Why Not Two FDIC Funds--One for Big Banks, One for Small?

The amended Dodd-Frank regulatory expansion bill has a new last-minute theory: Charge different banks different deposit insurance premium rates, not according to risk, but by size. The bill, now passed by the House but not the Senate, would impose a higher premium on banks with more than $10 billion of assets, but no increase on those smaller than $10 billion.

In round numbers, this would mean a higher cost for about 1% of banks, but a pass for the other 99%.

Well, the political rationale for this is pretty clear: sock those big banks and avoid having small banks complain to their members of Congress. But is there any principled argument involved--any financial logic to it? If so, it's not apparent.

If you have to keep two sets of books, one for large banks and one for smaller banks, you in effect have two separate funds, so let's carry the idea through and have two separate funds in fact.

"ICBA believes the conferees have come up with a constructive solution," said a representative of some of the smaller 99%. Well, of course, if you're the ones who don't have to pay, you might see it like that.

"Dodd said the change in the formula would not affect banks with less than $10 billion in assets, so that it would not trigger opposition from the Independent Community Bankers of America," CongressDaily reported.

Sen. Dodd also said that Sheila Bair, the chairman of the Federal Deposit Insurance Corp., supported getting more fees for the FDIC fund.

No surprise there! The FDIC fund's net worth is now about negative $20 billion, and it isn't hoping to get back to its target level until 2017--and that assumes there are no more credit busts in the meantime.

In addition, the FDIC's risk is being increased by the bill's permanent increase of its coverage, to $250,000 per account. However they're collected, more premiums would certainly be welcome from the FDIC's point of view.

The always insightful banking expert Bert Ely pointed out that "the provision would effectively force the FDIC to keep two sets of books, for large and small banks." This is absolutely right, and it suggests a further conclusion: the Dodd-Frank bill's proposed assessment is inconsistent with the existence of only one deposit insurance fund.

If you have to keep two sets of books, one for large banks and one for smaller banks, you in effect have two separate funds, so let's carry the idea through and have two separate funds in fact.

Thus the Dodd-Frank bill's newly invented money-raising logic implies that there are two different banking industries, big and little, and there should correspondingly be two separate deposit insurance funds, one for each, with their different assessment rates.

This would have the distinct advantage of stopping any deposit insurance subsidy of smaller banks by big banks, or big banks by smaller, since the funds would operate separately.

It has often been argued that large banks subsidize small banks through deposit insurance because premiums have been assessed on total deposits rather than insured deposits, which causes the big banks to pay disproportionately more.

With the current move to assess assets rather than deposits for FDIC premiums, this subsidy argument becomes stronger. On the other hand, the smaller banks have frequently protested their innocence of the financial crisis, although they are certainly not innocent of extreme real estate risk concentrations.

The real question is simply to match the amounts paid in to the deposit insurance funds with the amount paid out in losses for the two groups of banks.

Then we could not only see, but also manage, the relative riskiness of the FDIC's deposit guarantees versus their premium income for the two groups.

We would find out if the Dodd-Frank bill's higher FDIC assessments on large banks (if enacted) generate a rising surplus in the large bank deposit insurance fund or not.

Correspondingly, we would find out if the lower FDIC assessments paid by smaller banks in fact cover the deposit insurance losses of these banks, or not.

Out of the Dodd-Frank bill's last-minute scramble for a money-raising scheme, we could then actually make an intellectual and policy advance in the operation of federal deposit insurance.

Alex J. Pollock is a resident fellow at AEI.

Photo Credit: iStockphoto/DNY59

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