FDIC Reform: Don’t Put Taxpayers Back at Risk

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Enacted at the depth of a banking crisis, theFederal Deposit Insurance Corporation ImprovementAct of 1991 effectively turned the depositinsurance system into a privately funded, albeit stillmandatory and government-managed, system. Inthe 10 years since the FDICIA's enactment, the newsystem has worked reasonably well to preserve thesafety and soundness of the banking system and toprotect taxpayers from funding losses to the FederalDeposit Insurance Corporation fund, for whichbanks are now responsible. Nevertheless, the FDIChas recently encouraged a reexamination of the currentstructure of the deposit insurance system toimprove its performance.

Some of the changes proposed by the FDIC mayactually return the system to one in which the taxpayeris again at greater risk for funding bank losses.Chief among those changes is a measure, included ina number of bills now pending in Congress, thatwould allow the FDIC greater flexibility in the way itcharges insurance premiums on banks. In particular,it would alleviate the requirement to increase premiumsas harshly and rapidly when losses drive thefund below the designated 1.25 percent reserve-to-insured-deposits ratio to replenish the fund withinone year. But that would increase the likelihood ofthe fund going and staying negative and increase theprobability of putting the taxpayer back on the hook.

A second proposed change would increase themaximum coverage of $100,000 per account. That islikely to encourage some depositors to become lessconcerned about the financial health of their banksand banks to take on more risks, which wouldincrease the chances of bank losses and failures.

Last, the FDIC would like to see insurance premiumsreflect the riskiness of insured banks.Although it sounds good in theory, this is one taskthat bank regulators are ill-equipped to perform,because the appropriate risk also depends on therisks imposed by the regulators themselves whenthey fail to act in a consistent and efficient mannerin resolving troubled banks.

An implicit government guarantee of banks willremain as long as the deposit insurance system isgovernment operated. For that reason, to reduce thatguarantee, insured banks should at least be given agreater voice in the management of the FDIC.

Many of the proposed changes would diminishmarket discipline and encourage regulatoryforbearance. Their adoption could inadvertentlylead to a reversion to the pre-1991 system ofalmost unlimited taxpayer liability.

George G. Kaufman

George G. Kaufman is John Smith Professor of Banking and Finance, Loyola University, Chicago, and cochair of the Shadow Financial Regulatory Committee.