Comments on H.R. 5590: A Bill to Recapitalize the Bank Insurance Fund

Published by the Government Accountability Office on 1990-09-27.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                  United States General Accounting Oftfce     / fz   32   2     ”

For Release        Comments on H.R. 5590:  A Bill             to Recapitalize
on Delivery        the Bank Insurance Fund /
Expected at
10:00 a.m.
September 27,

                   Statement   of
                   Richard   L. Fogel
                   Assistant   Comptroller General
                   General Government Programs

                   Before the
                   Subcommittee  on Financial    Institutions
                   Supervision,  Regulation   and Insurance
                   House of Representatives

GAO/T-GGD-90-64                                                      GAOForu1100(~2/~7:
Mr.      Chairman               and Members of                    the Subcommittee:

I am pleased                    to be here            today          to discuss                     H.R,       5590,        a bill          to
recapitalize                    the Bank Insurance                         Fund             (BIF)      with         a contribution
by the banking                    industry            equal          to 1% of                 its      total         deposits.                The
legislation                would        allow         this        deposit               to be carried                   as an asset                 on
the books            of banking                institutions                      and as equity                      on BIF's          books.
The deposit                would        be expensed                  if     it         is     needed           to    resolve          failed
institutions                and would                be replenished                         by the banking                    industry
under        procedures              to be prescribed                         by FDIC to maintain                              its         level
at     1%.     As we understand                            the    proposed                  legislation,                the     1% deposit
would        recapitalize                BIF in             the      same way that                         the      National          Credit
Union        Share         Insurance                Fund was recapitalized                                  in      1984.

Due to BIF's                undercapitalization,                                 the        federal           system         of deposit
insurance            for        banks       faces           a period              of danger                 and uncertainty
unprecedented                   since         its     establishment                         in      the Great           Depression.
We support                the     fund's            need for            additional                   resources.                However,             at
this       point      we are            not         persuaded              that         the         restructuring               of         the
deposit        insurance                financing                that       this            bill      would          require          is
necessary            to place              the deposit                    insurance                 system          on sound
financial            footing.


In*the        past         2 years,            the FDIC fund                      (now BIF)                 lost      about          $5.1
billion.             As a result,                    the     ratio          of     insurance                  reserves          to     insured
deposits           fell         to   .7 percent,                  an all           time             low,      at     the end of              1989.
And additional                insurance        losses         can certainly                      be expected
because      there        are     still      over      1,000        banks          on the          problem            list         and
failures         are     continuing           to occur         at    the       rate         of     about         200 per
year.       A recession,               accompanied            by the         failure              of     one or more
very     large     banks,         could      lead      to     insurance                 losses         that      would
exhaust      the       fund     and require            taxpayer           assistance.

The need to provide                    additional            funding         for         BIF cannot              be
overemphasized.                 One of       the most           important                lessons          from        the
thrift      industry           debacle       is     that      a weakly             capitalized                 insurance
fund     encourages            regulators           to defer         action              and the          owners         and
managers         of problem            institutions            to gamble                 on not          being        closed
down.       Additional            funding,          which      includes                 having         enough         cash         on
hand to resolve                cases       in an appropriate                   and timely                 manner,             is
therefore         needed        to avoid          a situation             in which                bank        regulators
fail     to act        on problems           because          of BIF's             lack          of money.

COMMENTSON H.R.                 5590

One of      the benefits              of H.R.         5590 is        that          it     sends          a clear             signal
to the banking                industry       that      it,     not     the         taxpayer,              is     to the
greatest         extent        possible        to be held            responsible                   for        the     losses            in
the deposit            insurance           system.           This    is     the          right         objective              and
the main point             at     issue      involves          judgements                 about          how to
accomplish         it.         In our       view,      the goal           of       industry              responsibility
can best         be met at          this     time     by giving             FDIC authority                       to    raise
premiums         as needed         to pay for              insurance           losses             and to achieve                    an
adequate            level        of     reserves.                H.R.         5610,     which         was recently                passed
by the        House,           lifts      the         current           constraints                on FDIC's          ability             to
increase           premiums,             and will,               if     enacted,             pave     the     way for           this
result.            We hope the Congress                               can agree         soon on this                 measure.

We have        three           sets      of     concerns               with     H.R.         5590:       1) the         nature            of
the     accounting               treatment              accorded              the deposit,             2) the         size        and
timing        of     the       deposit          in      relation              to FDIC's            needs      and the
industry's            ability            to pay,           3) and the                 implications              of    the
proposed           legislation                 for      resolution              of     several         deposit          insurance
reform        issues.

Accounting               Issues

The funding               arrangement                 contained               in H.R.         5590 differs              from
raising        premiums                because          the      1% deposit             can be treated                  as an
asset      rather           than        an expense              on the books                  of     insured         banks        until
the deposit               is    actually              used'to           pay insurance                 losses.          Although
technical            accounting               arguments                can be advanced                 for      and against
treating           the      deposit           as an asset,                    we are        very     concerned              about         the
effects        of        the    controversy                that         could         surround         public         discussion
of    these        arguments.                 Such discussion                    may confuse                 many people               and
deflect        attention                from         policies           needed         to     increase          industry
capitalization                  and improve                the        accuracy          of     financial             reporting.

From a conservative                       accounting                  viewpoint,             we believe              that     a
deposit        such as that                   contemplated                    under     H.R.        5590 should              be
viewed          as an expense                    rather            than       an asset.                 The basic             reason           for
this      is     that           the     deposit             is     not     a resource                  available            to protect
creditors                 in    the     event         of      insolvency.                     We also           strongly           support
efforts          to raise               industry             capital            adequacy               requirements                over        the
long      run,        but            these     requirements                   must be based                     on measures               of
real      economic               strength.                  Therefore,             if         the      1% deposit            were         to be
recorded             as an asset                 by banks,               we think              it      should        be excluded
from      the     asset              base used              to determine                 capital             adequacy.               This
adjustment                 would,            however,            unduly         complicate                the      process           of
linking          capital               regulation                to GAAP-based                      financial         statements.

Timing         Issues

Because          there           are         about     $2.8         trillion             in deposits                 in commercial
banks      and BIF-insured                           savings         banks,             the         1% deposit         requirement
in H.R.          5590 would                   bring         a lot        of money into                    the      fund      right          away
and give          BIF a margin                       of safety             that         is now missing.                      However,               we
are     concerned                about         how much money the                             industry            should          be asked
to pay at             any one time.                         This     legislation                     would        require          banks         to
deposit          with           BIF the          equivalent                of more than                   a year's           worth          of
industry          earnings,                   and the question                     becomes whether                     BIF's             funding
needs warrant                    such drastic                    action.           No one can predict                             with
precision             the        extent          or timing               of     losses          that       will       occur          in    the
banking          industry               or'the             implications             of         those         losses         for     BIP's
finances.                 But,         given         the     pressure             on bank earnings                     which             can be
expected             in        the     near      future,            we think             it     would           be reasonable                  to
spread         the         increase            in funding                over      several              years       through              higher
premiums,            provided           it     gives      BIF the money it                        needs.           If         H.R.     5610
is enacted,                 Congress         can hold        FDIC responsible                        for        raising                    .
premiums,           to match          funding           needs with            the         industry's             ability              to

Deposit          Insurance            Reform        Issues

If     a fundamental                 change        is    to be made in                the         way deposit
insurance            is       financed,         we believe            it     should              be considered                      from
the broader               perspective            of deposit                insurance              reform.               In this
regard,        we have concerns:about                           the        implications                of H.R.                5590 for
two deposit                 insurance          issues.

First,       in our            recent        testimony          on deposit                 insurance             reform1
before       the       full         committee           we pointed           out      that         as insurance
premiums            rise,       the     unfairness           of charging                   all     institutions                      the
same premiums                  becomes more starkly                        revealed.               Because              not     all
institutions                  are    equally        risky       we favor             the         implementation                      of a
system      of       risk       based        deposit        insurance           premiums.                   H.R.         5590 does
not      preclude             such a system              from    being         developed,                 but      it         seems to
us that        it      would         make it        more difficult                   to      implement            one.              Under
H.R.      5590,        BIF's         funding        needs would              be met through                      a combination
of    the    1% deposit,                interest          on the deposit                    and other             reserves,
and premiums.                   The balance              among these               items          could         vary
considerably                  from    year      to year,         making         it        more      difficult                  to

lDeposit  Insurance  and Related                                Reforms            (GAO/T-GGD-90-46,
September 19, 1990.)

        develop           a predictable                       system          that     penalizes            the         institutions
        posing          the         greatest             risk     to the             fund     and that            recognizes               as well
        those          that         are    of particularly                       low risk.

        Second,           it        is    not         clear     whether              H.R.     5590,        in     its         references          to
        "total          deposits,"                    intends      to expand                the     assessment                 base      to
        include          about            $300 billion                 in      foreign         deposits.                  These deposits
        are      not      insured             but        are,     in     fact,         usually           protec'ted             when a bank
        fails.           If         the    bill's             1% deposit              does not           extend           to     foreign
        deposits,               there         would           be a strong              incentive            for         banks      with
        offshore               operations                to turn         to those             operations                for     more of
        their      funding.                     If,     on the         other          hand,        the     intent             of H.R.         5590
        is     to include                 foreign             deposits          we are concerned                        about      how such an
        increase               in    the      cost        of doing             business            overseas             will      affect         U.S.
        banks'          international                     competitiveness.                         There        are      arguments            both
        for      and against                  assessing            foreign             deposits            in     the         deposit
        insurance               system.                We are      currently                evaluating              these         arguments            as
        part      of our FIRREA mandated                                 study         of deposit               insurance               reform
        issues.               We are          not       certain          at     this        time     whether             the      adverse
        competitive                  impact            of extending                  the base outweighs                        the beneficial
        effects          of         raising            insurance            fund       revenues            through             assessments             on
        foreign          deposits.

        This      completes                my prepared                 statement.                 My colleagues                   and I would
        be pleased                  to    respond             to questions.