Raiser
Both the increase in the insurance coverage levels and the last minute provision to raise the minimum level of DIF to 1.35% were used as a way to increase federal government revenues and meet the “pay-go” requirements. Pay-go (or pay-as-you-go) rules require that any new spending must be offset by new sources of revenue so that there is no addition to the federal budget deficit. Premiums paid to FDIC are considered revenue to the federal government as FDIC is “on-budget.” Thus, the actions set a precedent to use premiums as a revenue raiser to support other government spending programs. It also undermines the integrity of the insurance assessment process and could ultimately undermine depositor confidence in the FDIC, as the fund will be seen as a political fund to be used for other purposes. Such an approach, in terms of its impact, is a tax on bank capital, and every dollar of bank capital serves as the basis for making loans of eight dollars or more.

I repeat my call for you to urge your Senator oppose the Dodd-Frank bill as the provisions apply crushing burdens on community banks and changes the historical treatment of the Deposit Insurance Fund.

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