Page 1       TOP OF DOC


U.S. House of Representatives,
Subcommittee on Financial Institutions and Consumer Credit,
Committee on Financial Services,
Washington, DC.

    The subcommittee met, pursuant to call, at 9:36 a.m., in room 2129, Rayburn House Office Building, Hon. Spencer Bachus, [chairman of the subcommittee] presiding.

    Present: Chairman Bachus; Representatives Weldon, Roukema, Baker, F. Lucas of Oklahoma, Kelly, Gillmor, Manzullo, Toomey, Cantor, Grucci, Hart, Ferguson, Tiberi, Waters, C. Maloney of New York, Watt, Ackerman, Bentsen, Sherman, Meeks, Moore, Hooley, Carson, Hinojosa, Lucas of Kentucky, Shows, and LaFalce.

    Chairman BACHUS. The hearing will come to order. The subcommittee meets today for the first of a planned series of hearings on the subject of reforming our country's deposit insurance system. And I want to stress that this is the first of what will be more hearings on the subject. The focus of today's hearing will be on a report prepared by the FDIC entitled ''Keeping the Promise: Recommendations for Deposit Insurance Reform.''

    As we commence this hearing, the Vice President is speaking before the Republican Conference, so on the Majority side, our attendance may be down some. I understand that the Democrats are also in a caucus. But our primary focus at today's hearings will be listening to our witness, and I don't anticipate a lot of questions, although the Members are free to ask as many as they want to. I don't say that in a limiting way.
 Page 2       PREV PAGE       TOP OF DOC

    Federal deposit insurance, established during the Great Depression to restore confidence in the Nation's troubled banking system, is that rare product of the legislative sausage-making factory that has actually worked pretty well as it was intended to. It has enhanced economic stability, largely eliminated the prospect of panic-driven runs on banking institutions, and succeeded in minimizing the risk to taxpayers from bank failures. Yet even the most effective Government programs require periodic review and updating to ensure that they continue to serve the purposes for which they were originally created.

    Our objective this morning is to begin what I hope will be a constructive dialogue about the future of the deposit insurance system. I can think of no better starting point for that discussion than the report filed by the FDIC last month.

    We are pleased to have FDIC Chairman Donna Tanoue with us this morning to present the Agency's findings and recommendations, and I will say that your report and recommendations basically focus on every aspect of the reforms that people have proposed.

    The subcommittee's consideration of deposit insurance reform comes at a time when the system itself is as healthy as it has been in more than 20 years. Thanks largely to sizable contributions by the banking and thrift industries in the 1990's, the Bank Insurance Fund and the Savings Association Insurance Fund are both fully capitalized, with combined balances exceeding $41 billion.

    The strong condition of the deposit insurance funds might cause some to conclude that the status quo should simply be maintained, or argue for a more proactive approach. As the FDIC has correctly pointed out, the current system leaves open the possibility of sizable 23-basis-point premium assessment on institutions if and when the designated reserve ratio falls below 1.25 percent.
 Page 3       PREV PAGE       TOP OF DOC

    While there is significant debate within the industry about the factors that might cause a penetration of this 1.25 hard target, there is no doubt that a 23-basis-point assessment, which has been aptly compared to falling off a cliff, would have serious consequences both for banks' profitability and for their ability to fund economic growth in the communities they serve.

    If such were to occur in a period of economic weakness, it would even be worse. The FDIC's request for more flexibility in setting the reserve ratio, therefore, warrants the subcommittee's careful consideration.

    Perhaps no deposit insurance issue has been more hotly debated than the question of whether to increase coverage levels above the current $100,000 per account limit. While several influential policymakers have been openly skeptical of the need for such an increase, many of us on this subcommittee have heard from community bankers in our district who strongly believe that a substantial coverage increase is critical to their ability to attract core deposits and remain competitive in their local markets. In my view, devising solutions to the funding challenges faced by community banks should be this subcommittee's highest priority. It is my hope that the subcommittee will be reviewing various reform proposals with that in mind.

    In this regard I am particularly interested in hearing from our witnesses on the issue of higher coverage levels for municipal deposits, which have historically been a vital source of funding for community banks, but have become increasingly expensive to attract and maintain.

 Page 4       PREV PAGE       TOP OF DOC
    I notice the FDIC's recommendations for coverage limits is simply to go up on all deposits—at least that is my understanding from reading your proposal—and index them for inflation as opposed to singling out retirement accounts, pension accounts or municipal accounts.

    In closing, I want to commend Chairman Oxley for his leadership in placing the issue of deposit insurance reform on the subcommittee's agenda. I look forward to working with him and other Members of the subcommittee to develop legislation that ensures the continued strength and vitality of a system that has served us well for over 70 years.

    I now recognize the Ranking Minority Member Ms. Waters for her opening statement.

    Ms. WATERS. I thank you very much, Chairman Bachus. I would like to be somewhat brief in my opening remarks to allow time to hear from the witnesses.

    First of all, I really do want to thank you for calling this hearing, and I look forward to working with you on Federal deposit insurance reform. I want to commend Chairman Tanoue for her work on this issue. She has worked very hard to produce a comprehensive analysis of the strengths and weaknesses of the deposit insurance system, and I think she and her staff have given their time and attention to this issue than anyone since Congressman Henry Steagall, who was the original architect of the system in 1932. It was his infamous partnership with Senator Carter Glass that produced the system we know today, as well as other aspects of banking law that we won't necessarily be talking about today.

 Page 5       PREV PAGE       TOP OF DOC
    In any case, deposit insurance has served America well for over 65 years. It has maintained public confidence in our banking system throughout times of prosperity and times that weren't so good. It is important that we examine these issues closely in order to maintain and strengthen today's system for tomorrow's consumers.

    I look forward to hearing the testimony of the witnesses so that we can ensure that we have a deposit insurance system that will serve us well throughout the new millennium.

    I thank you very much, Mr. Chairman, and I yield back the balance of my time.

    Chairman BACHUS. Thank you.

    Mr. Baker.

    Mr. BAKER. Thank you, Mr. Chairman. I want to compliment you for bringing this subject to the subcommittee's attention and conducting this hearing this morning. My concerns go to the basic fairness of the current system, and I have read with considerable interest past studies of how the current system has been constructed and the consequences of it.

    For example, there are a significant number of new institutions de novo who have enjoyed full and complete insurance coverage without contributing a penny toward the cost of that premium expense, while at the same time there are those institutions which have been operational for many years, operating at relatively low risk levels, that endured the difficult years of the S&L bailout and repayment of obligations not of their own making.
 Page 6       PREV PAGE       TOP OF DOC

    And in looking at the statutorily created risk categories, the difference between the profile of the most risky institution and the least risky institution, there is no differential in premium paid because they pay nothing. There seems to be little incentive in the current regime to operate prudently, safely and conservatively.

    My view is that there should be some modest increase in the amount of coverage provided today, given inflationary factors, but we should be very careful as we move forward in increasing exposure for the taxpayer.

    However, as to whether someone deposits their funds at a small institution or one of the largest, there should be no disparity in the coverage given to the depositor, so that there should be a uniform system from the depositor's side.

    However, I would like to know the view of the FDIC with regard to one particular recommendation. I believe the agency has evaluated in past years with regard to coinsurance. And perhaps in looking at the market where you have 10 percent of the institutions that represent potentially 90 percent of the exposure to the fund, perhaps a different premium structure than we currently view today with regard to coinsurance, where the larger institutions perhaps would contribute significantly more in premium to those that represent no risk to the fund ultimately.

    My basic question, then, Ms. Tanoue, is can you comment on the possibility and usefulness of risk sharing, either through reinsurance or other means, in determining an adequate price for deposit insurance; and second, if such arrangement could, in fact, be useful to limit the Government's exposure in a potential institution's failure?
 Page 7       PREV PAGE       TOP OF DOC

    Chairman BACHUS. I am sorry. We are still in opening statements, Mr. Baker.

    Mr. BAKER. I am sorry. Rhetorically. Thank you, Mr. Chairman.

    Chairman BACHUS. Mr. LaFalce.

    Mr. LAFALCE. Thank you very much, Mr. Chairman.

    Today, the American deposit insurance system appears sound, with surpluses in both the BIF and the SAIF above the statutory minimum reserves. However, the current system contains features, many enacted during the banking and thrift crises of a decade ago, which do not represent optimal public policy. Therefore, it is very appropriate for you to have this hearing and for Congress to examine the structure of this system to ensure that it provides the protection of depositors and taxpayers that it should.

    The FDIC recently issued a comprehensive report on the deposit insurance system. In examining the need for reform, Congress should thoroughly review all of the issues identified in the FDIC report and other relevant analyses of the current system.

    In my view, a priority should be the merger of the BIF and the SAIF. This would clearly benefit the deposit insurance system by creating a single more diversified fund that is less vulnerable to a regional economic problem.

 Page 8       PREV PAGE       TOP OF DOC
    In addition, a merger of the funds would more accurately reflect the reality of today's financial services industry, in which over 40 percent of the SAIF deposits are held by commercial banks and FDIC-regulated State savings banks. But I am increasingly of the opinion that the ultimate stability of any combined fund would be dependent on the adoption of a more effective risk-based premium system.

    Part of the unfortunate fallout of the banking and thrift crises is the current FDIC recapitalization provision that requires the FDIC to impose a 23-basis-points assessment if one of the FDIC funds falls below the required reserve ratio and the funds cannot be recapitalized in a year. Such a mandatory assessment could come precisely at the wrong time during an economic downturn.

    Chairman Greenspan recently expressed concern about precisely this aspect of the current system, and the FDIC has put forward meaningful recommendations to deal with this problem. The change in this approach should be a part of any deposit insurance reform legislation.

    Another priority should be a reexamination of the current risk-based system in which over 92 percent of all banks and thrifts have paid no deposit insurance premium since 1996. This zero premium creates a poor set of incentives for risk-taking that would not exist if pricing were more accurately tied to risk.

    Additionally, the zero premium situation permits institutions with dramatic deposit growth to significantly increase the amount of funds protected by the deposit insurance system without compensating the FDIC.

 Page 9       PREV PAGE       TOP OF DOC
    Many in the industry are understandably concerned that the current pricing system allows institutions with large growth in deposits to spread the cost of the increased exposure to the other members of the system. And this, too, is clearly another issue that deserves attention in our discussion.

    Now, some banks, especially community banks, and a number of Members of Congress have called for an examination of the level of deposit insurance coverage. I am not yet convinced of the wisdom of this, and the burden of proving either the necessity or desirability of such an increase rests, it seems to me, on the advocates of an increase. However, this is clearly a very important issue for the banking industry, particularly those community banks that rely more on core deposits for funding. Then it is also an important issue for many consumers who wish to ensure their savings are secure.

    This subcommittee in Congress should give due consideration to their concerns, but we must also give great consideration to the views of those such as Chairman Greenspan, former Secretary of the Treasury Summers, and so forth, who believe that an increase in the level of coverage will increase the moral hazard within our deposit insurance system. There may be a way to increase the coverage, but also at the same time better assessing both risk and the premiums necessary for that risk. I look forward to a thoughtful exploration of this issue.

    Any debate on comprehensive deposit reform must also inevitably include a discussion of the proper level of reserves of the FDIC. In determining the proper level for the FDIC's reserves and insurance premiums, policymakers must strike an appropriate accommodation between many objectives, and at least two: first and most importantly, ensuring that the FDIC is able to meet its obligation to depositors, while protecting taxpayers, and that might well include paying for the costs and examinations and supervision by regulators other than the FDIC; and second, minimizing transfers of capital from the thrift and banking industries where that capital can be used to fund business loans, mortgage and other consumer credit needs. The current approach that is a hard 1.25 ratio may not best achieve an appropriate balance.
 Page 10       PREV PAGE       TOP OF DOC

    And I look forward to hearing the testimony of the FDIC Chairman and other witnesses. I thank the Chair very much.

    Chairman BACHUS. Thank you.

    Are there any Members on the Majority side that wish to be recognized? Not so.

    Ms. Carson.

    Ms. CARSON. Thank you very much, Mr. Chairman, for convening this hearing. I look forward to the panelist testimonies. I thank them for their presence. I am especially pleased to see here again my good friend Mr. David Bochnowski from the State of Indiana, who will be testifying on the second panel. He brings to this hearing a wealth of experience, a lifetime of public service dedicated to the people of Indiana and the United States, and I certainly thank him for attending today.

    Mr. Chairman, Members of the subcommittee, since the 1930's, the full faith and credit of the United States has stood behind $3 trillion of insured deposits at banks and savings associations. Although Congress has only modified the system twice, once in 1989 and again in 1991, in response to financial crisis, there has been a renewed effort to reform the current system.

    In August of last year, FDIC Chairman Donna Tanoue—I hope I didn't mispronounce your name—released an 84-page overview of options on deposit insurance reform position paper, which was opened to public comment until the beginning of this year. The FDIC in the paper described in detail several possible approaches to reform the deposit insurance system without advocating any of them, except to recommend the merger of the Bank Insurance Fund, BIF, and the Savings Association Insurance Fund, SAIF.
 Page 11       PREV PAGE       TOP OF DOC

    Today, we are faced with a very different report. One which takes a strong stance on four key areas of reform, including the need to merge the BIF and the SAIF, the need to reform how deposit insurance is priced to reflect risk, the need to adjust insurance premiums, and the need to keep insurance coverage in line with inflation. However, while there is general agreement between FDIC, the banking industry and Congress on some of these issues, there are still areas that we need to address with specific care.

    Unlike the previous reforms of deposit insurance in 1989 and 1991, economic crisis is not acting as a catalyst. To an onlooker, concern over deposit insurance may seem to come at an unlikely time, at least as far as the U.S. banking industry is concerned. Banks are performing well, along with the U.S. economy, despite the slight slowdown, downturn, recently, and the industry has been stable in recent years. However, interstate banking restrictions have been lifted, and the barriers between commercial and investment banking are starting to fall.

    U.S. Banks are consolidating in record numbers, and the size and complexity of our largest banks are growing. While this consolidation and growth may not in itself be bad, one thing is clear. The loss of just one of these too-big-to-fail banks could pose an even greater systemic risk than before. Yet too much depositor protection could result in such banks taking too much risk.

    Having said this, we are faced with a unique opportunity, because we are not forced to reform deposit insurance because of an economic crisis. We have an opportunity to reform deposit insurance to avert future economic crisis. I stress again we must do it with care and develop a consensus within the banking industry on the right way to approach this issue.
 Page 12       PREV PAGE       TOP OF DOC

    There is general agreement that the BIF and the SAIF funds should be merged, and as my colleague Mr. LaFalce pointed out when he introduced his legislation to do this, the merger of the BIF and SAIF would clearly benefit the deposit insurance system by creating a single more diversified fund that is less vulnerable to regional problems.

    However, there has been a great deal of discussion within the banking industry as well as here in Congress over some of the other issues presented in the FDIC report. For example, if insurance coverage is to be kept in line with inflation, what is the appropriate year for beginning this inflation adjustment? The FDIC has pointed out that if the base year were 1980, when the limit increased from $40,000 to $100,000, the insurance level would be approximately $200,000 today to account for inflation. If 1974 was chosen as the base year, when the limit was increased from $20,000 to $40,000, the new limit would be approximately $135,000.

    Both Senator Phil Gramm and Mr. Greenspan initially expressed opposition at setting the level at $200,000, and there were also many bankers who were very concerned about the loss of the current buffer above the 1.25 reserve ratio and a potential for premium increases that would accompany a doubling of the insurance limit. There were also bankers who expressed concern about the political price that would have to be paid if such an increase were to be enacted.

    We must also consider the problems associated with effectively pricing deposit insurance to reflect risk. We must establish which financial institutions currently pay FDIC insurance premiums and which ones do not. Are the distinctions reasonable, or should they be changed? How can we as policymakers toughen risk-based premium pricing but still ensure that it is fair? It is my understanding that many banking industry trade—officials—and there is one more point that I want to make, and that is for community bankers who believe insurance reform will help them compete with larger banks and want to FDIC to increase the coverage to $200,000.
 Page 13       PREV PAGE       TOP OF DOC

    I am sorry, Mr. Chairman, that I extended my time, but I appreciate the opportunity to make a few points. Thank you.

    Chairman BACHUS. Are there any other Members that wish to be recognized?

    All right. At this time we will introduce our first panel, which is made up of one panelist, the Honorable Donna Tanoue, Chairwoman of the Federal Deposit Insurance Corporation, whose report, as she says, has raised some yellow flags, and we look forward to hearing from you, Ms. Tanoue. And as I have told you privately, if you want to take longer than 5 minutes, that would be fine.


    Ms. TANOUE. Thank you. Mr. Chairman, and Members of the subcommittee, on behalf of my colleagues at the FDIC, I want to extend our sincere appreciation for the subcommittee's recognition of the importance of Federal deposit insurance reform and for your holding hearings today.

    Chairman BACHUS. Chairwoman, if you would move the mike a little closer.

    Ms. TANOUE. OK.
 Page 14       PREV PAGE       TOP OF DOC

    In addition, we appreciate the efforts of several Members of the Congress who have introduced or cosponsored legislative initiatives addressing deposit insurance issues. We believe strongly that these efforts will stimulate and further advance the debate.

    Deposit insurance plays a vital role in promoting financial stability. As a recent survey by the Gallup organization showed, the security that Federal deposit insurance provides is a very important and continuing consideration when Americans weigh where to place their money.

    This morning I would like to talk about why reforming our deposit insurance system is important, why reform should be addressed now, what our recommendations are, and why reform of deposit insurance should be comprehensive.

    Why is reform important? As good as it is, our current system has certain flaws, some of which undercut the very purpose for which deposit insurance was created. Under our current system, 92 percent of the insured institutions pay no premium for coverage. Because deposit insurance has been free for most of these institutions, our current system distorts incentives. The results? More than 900 institutions, or about 1 out of every 10 institutions in our country, have never paid premiums. Major investment firms have begun sweeping large dollar volumes of brokerage accounts into deposit accounts in their FDIC-insured subsidiaries.

    In addition, underpriced deposit insurance also may promote moral hazard, the incentive for insured institutions to engage in riskier behavior than they might otherwise in the absence of deposit insurance.
 Page 15       PREV PAGE       TOP OF DOC

    Our current system could also have a harmful economic side effect, a procyclical bias, that is, a tendency to make an economic downturn longer and deeper than it might otherwise be. How is that? During a severe downturn, the current statutory framework would require that the FDIC charge banks high premiums, thus limiting the availability of credit to communities when they need it most, and thus impeding economic recovery.

    If we don't reform our system, it is likely to take a toll on the safety and soundness of the banking industry and on the economy, because a premium increase would hit when banks are less healthy and losses might be depleting the insurance funds.

    Why do we advocate deposit insurance reform now? Despite some recent trends that are of some concern, both the economy and the banking industry remain strong. We need to address the flaws in our deposit insurance system now, without the pressures and distractions that a downturn would bring or the urgent demands for action that might arise during a crisis.

    We at the FDIC have five recommendations. Recommendation number one: the FDIC should be permitted to charge all institutions premiums on the basis of risk. Insurers generally price their product to reflect the risk of loss. Today, because more than 92 percent of our insured institutions are in the FDIC's best risk category and paying no deposit insurance assessment, our premium system is ineffective in capturing and curbing risk.

    Recommendation number two: change the law to eliminate sharp premium swings. If the fund falls below a target level, the law should allow premiums to increase gradually. Charging premiums more evenly over time, allowing the fund to absorb some losses temporarily, and increasing premiums more gradually than is required at present would soften the blow of an economic downturn.
 Page 16       PREV PAGE       TOP OF DOC

    Recommendation number three: give the FDIC the authority to rebate portions of deposit insurance premiums based on past contributions to the fund when the fund is above a specified target level. Tying rebates to the current assessment base would increase moral hazard. Fairness dictates that rebates should be based on past contributions to the fund. Allowing the FDIC to pay rebates would create a self-correcting mechanism to control the growth of the fund. The higher the fund gets, the larger the rebate. Thus, should the fund continue to grow, rebates eventually might exceed assessment income and provide a break on the growth of the insurance fund.

    Recommendation number four: merge the Bank Insurance Fund and the Savings Association Insurance Fund. As I am sure many of you are aware, the FDIC has made this recommendation for a number of years, in large part because the resulting fund would be stronger and more diversified.

    Recommendation number five: index deposit insurance coverage for inflation so that depositors do not see the real value of their coverage erode over time. While Congress should decide on the initial coverage level, indexing would provide a systematic method of maintaining the real value of deposit insurance coverage.

    In closing, I would like to emphasize that it is important for these recommendations to be implemented and to be considered and implemented as a package. Picking and choosing among the parts of our proposal could weaken the deposit insurance system, magnify economic instability and distort economic incentives. In particular I can't emphasize enough that the ability to price for risk is essential to an effective deposit insurance system and must be included in any reform package.
 Page 17       PREV PAGE       TOP OF DOC

    Thank you, and I am happy to address any questions or comments that you might have.

    Chairman BACHUS. Chairman Tanoue, I will lead off the questioning, and I think we are all concerned about a possible erosion of the ratio below $1.25. And you have pointed out several factors where that may happen. One, you have talked about the addition of new deposits. Sort of looking at the figures—at least up until 6 months ago, the infusion of new deposits hasn't brought down that ratio that much as it seems to be—is it about $1.35?

    Ms. TANOUE. Yes.

    Chairman BACHUS. Go ahead.

    Ms. TANOUE. That is true. Some recent examples of rapid and dramatic growth, though, have made people more appreciative and more sensitive to how the factor of growth in deposits can affect the reserve ratio level. What we have tried to emphasize at the FDIC, however, is that it could be a potential combination of factors, perhaps a slowing of the economy, unanticipated or expensive bank failures and perhaps continued deposit growth. It is not inconceivable that those factors could combine to reduce the current cushion and perhaps to reduce the reserve ratio over time and, therefore, to cause the FDIC to charge very steep premiums.

    Chairman BACHUS. Have you noticed, we have had some periods of stock market volatility in the past year. We have had large shifts of deposits from some of the full-service financial institutions into insured deposits. Has there been any evidence that that has caused—has the ratio at times dropped three or four basis points, or has it pretty much been steady at a $1.35 ratio?
 Page 18       PREV PAGE       TOP OF DOC

    Ms. TANOUE. Some of the recent infusion of deposits into the system has caused a reduction in terms of several basis points, but I would like to emphasize that the issue of rapid growth is on the minds of many. The FDIC has made several recommendations to address this issue of rapid growth. And we would do so first by recommending that all insured institutions pay premiums based on risk, including those that are growing rapidly. If that growth—and I would underscore ''if''—if that growth presents additional risk exposure to the fund, then we would recommend that premiums reflect that additional exposure.

    In concert with the recommendation to charge all institutions based on risk, we are recommending that rebates be paid if the fund meets the target level that is established or deemed essential by the FDIC and that those rebates take into consideration past contributions to the fund. We would recommend that such rebates not be made based on the current assessment base, because we think that would create some perverse incentives. In other words, you might have a situation—if you use the current assessment base for your rebate methodology—you might have a situation where you are encouraging growth and actually rewarding institutions that are growing rapidly, but may not have made past contributions to the fund.

    Chairman BACHUS. You have mentioned that if the ratio fell below $1.25 or 1.25 percent, that it could trigger—well, it would, if it was not recapitalized within a year—a 23-basis point premium, and you further said that that could trigger a $65 billion loss of ability to loan money. Would you give me some basis for the $65 billion figure?

 Page 19       PREV PAGE       TOP OF DOC
    Ms. TANOUE. Yes. The current statutory framework envisions a situation if the fund falls below the 1.25 designated reserve ratio, and the fund isn't recapitalized within a year, the FDIC would be required to charge premiums as steep as 23 basis points. We are recommending, again, that institutions be charged premiums based on risk, but I would like to emphasize that we are not trying to increase the assessment burden. We are trying to allocate the existing assessment burden more evenly over time. So we would avoid that kind of premium volatility.

    We believe that if institutions could pay small, steady premiums over time, they would be able to manage their operational expenses better and, again, avoid a situation where during tougher economic times, they might be called upon to pay such steep premiums, thereby taking monies out of the economy and taking monies away really at a time when communities would really need money for credit extension most.

    Chairman BACHUS. I guess my question was the $65—you mentioned there might be a $65 billion reduction in lending.

    Ms. TANOUE. Yes.

    Chairman BACHUS. And was that based on the cost of the premiums?

    Ms. TANOUE. That is based, yes, potentially on the steep increase in premiums during a downturn.

 Page 20       PREV PAGE       TOP OF DOC
    Chairman BACHUS. My time has expired, but I would also be interested in whether you have any evidence—and I want to ask this as a question—any evidence that fast growth in and of itself increases risk, whether you have focused on that, or whether charging premiums to fast-growing institutions is more a question of fairness as opposed to risk?

    Ms. TANOUE. I would say that fast growth in and of itself is not risky, per se. At the FDIC we would look at fast growth in combination with other factors, capital, assets, management, the quality of an asset portfolio.

    Chairman BACHUS. Thank you.

    Ms. Waters.

    Ms. WATERS. Mr. Chairman, we all must be concerned about whether or not we are going to take resources away from consumers, that whether or not the recommendations that you are making would place consumers who would need loans, need to have access to the resources of the banks, in jeopardy here, and I guess, you know, what I would like you to respond to that a little bit more, and I would also like to understand a little bit better your discussion about how you determine risk. You make the case that the risk now is determined for the short term rather than the long term, and you believe that it should be looked at over a longer period of time. I would like you to explain that a little bit better, and I would also kind to like the ask the question that if under the present system we have a surplus, we have excess to the point of rebate, then what is so terribly wrong with it?

 Page 21       PREV PAGE       TOP OF DOC
    Ms. TANOUE. Well, perhaps I could take that last issue first. In terms of the size of the fund, an appropriate level of the fund, the FDIC would conduct an analysis based on expected loss presented by the institutions that are insured by the fund, but there is always a tradeoff between the size of the fund, ensuring that the fund is sufficient and adequate to protect taxpayers, and also ensuring that the fund doesn't grow so large that funds over and above, say, the level that is deemed necessary by the FDIC might not be otherwise returned to institutions to be put back into the communities for community lending.

    In terms of assessing risk, that is our job basically, and we have put forward in the recommendations an example of how we might assess the risk exposure of institutions, particularly the small institutions. And we consider a number of factors, including supervisory ratings based on examinations as well as a number of different types of financial ratios.

    Going back to the earlier point that you made, one of the central features of our recommendation is to avoid the potential premium volatility that exists potentially under the current statutory framework. We want to, again, allocate the assessment burden of our institutions more evenly over time and to avoid a situation where we might be calling upon them to pay premiums again as high as 23 basis points at a time when the economy might be suffering a sharp downturn.

    We believe that if you moderate the premiums more slowly and steadily over time, you would avoid that type of sharp premium increase at the roughest part of the economic cycle, and we would avoid a situation where we are exacerbating the economic downturn by extracting large sums of money from insured institutions at a time when communities might need that money for lending purposes and also to help an economic recovery.
 Page 22       PREV PAGE       TOP OF DOC

    Mr. WELDON. [Presiding.] The gentlelady yields back her time.

    The hearing will stand in recess for a vote on the floor of the House and reconvene in about 10 minutes.


    Chairman BACHUS. The hearing will come back to order.

    Mr. Gillmor, you are recognized for questions.

    Mr. GILLMOR. Thank you very much, Mr. Chairman and Madam Chairwoman. I would like to just ask you to comment on the question of municipal deposits. Concerns that I hear expressed on a number of occasions in my district are from local communities who would like to put public funds into their local financial institutions, but because some of these institutions are relatively small and also because of the FDIC coverage limit, they have to put the money in some other institution outside the community. This is detrimental because it takes money out of the community, which could be utilized there. I am—along with some other Members—considering legislation that would extend the level of insurance for municipal deposits in local banks. I would just like what ever comments you would want to make on that subject.

    Ms. TANOUE. Thank you. We have taken a look at the issue of raising coverage for municipal deposits. Raising the coverage level for this category of deposits could potentially provide banks with greater latitude to invest in other assets. Higher coverage level also might help such institutions be more competitive for public deposits. But the collateralization requirements that are placed by different States also place limits on the ability of riskier institutions to attract public moneys, while a higher deposit insurance coverage level might not. And I would also point out that giving higher coverage or full coverage for municipal deposits might also relieve some of the State treasurers or community treasurers from having to vigorously monitor local institutions or financial institutions, and that might result in a loss of some level of depositor discipline. But having said that, I will say that there are obviously potential benefits as well as consequences of favoring these types of deposits with higher coverage levels and the full potential benefits and consequences are not yet certain. It is our view that this issue should be looked at further, analyzed further and discussed with the parties that have a stake in the system.
 Page 23       PREV PAGE       TOP OF DOC

    Mr. GILLMOR. If I might attempt to characterize your response, I guess I would say if this is accurate, it is cautiously favorable, but we still want to look at it; is that pretty close to on the mark?

    Ms. TANOUE. I would say cautious.

    Mr. GILLMOR. But also favorable, we hope.

    Ms. TANOUE. I guess what I would also point out is that there are obviously other calls for higher coverage levels that might favor other classes of depositors, and these will all present issues for Congress to consider. Some people are asking for higher coverage for certain types of retirement accounts, and we could anticipate that the calls for higher coverage for different categories might expand. Those might include deposits by charities or savings for college You would have to take a hard look from a public policy standpoint at the potential benefits and consequences.

    Mr. GILLMOR. Well, I think my time is about to expire, but I might say, I think you can find a lot of worthy types of deposits, but the one thing that distinguishes this category of deposits from others is that it is local money raised in that community, which may not be the case with other deposits, and the failure to provide that protection is taking money out of those communities, which means small businesses aren't getting loans, which means that some home mortgages aren't being made. So I think there is a little bit of a distinguishing character to these types of deposits, but I appreciate your comments.

 Page 24       PREV PAGE       TOP OF DOC
    Chairman BACHUS. Would the gentleman yield?

    Mr. GILLMOR. Yeah, I yield.

    Chairman BACHUS. I would also say, Chairman, you talked about moral hazard, or that this may encourage some lack of supervision, but I would focus on the fact these are community banks, and these would be the cities in which they do business, and I would think those cities would probably be more aware of those banks and the soundness in that there would probably be a local board of directors, and they would probably be well qualified to make judgments on the soundness of the bank, you know.

    Ms. TANOUE. Again, we would want to look hard and we probably want to do more analysis on any potential significant increase in deposit coverage for any new category of expanded deposit insurance coverage.

    Chairman BACHUS. I am not sure these cities now are depositing their moneys with different banks, so I think they would simply be transferring a lot of that money into banks, into the city, would try to invest it or deposit it in their own city or in their own county to ensure that it was loaned within their own communities. But we may further explore this with you with some.

    Ms. TANOUE. We would be happy to discuss it further.

    Mr. Chairman, if I could, you had asked me a question earlier about the $65 billion potential contraction in lending, and I was wondering if I might call up one of my staff members to explain how we calculated that.
 Page 25       PREV PAGE       TOP OF DOC

    Chairman BACHUS. Certainly.

    Ms. TANOUE. And to explain it more directly, if I could ask Fred Carns who is with our Division of Insurance.

    Chairman BACHUS. If you could just identify yourself for the record. I know the Chairman just did that.

    Mr. CARNS. I am Fred Carns, Associate Director of the Division of Insurance with the FDIC. Just in simple terms, the $65 billion, a 23 basis-point assessment with today's total deposits of about $4 trillion would result in about $9 billion in assessments from that 23 basis point rate, and then with the industry's average capital ratio in the neighborhood of 14 percent, that translates into lending of about 7 times that amount, or somewhere in the neighborhood of $65 billion.

    Chairman BACHUS. Thank you.

    Ms. TANOUE. Thank you, Mr. Chairman.

    Chairman BACHUS. Mr. Watt.

    Mr. WATT. Thank you, Mr. Chairman. And I thank the Chairwoman for being here today. Right at the outset of your prepared comments, you expressed appreciation to the efforts of Members of Congress who have introduced or cosponsored legislative initiatives addressing deposit insurance and applauded those efforts which stimulate and further advance the debate. I happen to be one of those people as cosponsor of H.R. 557, which acknowledges that there is an excess in the deposit insurance fund and advocates first the application of that excess to FICO assessments, and then subsequently to rebates after the FICO bonds have been paid off. I notice that you have, I guess, pretty much for the first time, acknowledged the possibility that there might be value to some rebates, and I won't ask you to comment particularly on our bill. I want to go through and compare how your recommendations match up with the bill, but I am delighted to see that you have acknowledged that rebating some of these excess insurance deposits might help us get more money into the lending process, and I take it that is what this last set of comments was about in response to the Chairman's questions.
 Page 26       PREV PAGE       TOP OF DOC

    Let me ask a question about, just for my own edification, the banks that are currently exempt from paying insurance, paying into the insurance fund, I take it that that was, that is based on some analysis of that those banks don't substantially contribute to risk. How does that correspond with the movement toward a risk-based analysis to get to assessing the premium?

    Ms. TANOUE. Well, essentially, in 1996, when the Congress passed the legislation recapitalizing the SAIF and the BIF, the Congress chose to limit the FDIC's discretion to differentiate among its institutions and to charge premiums to those institutions that are basically rated one or two. So under the current law, the FDIC can only charge premiums to institutions that are rated 3, 4 or 5.

    Mr. WATT. Isn't that, in and of itself, a somewhat of a risk-based system that Congress has put in place? Isn't that a determination that banks that are rated 1 and 2, much, much less likely to contribute to a draw on the insurance fund?

    Ms. TANOUE. Congress did envision a risk-based premium system, and as I testified earlier, our system is painfully and obviously deficient. In terms of the 1- or 2-rated institutions that fall within the best category for insurance purposes, I would want to emphasize that you can't assume that a 1- or 2-rated institution does not present risk to the fund.

    Mr. WATT. How do they get to be 1 or 2, then, if they are presenting risk?
 Page 27       PREV PAGE       TOP OF DOC

    Ms. TANOUE. Well, I would mention that our studies show that in looking back over historical periods, 2 years prior to failure, almost 47 percent of the institutions that failed during the crisis period had ratings of 1 or 2, and if you look 3 years prior to the failure, over 60 percent of the banks are rated 1 or 2. We have further studies that also show that the 5-year failure rate for CAMELS 2-rated institutions since 1984 was more than 2 1/2 times the failure rate for 1-rated institutions.

    So again, I think there is a great deal of information that shows that institutions, even if they are rated 1 or 2, do present risk. And our point is that currently, our system doesn't distinguish among those institutions. Again, more than 92 percent of the industry, thousands and thousands and thousands of institutions, do not pay premiums even though there are large and discernible and identifiable differences in terms of risk exposure among those institutions. And so essentially you have those institutions that are less risky subsidizing those that are riskier.

    Mr. WATT. I than think my time is expired although the clock seems to move faster. Maybe if I just talk slower.

    Chairman BACHUS. We have actually two clocks.

    Mr. WATT. I yield.

    Chairman BACHUS. Thank you, Mr. Watt.

 Page 28       PREV PAGE       TOP OF DOC
    Mr. Weldon.

    Mr. WELDON. Thank you, Mr. Chairman. Madam Chairwoman, on the issue of rebates, you have testified that they should be based on past contributions to the fund and not on current premium assessments. What is your recommendation to us as to how those rebates should be calculated? For example, what I am talking about, the banks that helped recapitalize the BIF and the SAIF, should they be entitled to a greater refund if there is going to be a rebate than, say, those who did not contribute to that recapitalization?

    Ms. TANOUE. There are a number of ways that the FDIC could develop rebate methodology, but again, one of our most important recommendations is that rebates be based on past contributions to the fund, and that would mean essentially that those institutions that helped to build the fund over time would see rebates earlier and in larger amounts.

    Mr. WELDON. What about those institutions that have contributed nothing to the fund?

    Ms. TANOUE. Those institutions would, assuming the risk-based premium system is put into effect and all institutions are charged premiums, those institutions, once they started putting money into the system, would eventually over time earn the right to attain rebates.

    Mr. WELDON. Some people would advocate retiring FICO bonds early as opposed to issuing rebates. Can you comment on that?
 Page 29       PREV PAGE       TOP OF DOC

    Ms. TANOUE. Yes, our recommendations basically would recommend rebates once target levels of a fund are met, but we would leave it to the institutions themselves to decide how to use those moneys once they are rebated. Now I know that there is the bill that Congressman Lucas mentioned, H.R. 557, that would use funds above a certain level to pay for the FICO obligation. I would emphasize that that bill would not base rebates on past contributions. Old members of the fund would benefit from reduced FICO payments, even those that had never paid a penny in terms of insurance assessments.

    Mr. WELDON. You talked about indexing insurance coverage, and I think you also mentioned increasing the limit. Should we do both, increase the limit and index? Which do you think is more important: indexing it or increasing the limit if we are going to increase the limit on FDIC, the size of FDIC insurance?

    Ms. TANOUE. Our recommendation really goes only to recommending indexation of the current coverage level. We believe that Federal deposit insurance is a valuable program and confers a valuable benefit. And like other important Federal import programs like Social Security and Medicare, those benefits are indexed to inflation, and so Federal deposit insurance coverage should be as well. As to increasing coverage levels, that is a public policy decision that we would leave to Congress. We would point out, however, that you can index based on different points, from 1974, 1980, or you could start from today and those would result in very different coverage levels over time. I would also want to emphasize that in looking at any potential increase in coverage, we would strongly recommend that one part of any package of recommendations must be the putting into place of an effective risk-based premium system which would lend itself to mitigating any concern about increased moral hazard as a result of increasing coverage levels.
 Page 30       PREV PAGE       TOP OF DOC

    Mr. WELDON. And finally, can you comment for me on the too-big-to-fail doctrine? Do you think this permits certain large institutions to take on too much risk?

    Ms. TANOUE. We have not addressed the too-big-to-fail issue, or the issue of systemic risk directly in our recommendations. There has been some concern that there is implicitly greater coverage for those institutions that are very large in size, and we would not recommend at this time charging premiums that would take such a factor into consideration.

    Mr. WELDON. Thank you very much. Mr. Chairman, I believe my time has expired.

    Chairman BACHUS. Ms. Hooley.

    Ms. HOOLEY. Thank you, Mr. Chairman.

    Madam Chairwoman, some people and some regulators have testified that the current zero premium creates improper incentive s for bankers to take risk. Do you agree with this, and can you explain why?

    Ms. TANOUE. I do think that when you have a zero-based deposit insurance premium, that that can sometimes create the wrong incentives or create no incentives. We believe that it might increase the tendency of some institutions to take more risk, to engage in riskier activities than they might otherwise, if there was a risk-based premium system in place, a truly effective system in place.
 Page 31       PREV PAGE       TOP OF DOC

    Ms. HOOLEY. Is that problem more acute when the economy is in a downturn, or does that, do you think that has an impact at all?

    Ms. TANOUE. I think it is an issue regardless of the economic circumstances.

    Ms. HOOLEY. So you think that banks will take more risk, and it doesn't really matter whether the economy is in a downturn. Is that what I heard you say?

    Ms. TANOUE. Well, if the institutions are not paying anything in premiums, that would probably exacerbate the impact on the economy.

    Ms. HOOLEY. OK. Do you think it will have a negative impact on the economy?

    Ms. TANOUE. It could potentially have a negative impact, yes.

    Ms. HOOLEY. OK. Thank you. I yield back the rest of my time.

    Chairman BACHUS. Thank you. Mr. Toomey. Ms. Hart.

    Ms. HART. I have no questions.

    Chairman BACHUS. Mr. Grucci, do you have questions?
 Page 32       PREV PAGE       TOP OF DOC

    Mr. GRUCCI. No, sir.

    Chairman BACHUS. Mrs. Roukema.

    Mrs. ROUKEMA. All right. I will take the opportunity, and I do apologize for not being here for your full testimony. There were unavoidable conflicts so you may have already addressed this, and I must say that I am not fully apprised of the totality of Chairman Greenspan's statement, recent statement, and it was reported in the paper the other day. I believe he recommended a regulatory policy that would quote: ''flatten out or even reverse the cyclicality of the current system.''

    Did you address that question, or what is your reaction to Chairman Greenspan's statement, and what is the implications of it? I am not quite sure I understand it in its totality, and when Chairman Greenspan speaks, many of us listen. Could you assess that for us or give us an initial reaction?

    Ms. TANOUE. I think our recommendations are very consistent with what Chairman Greenspan was talking about there. One of the key features that we focus on in our recommendation is the potential procyclical bias that our system has and that we would charge institutions potentially very steep premiums during a severe economic downturn, and our recommendations really go to avoiding that circumstance, avoiding charging institutions the highest premiums at a time when they are least able to pay, and we tried to allocate the assessment burden more evenly over time and to avoid such a procyclical bias in our system.

 Page 33       PREV PAGE       TOP OF DOC
    Mrs. ROUKEMA. So you feel that that is consistent with Chairman Greenspan's perspective and will resolve the problem and make it sound and secure?

    Ms. TANOUE. Well, we think that the recommendations that we have put forward would go a long way to strengthening the system.

    Mrs. ROUKEMA. All right, thank you. I will, of course, review your testimony. If there are further questions, I will submit them to you in writing, because this is certainly something that I believe strongly in, and I certainly am for merging the funds and want to work to make them secure for the future.

    Ms. TANOUE. Thank you.

    Mrs. ROUKEMA. Thank you.

    Chairman BACHUS. Mr. Bentsen, I want to apologize to you, I was down the list and I overlooked you earlier.

    Mr. BENTSEN. No apology necessary, Mr. Chairman. I was trying to remember everything I read about your invigorating testimony that I looked at.

    Madam Chairwoman, a couple of questions. It would look like what your study is—what the FDIC is proposing is to move to a more of a subjective-based premium, risk based premium, and a subjective reserve ratio, and as I read through your testimony, in looking at the example that you go through in the back, is it the idea would be, if I understand correctly, is to reinstate a premium on all insured deposits, and then adjust that premium based upon some risk analysis that the FDIC comes up with. And then on top of that, assuming that the total DRR is between, say, 115 and 135, then lay back a rebate of 30 percent to insured depository institutions based upon first, or maybe only their history and paying premiums, those that have paid, who have paid the most premiums would be first in line for rebates.
 Page 34       PREV PAGE       TOP OF DOC

    Is that generally a correct analysis? And is this just a model that you all are proposing, or one idea of how you would establish the structure, or is this the basic concept?

    Ms. TANOUE. We have put forth the basic concepts, and then we have put forth some numerical examples to illustrate how those concepts might work, but obviously these are designed to engender further discussion and further narrow the debate. One thing that caught my attention was when you mentioned subjective premium system and a subjective reserve ratio. We would be asking that the FDIC be given discretion to establish an appropriate range or target, appropriate level.

    Mr. BENTSEN. And that is fine. I will swap adjectives with you. ''Discretionary'' is probably a better adjective. I understand as opposed to a statutory DRR, but is the idea—I think your concept is interesting and I am sure some of the subsequent panelists will tell us what might be wrong with it, but it seems to me your idea sort of mirrors what our colleague from New Jersey just talked about with what the Chairman of the Federal Reserve had said, which is to establish sort of a current flow of funds so you don't have either a procyclical or countercyclical effect, if all of a sudden the economy turns downward and the fund starts to get hit, that you have to jack premiums up so high that you have a countercyclical effect coming out of the fund with everything else going on in the economy.

    And this way, given the FDIC, a substantial amount of discretion I would add would allow you basically to go back and say within this range of 115 to 135, everybody pays a premium to start, but then, based upon your payment history, not your payment history, but how long you have been paying premiums, and what I don't know is based upon, well, I guess your initial premium would be set.
 Page 35       PREV PAGE       TOP OF DOC

    Ms. TANOUE. Based on certain risk exposure, yes.

    Mr. BENTSEN. But the rebate, I am curious why the rebate would only be set on how long you had been paying premiums. I understand that, but why you also wouldn't look at some risk bases as well unless you think you have already accounted for that?

    Ms. TANOUE. There is a potential to incorporate risk-based factors into the rebate methodology as well. So, for example, whether a rebate should be given to an institution that is actually paying premiums, because it is in serious financial trouble that would be a factor that would have to be looked at as we further look at how to develop the rebate methodology.

    Mr. BENTSEN. It seems to me, and you sort of acknowledge this—I know my time is up. If I can just finish this point. You seem to acknowledge the historical aspect will go away as new funds are melded in and everybody will sort of equal out for the most part. So it would seem to me that you would want to have some risk basis associated with the rebate function so thank you. Thank you, Mr. Chairman.

    Mr. BAKER. [Presiding.] Thank you, Mr. Bentsen. Obviously Mr. Bachus stepped out for a moment, and fortunately I am next in line so I will recognize myself.

    You may recall this question from earlier comments. I have grave concerns about the basic equity of the current assessment requirements. The compression of the rating from the best to the least under the current regime seems not to reward conservative management, and in fact, there is no penalty of significance for being a bad operator in the current assessment of premium, much less the new entries into the market who paid nothing for 100 percent coverage plus the sweep account issue that you have talked about.
 Page 36       PREV PAGE       TOP OF DOC

    So in looking at the reconstruction of the insurance pool, I strongly recommend and support whatever the agency recommends in the way of appropriately assigning risk to the responsible parties, and then join those who suggest that some premium be assessed to everybody continually. I know that this is, to some extent, modestly controversial, but it is apparent that should we have significant downturn in our economic condition and a very small number of the very large institutions run into trouble, that we could rapidly dissipate the reserves that we have built up.

    However, my specific question is, and I have to read this to make sure I get it constructed properly, can you comment on the possibilities and usefulness of risk sharing, either through reinsurance or other means in determining an adequate price for deposit insurance; and second, if such arrangement could, in fact, be used to limit the Government's exposure in a potential institution's failure.

    And my point here is that we have talked internally in the office in looking at this issue, and reports generated by the FDIC of maintaining for the individual depositor, uniformity in the level of coverage, so when you walk in the bank, you don't know how the premium is paid or anything else. You just know that no matter where you are, you get the same coverage. But for those larger institutions which represent the bulk of the risk to the fund, coinsurance, some differing manner of assessment that brings about more market discipline in understanding the risk, those institutions really pose to the fund, and I don't know if you want to answer that today or get back to me at a later time.

    Ms. TANOUE. Well, let me just say that the FDIC shares your interest in exploring the potential for reinsurance and we think that reinsurance does have the potential to offer us additional information about how we might be pricing risk in terms of the institutions of various classes of institutions.
 Page 37       PREV PAGE       TOP OF DOC

    You may be aware that the FDIC, several months ago, contracted with a company for this very purpose, and essentially they have developed a prospectus, and we will be going to the market to ascertain what interest there might be in the private sector in this issue with the FDIC, and we would be happy to keep you apprised of the developments.

    Mr. BAKER. Thank you very much. I appreciate that.

    Mr. Moore.

    Mr. MOORE. I have no questions, Mr. Chairman.

    Mr. BAKER. Mr. Hinojosa.

    Mr. HINOJOSA. Thank you, Mr. Chairman. Thank you for coming to speak to our subcommittee. I was looking at your conclusions and you talk about the economy being strong and that there is a window of opportunity to make improvements to the deposit insurance system. I am pleased that you are proactive instead of reactive, and I want to address the part where you talk about, you say in particular, the ability to price for risk is essential to an effective deposit insurance system. I have concerns that I want to express to you, and that is that as you make the risk calculations for each of the banks and knowing that even if they have a rating of 1 and 2, that some of them could go under, I would like to see what your response is.

    What assurances can you give me that any policy decisions that are being made to change and improve the system will not hurt the smaller community banks, many of which I have in a congressional district like mine?
 Page 38       PREV PAGE       TOP OF DOC

    Ms. TANOUE. Well, let me just say as the primary supervisor for State chartered non-member institutions, we always have taken into consideration how proposals might affect institutions, and particularly community institutions, and let me also say that in developing any kind of methodology to assess premiums based on risk, it would be envisioned that the FDIC would have to go out for notice and comment through a public rulemaking.

    So in other words, the methodology that we might come up with would have to be put out for the public to comment on before any kind of rulemaking could occur.

    Mr. HINOJOSA. And how long would you have as a period to get input?

    Ms. TANOUE. Usually the rulemaking process allows for certain substantial periods of time to allow interested parties to comment fully.

    Mr. HINOJOSA. Give me an idea, would it be 90 days? 6 months?

    Ms. TANOUE. Excuse me just one moment. I was just checking as to whether the Administrative Procedures Act had some minimum timeframe and sometimes, apparently, it is usually about 90 days, but an agency can always provide for more time for public comment.

    Mr. HINOJOSA. Very well. Mr. Chairman, I have no other questions.

 Page 39       PREV PAGE       TOP OF DOC
    Ms. TANOUE. If I could just add one other thing. During this whole process that we have been looking at the deposit insurance issues, I would emphasize that the FDIC has worked very hard to provide for extensive outreach opportunities with the industry, and we have worked very closely and extensively with all the banking trade organizations and made a significant effort to be aware of their concerns throughout the process, and we would continue to do so.

    Chairman BACHUS. [Presiding.] Chairman, has any consideration been given to granting banks the power to, or the ability to purchase on an optional basis, additional insurance for municipal deposits?

    Ms. TANOUE. Yes. That subject was raised earlier and we have taken a look at that. We believe that conferring additional coverage for any category of deposits, including municipal deposits, does warrant further analysis and study and discussion with the parties.

    Chairman BACHUS. If we were able to calculate, if we had some preset level and a definition and it was limited to local deposits or to, in State deposits and the premium was calculated and would fully cover the additional risk to the insurance fund, would that address most of your concerns or your concern?

    Ms. TANOUE. You know, I am not sure at this point if higher coverage was to be provided for municipal deposit, what the potential impact or effect would be in terms of additional risk to the fund. But again, we are happy to look at that issue further and then get back to you.
 Page 40       PREV PAGE       TOP OF DOC

    Chairman BACHUS. When you look at it, could you also maybe look at the collateral requirements.

    Ms. TANOUE. Well, the collateral requirements vary from State to State, but we can take that into consideration as well.

    Chairman BACHUS. All right. Thank you.

    Mrs. Maloney.

    Mrs. MALONEY. First of all, I would like to thank Donna Tanoue for your service and leadership at the FDIC, and I wish you the best in all your future endeavors, and I certainly thank Chairman Bachus for holding this important hearing on modernizing the deposit insurance system.

    For over 65 years, our deposit insurance system has effectively maintained public confidence in the banking system during periods when financial institutions have been profitable and when they have suffered failures. As we consider modernizing the system, maintaining public confidence in our financial institution and guarding their safety and soundness must be our driving focus. We are fortunate to be considering this topic at a time when banks are highly profitable and well capitalized.

    At the same time, uncertainty about the future of the economy is a warning that the good times will not last forever. While the insurance funds are still comfortably above their mandated reserve ratios, the uncertainty about equity market has driven a substantial amount of funds into the banking system, increasing the deposit base. The possibility that this trend continues makes the need to merge the insurance funds even more timely.
 Page 41       PREV PAGE       TOP OF DOC

    I really want to compliment you on a very thoughtful proposal for the future of the insurance system, and I agree with the FDIC's position that a modern insurance system should include a general principle of risk-based pricing. But I would like to know, since today, we have 92 percent of our institutions do not pay for deposit insurance, yet many of these institutions have made substantial contributions in the past to the funds.

    Individually, many are highly rated for safety and soundness and are well capitalized. How do you balance the fact that risk-based pricing may be the future but that many institutions have a history of contributing to and stabilizing the financing of the funds?

    Ms. TANOUE. Again, I would emphasize that if you have a system as we do now where 92 percent of the institutions are assigned to the same risk category, you don't truly have a risk-based pricing system, and there are large and identifiable differences in terms of risk exposure among these institutions that are presently classified in the best category.

    Our recommendations include a recommendation to charge premiums for all institutions, but also coupled with that, we are recommending that when the fund meets certain targets or ranges that are established by the FDIC from time to time, that consideration be given to giving rebates back to the insured institutions to prevent the fund from growing overly large, and to make sure that funds are going back into the communities as appropriate.

    Mrs. MALONEY. So I know that you have suggested rebates, but would institutions, but would institutions that have contributed to the funds be subject to charges under this system?
 Page 42       PREV PAGE       TOP OF DOC

    Ms. TANOUE. Yes. We would recommend that all institutions again be charged based on risk, but in terms of the recommendation for rebates, the rebates would be based taking into consideration not the current assessment base, but past contributions. So it would be a very important consideration.

    Mrs. MALONEY. So you will take in consideration the past?

    Ms. TANOUE. Yes.

    Mrs. MALONEY. Thank you very much, and again, congratulations on your service to the country and we appreciate the proposal that you have put forward today.

    Ms. TANOUE. Thank you.

    Chairman BACHUS. This concludes——

    Mr. WATT. Mr. Chairman, could I, before you excuse the witness, make a brief comment?

    Chairman BACHUS. Mr. Watt.

    Mr. WATT. I just wanted to thank her for flattering me by confusing me with Mr. Lucas.

 Page 43       PREV PAGE       TOP OF DOC
    Ms. TANOUE. Excuse me, that is right. Because you mentioned the bill. I apologize.

    Mr. WATT. I would suggest to you that you might want to drop Mr. Lucas and apologize to him.

    Chairman BACHUS. One has a southern accent and the other has a Midwestern accent. The subcommittee does want to wish you well in your further endeavors and thank you for your service to the country and to the banking system.

    Ms. TANOUE. Thank you very much. I appreciate the opportunity to testify today. Thank you.

    Chairman BACHUS. This concludes our first panel and we will ask the second panel of witnesses, all of whom are veterans testifying before this subcommittee, to take their seats.

    The subcommittee would like to welcome the second panel. All of you gentlemen testified before us in March on business checking. We welcome you back. To my left is Mr. James Smith, chairman and chief executive officer of Union State Bank and Trust of Clinton, Missouri, also president-elect of the American Bankers Association, who will be testifying on behalf of the ABA; Mr. David Bochnowski, Chairman and Chief Executive Officer, Peoples Bank, Munster Indiana, we welcome you back. You are testifying as Chairman of America's Community Bankers; Mr. Robert Gulledge, President and Chief Executive Officer, Citizens Bank of Robertsdale, Alabama, Chairman of the Independent Community Bankers of America. Bob, welcome back to Washington.
 Page 44       PREV PAGE       TOP OF DOC

    At this time, Mr. Smith, we will start with you, not because you are an ex-New York Yankee.


    Mr. SMITH. I want to thank you, Mr. Chairman, for holding this hearing. Assuring that the FDIC remains strong is of the utmost importance to the banking industry. Over the past decade, the industry has gone to great lengths to ensure that the insurance funds are strong. In fact, with $41 billion in financial resources, the FDIC is extraordinarily healthy. The outlook is also excellent. There have been few failures and the interest income on BIF and SAIF easily exceeds the FDIC's cost of operation. Thus now is a good time to consider how we might improve an already strong and effective system.

    I would like to commend the FDIC under the leadership of Chairman Tanoue for developing an approach to the key issues. While we do not agree with every detail in the FDIC report and are particularly concerned about the possibility of increasing premiums, that provides a reasonable basis for congressional discussion.

    An industry consensus is key to any bill being enacted. As you will see today, while some differences remain the positions of the ABA, America's Community Bankers and the Independent Community Bankers of America are very similar. Our three associations have agreed to discuss the issues together and work with this subcommittee to develop legislation that would have broad support.
 Page 45       PREV PAGE       TOP OF DOC

    I would add that while there is willingness to work with Congress, we do have concerns that such legislation could increase banks' costs or become a vehicle for extraneous amendments. If that were to be the case, support among banks would quickly dissipate. In my testimony today, I would like to make several key points. First, today's system is strong and effective, but some improvements could be made. The current system of deposit insurance has the confidence of depositors and banks. Its financial strength is buttressed by strong laws and regulations, including prompt corrective action and enhanced enforcement powers, just to name a few. Even more important is that the banking industry has an unfailing obligation to meet the financial needs of the insurance fund. Simply put, the system we have today is strong, well-capitalized and poised to handle any challenges that we may encounter.

    Second, a comprehensive approach is required as improvements are considered. Because deposit insurance issues are interwoven, any changes must consider the overall system. A piecemeal approach would only leave some important reforms undone, but worse, could lead to unintended problems. Since last year, support for our comprehensive approach has clearly grown. We are pleased that the FDIC's proposal is comprehensive and acknowledges the important interactions between issues. A comprehensive reform system should include, among other things, a mutual ownership approach for determining rebates. Permanent indexing of the insurance limit, consideration of an increase in the $100,000 level, but one that does not result in significant cost that would outweigh the value of the increase. A higher level of coverage for IRAs and Keoghs, some method to address the issue of fast-growing institutions and a cap on the fund and expanded rebate authority.

    On this last point, I would like to thank Mr. Lucas and Mr. Watt for introducing their bill that caps the fund and issues rebates to pay the FICO premium.
 Page 46       PREV PAGE       TOP OF DOC

    My third point is that changes should be adopted only if they do not create material additional costs to the industry. The current system is strong, and we see no reason why changes should be made that impose significant new costs or additional burdens on the industry. For instance, the example used by the FDIC in its report would result in unacceptable premium increases for many banks. We see no justification for such increases when the insurance funds are above the required reserve ratio.

    Mr. Chairman, we are prepared to work with you and the Members of this subcommittee to pass a reform package that would enhance the safety and soundness of the deposit insurance system. Thank you.

    Chairman BACHUS. Thank you.

    Mr. Bochnowski


    Mr. BOCHNOWSKI. Thank you, Mr. Chairman. It is a pleasure to be here representing America's Community Bankers and to speak to you on deposit insurance reform. Our complete recommendations, which we provided to the FDIC last December, are included in ''Deposit Insurance Reform for a New Century, a Comprehensive Response to the FDIC Reform Options,'' which has been made available to this subcommittee.
 Page 47       PREV PAGE       TOP OF DOC

    Bankers do have varying views on deposit insurance reform, but let me assure you in this subcommittee that we are engaged in an open and constructive dialogue. The staffs of our respective associations have met to begin a more detailed discussion of our respective policy positions. The entire industry has every incentive to cooperate, because the safety and soundness of the deposit insurance system is important to our customers and the Nation's economic health.

    Under Chairman Tanoue's leadership, the FDIC took advantage of the health of our banking system and the banking climate to review deposit insurance issues. ACB commends Chairman Tanoue for taking this important initiative.

    The most urgent deposit insurance issue we face today stems not from any weakness in the system, but ironically, from its strength. A few companies are taking advantage of that situation by shifting tens of billions of dollars from outside the banking system into insured accounts at banks they control. The problem is not that the FDIC is holding fewer dollars, BIF and SAIF balances are stable, but that those dollars are being asked to cover a rapidly rising amount of deposits in a few institutions.

    The situation could get worse. Under current law, if a fund falls below 1.25 percent, the designated reserve requirement, and the FDIC does not expect it to return to that level within a year, all insured institutions would have to pay a 23-basis-points premium. For a community bank with $100 million in deposits, that equals $230,000.

    ACB believes that Congress should act quickly on legislation to help ensure the continued strength of the FDIC and prevent unnecessary diversion of billions of dollars away from communities that could go into home lending, consumer lending and small business lending.
 Page 48       PREV PAGE       TOP OF DOC

    A bill is before you today that would do just that. Representatives Bob Ney and Stephanie Tubbs Jones have introduced the Deposit Insurance Stabilization Act, H.R. 1293. It has three key features. First, it would permit the FDIC to impose a fee on fast-growing institutions for their excessive deposited growth. Second, it would merge the BIF and SAIF insurance funds, creating a more stable, actuarially stronger insurance deposit fund. And third, it would allow for the flexible recapitalization of the deposit insurance fund.

    Acting on this bill now would not preclude action on broader deposit insurance reform. In fact, H.R. 1293 is an excellent place to begin.

    We are pleased that many of the FDIC's recommendations are consistent with our own for comprehensive reform, but they differ in one key respect. We agree on merging the Bank Insurance Fund in the Savings Association Insurance Fund, giving the FDIC flexibility to gradually recapitalize the fund in the event of a shortfall and establishing rebates based on past contributions, as well as indexing coverage levels.

    However, unlike the FDIC, ACB does not believe that the highest-rated institutions should be required to pay premiums when there are ample reserves in the fund. Rather, as provided in the Ney-Tubbs Jones bill, ACB recommends that the FDIC have the authority to assess a special premium on excessive growth by existing institutions, such as Merrill Lynch, if necessary to preserve adequate reserves.

    ACB also recommends indexing the coverage levels to help maintain the role of deposit insurance in the Nation's financial system.
 Page 49       PREV PAGE       TOP OF DOC

    Congress should use as a base the last time it adjusted coverage primarily for inflation, which was done in 1974. Under that system, which was at $40,000 then, adjusted for inflation, the coverage limit would be approximately $135,000 today.

    To recognize the increasingly important role that individual retirement accounts play in the economy and in our pension system, ACB recommends that Congress substantially increase the separate deposit insurance coverage for IRA, 401(k) and similar retirement accounts. ACB also recommends that Congress set a ceiling on the composite insurance fund designated reserve ratio, giving the FDIC the ability to adjust that ceiling, using well-defined standards after following full notice and comment procedures.

    ACB appreciates the opportunity to present our views on these important issues. The deposit insurance system is strong today, but could be made even stronger. We hope that Congress will use the work the FDIC and the industry have done to craft legislation that will make the improvements necessary to ensure the continued stability of this key part of our Nation's economy.

    Thank you for this opportunity. I look forward to answering your questions.

    Chairman BACHUS. Mr. Gulledge.

 Page 50       PREV PAGE       TOP OF DOC

    Mr. GULLEDGE. Good morning, Chairman Bachus, Ranking Member Waters and Members of the subcommittee. My name is Bob Gulledge, and I am a community banker from Robertsdale, Alabama. I also serve as Chairman of the Independent Community Bankers of America, on whose behalf I appear before you today.

    Chairman Bachus, I commend you and Chairman Oxley for moving this important issue forward. It has been 10 years since the Congress last took a systematic look at the deposit insurance program. Now is the time, during a non-crisis atmosphere, to modernize our very successful Federal Deposit Insurance system. I have been asked to testify on the FDIC's impressive and comprehensive deposit insurance reform recommendations.

    First, deposit insurance coverage levels have been badly eroded by inflation and must be increased and indexed for inflation. Today, in real dollars, deposit insurance is worth less than half what it was in 1980 and even less than what it was worth in 1974 when the coverage was raised to $40,000. The charts and table attached to my written testimony illustrate this dramatic loss in real value.

    Higher coverage levels are critical to support local lending, especially to our small businesses and agricultural customers. They are critical to meet today's savings and retirement needs, especially with a graying population. A Gallup Poll showed that four out of five consumers think that deposit insurance should keep pace with inflation. And they are critical because many community banks increasingly face funding pressures, because funding sources other than deposits are scarce.

 Page 51       PREV PAGE       TOP OF DOC
    Examiners are warning against our growing reliance on Federal Home Loan Bank advances. We don't have access to the capital markets like the large banks do. In troubled times, we, unlike large banks, are too small to save.

    A recent Grant Thornton survey revealed that four out of five community bank executives believe higher coverage levels will make it easier to attract and keep core deposits. The ICBA strongly supports the Hefley bill in the House and the Johnson-Hagel bill in the Senate. Both bills would substantially raise coverage levels and index them for inflation. This feature of deposit insurance reform is essential for our support of the legislation.

    The ICBA supports full FDIC coverage for municipal deposits and higher coverage for IRAs and retirement accounts.

    The second issue that must be addressed is the free rider issue. Free riders, the Merrill Lynches and Salomon Smith Barneys, have moved more than $83 billion in deposits under the FDIC umbrella without paying a nickel in insurance premiums; and by owning multiple banks, they offer their customers multiple accounts and higher coverage levels than we can. This is a double-barreled inequity, which must be addressed.

    Third, a risk-based premium system should be instituted that sets pricing fairly. Currently, 92 percent of the banks pay no premiums. The FDIC says this is because the current system underprices risk. This proposal, as well as a proposal to charge premiums even when the reserve ratio is above 1.25 percent, will face controversy. But we believe that as a part of an integrated reform package, most community bankers would be willing to pay a small, steady, fairly-priced premium. In exchange, we would get less premium volatility and a way to make sure the free riders pay their fair share. The ICBA generally supports a risk-based premium system.
 Page 52       PREV PAGE       TOP OF DOC

    Fourth, the FDIC proposes that the 1.25 percent hard target be eliminated and replaced with a flexible range with surcharges if the ratio gets too low and rebates if the ratio gets too high. We support the FDIC recommendation as a part of the integrated package that includes higher coverage levels. Using a more flexible target would help eliminate wild fluctuations in premiums. The statutory requirement that banks pay a 23 cent premium when the fund is below the designated reserve ratio should be repealed.

    We also strongly support the FDIC proposal to base rebates on past contributions to the fund rather than on the current assessment base. This would avoid unjustly rewarding those who haven't paid their fair share, like the free riders.

    Fifth, the FDIC proposes to merge the BIF and the SAIF. The ICBA supports the merger as part of an overall comprehensive reform package.

    In conclusion, Mr. Chairman, now is the time to consider these important FDIC reforms. Thousands of communities across America and millions of consumers and small businesses depend on their local community banks. And without substantially increased FDIC coverage levels, indexed for inflation, community banks will find it increasingly difficult to meet the credit needs of our communities.

    The less deposit insurance is really worth due to inflation erosion, the less confidence Americans will have about their savings in banks, and the soundness of our financial system will be diminished. Congress must not let this happen. We support the overall thrust of the FDIC's recommendations. We urge Congress to adopt an integrated reform package as soon as possible, and I will entertain questioning that you might have. Thank you very much.
 Page 53       PREV PAGE       TOP OF DOC

    Chairman BACHUS. Thank you.

    Mr. Smith, in your testimony, you suggest that retirement accounts should have a higher level of deposit insurance coverage. What do you see as an appropriate level of insurance coverage for retirement accounts, 401(k)s, IRAs?

    Mr. SMITH. Well, basically, in 1978, when we had insurance coverage of $40,000, Congress chose to give us insurance coverage on those types of accounts at $100,000. While insurance on regular accounts has risen to $100,000, the IRA accounts are still at a level that we think is too low. So we would like to see that that amount increased so we can encourage savings in our country, encourage our customers to save more; and I think this would be a great move that we could do to entice that.

    Chairman BACHUS. For instance, going back to 1980 and increasing it according to the CPI increase?

    Mr. SMITH. Well, it was 2 1/2 times in 1978, so if we did it 2 1/2 times today, the regular coverage would be $250,000 per account, and taking in inflation and indexing that to inflation, I think that would be a very appropriate number to look at.

    Chairman BACHUS. You suggest we should eliminate the too-big-to-fail doctrine. Congress has repeatedly tried to limit that doctrine. How would you advise us, or what suggestions do you have for us in eliminating that doctrine?

 Page 54       PREV PAGE       TOP OF DOC
    Mr. SMITH. I don't know that I have any specific suggestions. I think this topic should be on the table to be addressed under comprehensive reform. It was looked at in FDICIA and FIRREA, and some steps were taken, some measures were taken, to eliminate it; but the fact is that it is still there to some extent, and I think whatever Congress can do to eliminate the too-big-to-fail doctrine and put that issue on the table, it would be appropriate.

    Chairman BACHUS. OK. Thank you.

    Mr. Bochnowski, your testimony doesn't address the issue of municipal deposits, which it wasn't required to do, but do America's Community Bankers have a position on proposals that would either increase the coverage limits on such deposits or permit institutions to purchase coverage in excess of $100,000?

    Mr. BOCHNOWSKI. Mr. Chairman, we have been neutral on this in both speaking with our members and surveying them. It is not an issue which comes to the fore. A number of our States provide municipal deposit insurance—not privately, but at least through the State system, and it has not been an issue that has been a major concern to our members.

    Chairman BACHUS. I thank you.

    Mr. Gulledge, let me continue on that thought. In your testimony, you support further coverage of municipal deposits. Would that increase the risk to the Federal Deposit Insurance Fund, ultimately to other institutions or the taxpayer?

    Mr. GULLEDGE. Well, we do support the 100 percent coverage of municipal deposits, and we do feel that this is very important because this is a great source of funding for community banks and a great source of the funds to make meaningful contributions to their community in providing the services that they are organized for. And we do feel that this is not going to be a detriment to the fund.
 Page 55       PREV PAGE       TOP OF DOC

    At the end of 2000, there were $162 billion in municipal deposits. Of that $162 billion, only $113.8 billion of those were uninsured at that time. The BIF has $31 billion in reserves, and it presently has a reserve ratio of 1.35. If the BIF-insured deposits were increased by that $113.8 billion, then that would bring down the ratio to a 1.28 ratio, which still is above the statutory minimum.

    Chairman BACHUS. All right. Thank you.

    At this time, Ms. Waters.

    Ms. WATERS. Thank you very much. Let me just say to Mr. Gulledge that I appreciate the clearness of the case that you make about the free riders.

    Mr. GULLEDGE. The case of what? I am sorry.

    Ms. WATERS. The free riders must pay their fair share. I am surprised, even as I learn more about FDIC, that this has gone on for this long; and it must be corrected. And I strongly support the remedy to the free rider problem as you have articulated it. And I am anxious that we not allow the Merrill Lynches and the Smith Barneys or anybody else to be able to have that kind of an advantage. So I just wanted to say that so then you would understand that for at least one person here today, your testimony certainly has struck a very strong chord with me.

    Let me just ask Mr. Smith, what were you referring to when you said that some of the recommendations would cause unacceptable increases? What were you referring to?
 Page 56       PREV PAGE       TOP OF DOC

    Mr. SMITH. The FDIC recommendations would advocate that we start assessing certain rated banks that are not now paying premiums. They would have to start paying premiums. Right now banks that are CAMEL-rated 1 or 2 pay no premiums if they are well capitalized, and so I think under the FDIC recommendations, they certainly would start charging 2-rated banks a premium; and possibly some portion of the 1-rated banks, I think they want to change.

    Ms. WATERS. Did you hear what the chairwoman said about a 47 percent failure among 1- and 2-rated banks? I think that is what she said—within 2 years?

    Mr. SMITH. She quoted a specific period of time, and I am not sure how that equates out. I could only say from a banker who experienced the ag depression in the 1980's, who was in an ag bank—I experienced the depression in our bank, and the risk assessment is very real and very important. And the fact now that we have 92 percent of the banks in the 1 and 2 category, I would say, hurrah, because I think that is a great incentive, at least for me.

    I am in that category; I do not have to pay FDIC premiums. And so I try to run my bank to make sure we have the proper safety and soundness procedures in effect. I try to run my bank to make sure that we are taking care of our community properly, because that is my market. And at the same time, I want to try to make sure I don't have additional costs on my balance sheet with FDIC premiums.

    So I am not sure what timeframe Chairman Tanoue was talking about when she said 47 percent of the banks that were rated 1 or 2 failed.
 Page 57       PREV PAGE       TOP OF DOC

    Ms. WATERS. Well, Congressman Watt just clarified exactly what she said. She said that 47 percent of those banks that drew on the FDIC had shown that—what was it, the last 2 years?

    Mr. WATT. Rated either as 1 or 2 in the last 2 years. That is what she said.

    Ms. WATERS. That is what she said. So I guess, you know, what I was asking you was, given the information, the facts that have been presented to us, I guess I am wondering how you can make the case that the large number of banks that are not participating should not be participating.

    I just don't have an appreciation for the way the risk is determined, perhaps, whether or not it has been looked at as short-term risk or long-term risk, but I just don't see that you make the case that it would be unacceptable increases to have them pay in a small amount and spread the amount of the fund to be collected among all of the banks, small and large, so that no one small sector of the banking community is bearing all of the burden of capitalizing the fund.

    I mean, I just don't see the case that you make.

    Mr. SMITH. Well, I think what we are trying to say there, Congress will set a designated reserve level, whatever that level is. Our position is that banks that are well capitalized and CAMEL-rated 1 or 2 should not have to pay premiums if we have met the designated reserve level or exceeded it.
 Page 58       PREV PAGE       TOP OF DOC

    Obviously, we don't like the hard, designated reserve level of 1.25. We would like to have a softer level, maybe a range where we start paying if it falls down below, but also we could have the dividends on rebates if it gets above that. And I think two things have to happen. You have to be at the designated reserve level, and you have to be a well capitalized bank. And you have to be a CAMEL 1- or 2-rated by your regulatory agency.

    And my bank just underwent a safety and soundness exam in January from the FDIC, and I think that is risk assessment, because they do come in and take a look at everything in your bank, and they give you a rating from that.

    Ms. WATERS. Yeah. But you still don't answer the question that we are raising—some of us are raising—despite that kind of reserve and despite what appears to be low-risk situation, that you still fall within that 47 percent who have been rated 1 and 2 within 2 years before they drew on FDIC. I mean, the fact of the matter is, it could happen.

    Mr. SMITH. Well, I don't know that I have an answer there, depending upon the timeframes that they are looking at, because that probably was during the ag depression or during the real estate crisis that we experienced, which was, I think, a combination of an oil crisis and a real estate crisis, and we had an ag crisis, almost a domino effect across the country. I think we have a better regulatory structure in place today; I think we are smarter. I know, as a banker, I feel like I am smarter and have more things in place today in order to assess the risk and be sure that I am out front of any problems that we are going to address in our banks.

 Page 59       PREV PAGE       TOP OF DOC
    Ms. WATERS. How do you answer the question of Merrill Lynch and Smith Barney and the others with banks that do not pay into the fund?

    Mr. SMITH. Well, I think FDIC has said that they do not have the authority to charge them premiums at this time.

    Ms. WATERS. They have banks, though.

    Mr. SMITH. Pardon me?

    Ms. WATERS. They have banking operations.

    Mr. SMITH. That is correct, but I think if you are well capitalized and you fall under the criteria that are set, the FDIC is saying that if they fall under these criteria, we do not have the authority to charge them for the funds going into the system. You know, obviously, they are looking to capitalization and the things that are taking place there.

    Ms. WATERS. Thank you.

    Chairman BACHUS. In the FDICIA, the Congress actually set the criteria for their charging the premium and—with CAMEL ratings, when they are in the—either ranked 1 or 2. I might point out, we have heard that 47 percent of the banks who failed—now, we are talking about the banks who failed—47 percent of those that failed had a rating system of 1 or 2 in the 2 years prior.
 Page 60       PREV PAGE       TOP OF DOC

    Another way of saying that is that 53 percent of those banks that could have failed did not, and they were within—92 percent of the banks in this country are rated 1 or 2. So within the 92 percent of your total institutions, most—in other words, over 9 out of 10 banks do have a 1 or 2 rating; yet, less than 1 out of 2 failed within that category. So it actually confirms that we are doing, I think, a fairly good job of identifying the 8 percent, singling out the 8 percent who do not have a 1 or 2 rating. Most of the failures came from that group.

    And I would predict that when you look at 6 months or a year, if you shorten that period to 6 months as opposed to 2 years, that you would probably find almost all of the banks who failed had a rating of 3 at the time they failed. Some do go down. You know, this can be a 2-year process.

    Ms. WATERS. Mr. Chairman, if I may——

    Chairman BACHUS. Do you understand what I am saying?

    Ms. WATERS. Yes, I do.

    Chairman BACHUS. That most of the failures came within that 8 percent?

    Ms. WATERS. Well, you certainly can make that case.

 Page 61       PREV PAGE       TOP OF DOC
    I guess what I am looking at is the fact that while we are smarter and we can predict certain things, we are sitting here now and we don't know what the energy crisis is going to cause in this country.

    I never would—nobody could have predicted that in the State of California we would be facing rolling blackouts. Nobody could have predicted we would be up to $3 per gallon of gasoline. Nobody could have predicted that NASDAQ took the dip that it took this year. So what we do know is that there is enough volatility in our economy where, even though we have calculated as best we can, anything can happen. And so I just kind of keep that as a reference when I look at whether or not we are, in some cases, spreading the risk, we are being fair to all.

    The independent community banks are very important to me because, I think, despite the sophistication of banking, that these are the units that really keep middle America and small-town America and small-city America running. And so I want to make sure that they are not disadvantaged, that they have the ability to—I am not sure, and I have to ask this one question: The calculation by the FDIC, did it also calculate the retention of the reserve requirements for the banks, along with spreading out the FDIC charges? What did they say about reserve rates for the banks?

    Mr. SMITH. No. That is not included in it, because each bank holds their own reserves for any loan losses or any problem situations.

    And I would like to clarify that we do advocate that those large, fast-growing institutions with funds from Merrill Lynch, and so forth, be charged a premium. I was merely stating that the FDIC has told us that they don't have the authority to charge those; but we do think that they should be charged and that should be addressed in this bill.
 Page 62       PREV PAGE       TOP OF DOC

    Ms. WATERS. Thank you very much, Mr. Chairman.

    Chairman BACHUS. Thank you. So I think there is agreement there.

    Mrs. Kelly.

    Mrs. KELLY. Thank you, Mr. Chairman. I am sorry that I wasn't here earlier, because I am caught in a markup, but this is an important hearing and I wanted to know if I have permission to put a statement into the record and also if you are going to hold the hearing open, if I may have permission to submit written questions to the panels?

    Chairman BACHUS. Yes. In fact, it is a good point. Mrs. Kelly, all Members will have 5 days with which to enter in written statements or any other material they have.

    Mrs. KELLY. Thank you. I would like to yield my time to Mr. Weldon.

    Mr. WELDON. I thank the gentlelady.

    Mr. Gulledge, you are of the strong opinion that raising the coverage level on the deposit insurance will help ease the liquidity problems facing the small community bankers, members of your association. In your view, is there anything else that Congress can do to help stem the tide of core deposits leaving community banks? Are there new products, for example, that Congress could authorize or other measures that we could take to address the funding issues that I know are of tremendous importance to your association? And maybe some of the other members may want to comment on this as well.
 Page 63       PREV PAGE       TOP OF DOC

    Mr. GULLEDGE. Well, certainly I would voice the opinion that the increase of insurance coverage is the most important issue that is on the table at this point. This is very crucial to many, many community banks and particularly those in rural areas.

    Now, last year, the work that was done with the Federal Home Loan Banks did make advances from the Home Loan Banks more available, and this has helped a great deal. But there are problems with that. Some of the examiners are now questioning the heavy use of withdrawing at the windows there. The program that we need is to develop stronger core deposits, and I do believe the increase in insurance coverage and particularly with the municipal coverage, if that can be extended to full coverage, and also the increased coverage for the retirement accounts, I think that would be very helpful.

    Mr. WELDON. Mr. Bochnowski, did you want to add to that at all?

    Mr. BOCHNOWSKI. Thank you, Congressman. Yes, I would appreciate that opportunity.

    We would basically see it a little bit differently. We think that indexing coverage in 1974 would put behind us the issue of advancing coverage as time goes by. We do not favor moving to $200,000. We think that current market conditions maybe prove the point slightly, because all of us at the community bank level are experiencing an influx of funds as a result of what is happening in the equity markets. So we are not totally sure that increasing coverage is what would trigger consumers to bring money in.

 Page 64       PREV PAGE       TOP OF DOC
    We think that the action of this subcommittee in the House in passing business checking was a very wise decision. We think that is a wonderful opportunity for all of us to bring in more deposits.

    We would agree that to increase coverage for IRA accounts, 401(k) accounts, the Keogh accounts, that that could make a difference, particularly as time is going to go on, because so many of those accounts have built up great values in our institutions. And I think that those of us who are baby boomers, that as we age, we are going to see more and more of our funds go back into the banking system, and increased coverage there would be very helpful.

    Mr. WELDON. Mr. Gulledge, opponents of raising the level of deposit insurance claim that it will not really lead to any more deposits, rather a consolidation of accounts. Thus, while one bank may gain from the consolidation, another may actually lose accounts. Do you have any response to that criticism?

    Mr. GULLEDGE. My response would be that this goes straight to the area of competition, which banks should be strongly engaged in. My experience in my bank is that there are many customers who come in, and I see them take cashier's checks out of my bank to another bank simply and purely because we do not have the coverage of that. I think that it would make us all more competitive, and I think we would serve the public better if we had the additional coverage and we got out and had to work and compete for those deposits.

    Mr. WELDON. Mr. Bochnowski, in your testimony, you talk about setting a 1.35 percent ceiling on the reserves in the fund and using the excess to pay off the FICO bonds. What are banks paying now on FICO bonds?
 Page 65       PREV PAGE       TOP OF DOC

    Mr. BOCHNOWSKI. I would have to ask. It is 2.1.

    Mr. WELDON. 2.1?

    Mr. BOCHNOWSKI. 2.1 basis points.

    Mr. WELDON. Do you have any idea how much this would cost to do what you are talking about?

    Mr. BOCHNOWSKI. In specific numbers, no. It is about $800 million a year.

    Mr. WELDON. $800 million a year for the industry, or your members?

    Mr. BOCHNOWSKI. For the industry.

    Mr. WELDON. For the industry, industry-wide.

    I know I am asking you a lot of detailed questions. You can ask the people behind you. How long would it take to pay off the FICO bonds in that scenario?

    Mr. WATT. 217.

 Page 66       PREV PAGE       TOP OF DOC
    Mr. WELDON. Pardon me? Is that correct, 217,000? The gentleman from North Carolina says 217,000.

    Mr. BOCHNOWSKI. Seventeen years of interest.

    Mr. WELDON. Seventeen years of interest, OK.

    I think my time has expired; is that right? I had one more question.

    Chairman BACHUS. Go ahead and ask your—we will——

    Mr. WELDON. No. I will yield back.

    Chairman BACHUS. No. If you——

    Mr. WELDON. Mr. Bochnowski, in your testimony, you call for a special premium on institutions that have grown rapidly.

    Mr. BOCHNOWSKI. Right.

    Mr. WELDON. Can you define ''excessive growth''—I think that is the term you use—and isn't this going to be a penalty on banks that are successful if we implement something like this?

    Mr. BOCHNOWSKI. I think ''excessive growth'' would be defined anything that is outside of the norm, and I think the FDIC can calculate for us what normal growth rates are across the banking industry.
 Page 67       PREV PAGE       TOP OF DOC

    I don't see it as a penalty. I think that they have not paid into the fund, and they are the free riders that we are describing. When I look at the impact of the free riders on the First Congressional District of Indiana—and this gets back to Mr. Bachus' question earlier.

    The FDIC Chairman talked about the $65 billion impact on lending. We have 16 independent banks and thrifts left in our community; together, they have about $5 billion in deposits. If this 23-basis-points premium were imposed, if we fell over that cliff and we had to pay it because of what the outsiders are causing us to do, it would have an impact on $80 million of loans.

    Mr. WELDON. That would be sucked out of the district?

    Mr. BOCHNOWSKI. Correct, loans that we wouldn't be able to make. And what is astounding about that, Congressman, is that we haven't done anything.

    Mr. WELDON. Right.

    Mr. BOCHNOWSKI. We have just done our job, and someone from the outside can come in and cause that mischief. And that is why we think bill H.R. 1293 is important, because it goes to the heart of the problem immediately. And I think that that is an experience that we are all going to have.

    Mr. WELDON. H.R. 1293? Is that what you are talking about?
 Page 68       PREV PAGE       TOP OF DOC

    Mr. BOCHNOWSKI. Yes, sir.

    Chairman BACHUS. OK. Thank you.

    Mr. Watt.

    Mr. WATT. Thank you, Mr. Chairman.

    Let me just ask a couple of quick questions that I think I can get yes and no answers to, to try to get to a subsequent point.

    Is there any prohibition against banks currently reinsuring deposits beyond $100,000?

    Mr. SMITH. No, there is not.

    Mr. WATT. Would there be any prohibition against banks advertising that if they chose to do that?

    Mr. SMITH. Not that I am aware of, no.

    Mr. WATT. Is there anybody out there who is writing reinsurance?

 Page 69       PREV PAGE       TOP OF DOC
    Mr. SMITH. I am.

    Mr. WATT. A lot of people are?

    Mr. SMITH. Yes.

    Mr. WATT. Are doing reinsurance?

    Mr. SMITH. It is a private insurance carrier, but we provide insurance if they want more coverage, over the $100,000 limit.

    Mr. BOCHNOWSKI. Congressman, we do that a little bit differently. We don't do the reinsurance, but we do repurchase agreements where we can cover more than $100,000 by permitting our customer to buy a security that we own.

    Mr. WATT. OK.

    My visceral response is that I strongly favor indexing the $100,000 figure and moving it up and then indexing it.

    My visceral response on either an unlimited coverage for retirement accounts or for municipal accounts being 100 percent insured is that that would be fairer done in some reinsurance or separate fund, because you are basically creating a different level of coverage for people, which I think ought to be the same. Can I just get your reaction to that?

 Page 70       PREV PAGE       TOP OF DOC
    I mean, I obviously haven't studied this to any great degree. I am just giving kind of a visceral, gut response to it. Is there anything wrong with the analysis that I am—with my visceral response, I guess is the question.

    Mr. BOCHNOWSKI. We really haven't looked into that issue directly. I think the problem with reinsurance may be how the reinsurer rates each individual bank: Where are they going to get their information from; are they going to want access to our individual examination reports?

    Mr. WATT. How are you doing it now?

    Mr. BOCHNOWSKI. Well, we are not.

    Mr. WATT. What would be the difference, Mr. Smith?

    Mr. SMITH. No. Our banker bond carrier offers deposit insurance coverage, and they do not come in and rate the bank. Obviously, we have done business with this company for a number of years, and they provide the insurance level that we request. We have no criteria.

    Mr. WATT. Does it cost you more than the premium would be into the FDIC?

    Mr. SMITH. At this point, depending upon, of course, what level you would have to pay into the FDIC for the coverage, the premium now is costing about 4 cents.
 Page 71       PREV PAGE       TOP OF DOC

    Mr. WATT. And your FDIC premium—you are not in. But what is the typical——

    Mr. SMITH. Well, out of the 23 cents, if you were paying the maximum, that would be very healthy plug for our bank. Depending upon what level, of course, risk that the FDIC——

    Mr. WATT. Healthy level is what?

    Mr. SMITH. The average level right now is, I think, about 6 cents for people falling out of the 1 or 2.

    Mr. WATT. So you are actually paying less to fully insure municipal deposits than you would be paying if we just upped the coverage for municipal deposits under FDIC to full coverage; isn't that right?

    Mr. SMITH. I think——

    Mr. WATT. I mean, shouldn't that be a cost that you are passing basically factoring into the quotes you are giving to municipalities and factoring into whatever proposal you are making to a municipal government?

    Mr. SMITH. Well, in the municipal deposits, every State is different, and I can only give you the example of my State of Missouri. We have to collateralize every dollar over the $100,000 that they have in the bank, so we pledge a security for that.
 Page 72       PREV PAGE       TOP OF DOC

    Now, that does not cost us anything in actual dollars except some opportunity costs, possibly. The cost there is the burden of bookkeeping and recordkeeping that we have to go through to pledge a specific security to, say, the school system. And, for instance, if that security matures or that security is called, we have to go get that security released, and then we have to reassign another security for the school system to cover their deposits. There is no specific dollar cost on my books for that.

    What I was talking about, the additional deposit cost was if an individual comes in and they want to put $200,000 in the bank. They say, we would like to have coverage over the $100,000. We try to provide them that coverage.

    Now, probably I would somehow try to give them a rate that would help pay some of the cost of that coverage, and they understand that, because I explain it up front; but they would prefer to have the additional coverage over the $100,000 limit and possibly have some sharing there.

    Mr. WATT. Mr. Chairman, I am going to yield back, the point I am making is, I think in some of these individual municipal transactions, it seems to me that it would be fairer to think about building that into their costs rather than spreading it to all depositors, the cost of doing this.

    I mean, I obviously haven't reached a conclusion on this, and maybe you all want to talk to me more about it if we move in that direction. But my kind of gut reaction is, I am not sure that I think it is necessarily a good idea for us to be 100 percent insuring any individual class of depositors and putting that class of depositors in some separate category than the regular insurance fund, because the whole idea of a regular insurance fund, an FDIC insurance fund, was to give kind of a Social Security theory more than it is insuring 100 percent, as I understand it.
 Page 73       PREV PAGE       TOP OF DOC

    Maybe I am just wrong about that.

    Mr. BOCHNOWSKI. Mr. Watt, if I could add an observation. In Indiana we do have a public deposit insurance fund so, in theory, those deposits are covered. But insurance is not an issue. It is price-driven. The consideration of the depositor is—if the money is currently at a large securities firm right now, earning a certain yield, for us to bid on those funds successfully, we have to meet their price. Some days we want to meet that price, and some days we don't, and it is really a cost factor.

    Insurance, I think, at least in our State, is not as significant to bringing those funds in as price.

    Chairman BACHUS. Thank you.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    Yeah, I—on the municipal—and I don't want to ask too much about that, but I am not sure I see the case yet to do that on municipal, and I am not sure we would want to get that confused if we were looking at doing an FDIC reform bill, because there are a lot of avenues for municipalities to set up their funds, and I think you intertwine yourself with different State codes, and even municipal codes, on how funds can be deposited.

 Page 74       PREV PAGE       TOP OF DOC
    But let me go back to the FDIC's proposal.

    I looked at two out of three of the testimonies, but in listening to everyone's testimony, it would appear obviously that everyone is in favor of some broad concept of reform of the insurance system. And would it be fair to say—clearly, I think this is what the ABA is saying, and I didn't get a chance to go through the others—but, would it be fair to say that everyone is in favor of some form of a mutual insurance system, which is a term that the ABA uses in their testimony, as opposed to the current system?

    And getting more specific—and I am not necessarily saying that the FDIC concept is the prototype or the ideal model, and I would ask this of Mr. Smith in particular—is the primary concern with the FDIC model that both the risk-based premium might result in a higher premium for some banks or thrifts and that the rebate mechanism might result in some banks and thrifts paying a net-net higher premium than they would under the current system?

    And I guess I would add to that, is there an objection to having an ongoing payment, even if it is rebated back in a greater amount?

    Mr. SMITH. Well, as I travel around the country, clearly I don't think we have a consensus among the bankers, because we find a lot of bankers want the $200,000 level. A lot of bankers want maybe a lesser level, and I have found a lot of bankers that don't want any increase in the insurance. So I think it is important that we have a consensus.

    And if I don't get eaten up here, I think it is important that we have a consensus among the bankers, because I think cost is going to drive this consensus in order to get the bankers to agree upon a bill. And I think if we increase the cost to a significant number of bankers, then I think it is going to be difficult to get those bankers to agree upon.
 Page 75       PREV PAGE       TOP OF DOC

    Mr. BENTSEN. Excuse me.

    In terms of cost—I am not focusing as much on the level of insurance of—I mean, I think we will work out the 100,000 to whatever at some point; but I guess I am focusing more on the premium mechanism for the funds.

    Is the concern that the FDIC model would result in—I mean, on the one hand, it seems to me the FDIC model would bring everybody into the system; everybody who is accessing the fund would have some obligation to pay into the fund. And I think—and I would gather from what everyone said, there is consensus among this panel on that.

    Where the consensus breaks down, or where the concern rises, is the way the rebate model is structured under the FDIC proposal, is that for some would end up paying more premium, or paying a premium, since someone is paying a premium right now, as opposed to the status quo. Is that the concern?

    Mr. SMITH. We like the model, but basically we just don't necessarily like the numbers that they have put with the model. And I think—yes, I think we are interested in the model, in approving that model, but I think we would like to see what we can do about the numbers and how that would play out with the cost to our bankers across the United States.

    Mr. BOCHNOWSKI. We would not object to certain parts of their model, but do object, obviously, to others. We think that the CAMEL–1-rated banks should not pay a premium at all. We would be open to CAMEL–2s paying some premium. But we think that, in the end, it gets back to what is the maximum level of the fund and how will rebates come back; and to the extent that the mutual model provides opportunity for all to participate in that, then that would be something we could support.
 Page 76       PREV PAGE       TOP OF DOC

    Mr. GULLEDGE. Well, in my testimony, I indicated earlier that it was our belief that our banks would be willing to pay a premium if it was small, steady and fairly priced.

    And in order to get an integrated reform package, I would comment here also that the purpose of the study that the FDIC made is not to enhance revenues or total premiums. It is to find a more workable situation. And certainly—and I have testified earlier in my comments that the rebates should be based on what had been paid in previously by the banks rather than from the assessment base now.

    So I approve of the model.

    Mr. BENTSEN. Let me very quickly ask this, because I have been sitting here for a while.

    Is it fair to say that everyone here would agree, though, with going to more of a risk based—and arguably we have that under FIRREA or FDICIA—but, to more of a risk-based premium model? Obviously, more details are critical, but also—and I think Mr. Gulledge answered this.

    On the rebate, would you agree with what the FDIC talks about on historical payments, or would you see that there, as well, you would want to have a risk-based model for the level of rebates or who receives the rebates?

 Page 77       PREV PAGE       TOP OF DOC
    Mr. BOCHNOWSKI. I think that it is probably a hybrid. Again, if we have fast-growth institutions, should they be participating fully in the rebate? I am not sure that we are prepared to say that they should.

    Mr. SMITH. And I would agree with that.

    Mr. BENTSEN. Thank you.

    Thank you, Mr. Chairman.

    Chairman BACHUS. Thank you. Mrs. Maloney, and if you have additional time, you are going to yield to Mr. Crowley?

    Mrs. MALONEY. Absolutely.

    Chairman BACHUS. And then we will conclude with his questions.

    Mrs. MALONEY. The FDIC indicated that the 23 basis points, that is currently required by law if the reserve ratio dips below 2.5 percent, would reduce lending by $65 billion. Do you have any idea what the impact on lending would be from the FDIC's proposal of risk-based pricing combined with rebates? Would it reduce lending?

    Mr. SMITH. I can give you only the example of my bank during the early 1990's, when we had a 23-cent premium; it cost our bank about $120,000 a year. And if you extend that over a 10-year period, that is a lot of money. And if you loan that money in your community, and your customers buy goods and spend money, the United States Chamber of Commerce itself tells us every dollar turns over seven times, so I think you can see where this could—the multiplier effect could really have a big effect on what is available in our communities with these dollars.
 Page 78       PREV PAGE       TOP OF DOC

    Mr. BOCHNOWSKI. We know, Congresswoman, if we were to follow that 23 basis points in our company, it would impact us by not having approximately $5 million in lending, and that is 20 percent of our loan growth from last year.

    On a smaller scale, though, if we have—for the 1- and 2-rated companies—some modest premium, I think it is possible to say that—and that is to suggest that it is, you know, a 2- or 3-basis points premium—it is not going to be that steep. It is the higher end that causes the problem.

    Mr. GULLEDGE. Well, we believe that the enhancement in the safety and soundness of the banks resulting from these reforms would be good for everybody.

    Mrs. MALONEY. Thank you very much, and I yield my time to my distinguished colleague from New York.

    We have a vote taking place right now, so we don't have a lot of time.

    Chairman BACHUS. We have about 9 1/2 minutes, so you have plenty of time.

    Mr. CROWLEY. OK. Thank you, Mr. Chairman.

    I thank my colleague from New York, Mrs. Maloney. I have two questions, kind of playing a little bit of devil's advocate.
 Page 79       PREV PAGE       TOP OF DOC

    If you can say on the record or off the record—and Mr. Bochnowski, I hope I am——

    Mr. BOCHNOWSKI. Bochnowski.

    Mr. CROWLEY. Bochnowski. That is correct.

    At least many of the large banks are saying that Gramm-Leach-Bliley was in part done to create this benefit for the consumer, their customers—I am talking about the free rider issue—to have access for their consumers and their customers, the protections of FDIC accounts and all the protections that go along with them.

    Now, despite the fact that that may anger some, isn't that the argument they are making upon a fine argument?

    Mr. BOCHNOWSKI. It is a curious argument. I had an opportunity earlier in my testimony to suggest that if we were to have a premium enforced upon us in the First Congressional District in Indiana, it would have an impact of reducing the available dollars for loans by $80 million. I hardly think that Congress intended when they passed that law to put those of us who are community bankers in the position of having an $80 million retraction of credit in the First District of Indiana. And I don't know how that plays across the country and all other districts, but that is an example.

    So I think it is a very specious and curious argument that they make.
 Page 80       PREV PAGE       TOP OF DOC

    Mr. CROWLEY. Thank you.

    And this really is to the entire panel, if anyone wants to jump in: The increase in the amount of money that would come into these accounts and from these large banks, based on security brokerage accounts, common sense tells me that it would increase substantially the level of insured dollars within the FDIC; and because of that, the ratios would be changed and that although they are pretty flush at this point in time, right at this time, that there has been a slight decrease in the DRR since then, albeit they have only been around for about a year-and-a-half or so.

    Is it your contention or the panel's contention that you expect you will see a further decrease in DRR?

    Mr. BOCHNOWSKI. I believe that the numbers are that for every 100 billion that comes across the DR—declines by about 6 basis points. So there is approximately $180 million that the chairman has suggested that the bank security firms' combination have under their control that could move over.

    Mr. CROWLEY. How much do we anticipate will be rolled in these FDIC accounts?

    Mr. BOCHNOWSKI. I would have no way of knowing what they would do.

 Page 81       PREV PAGE       TOP OF DOC
    Mr. CROWLEY. Even if the return is going to be substantially less than what they could get?

    Mr. BOCHNOWSKI. It depends on market conditions. It also depends on a fiduciary question that they face. If the return is the same on the——

    Mr. CROWLEY. Insured accounts.

    Mr. BOCHNOWSKI. They might take the insured account.

    Mr. CROWLEY. Got you. Thank you.

    Thank you, Mr. Chairman.

    Chairman BACHUS. Thank you.

    In conclusion, we are going to adjourn this hearing. I do want to say that we have some additional information. The FDIC indicated that the failure rate was actually significantly lower than what was initially indicated.

    And let me also say this: Of over 10,000 banks last year, we had one bank failure of a small institution in West Virginia. So, I think when we talk about bank failures, we are talking about something that in the last few years—and we have passed additional regulations and put additional structures in place. They have been very successful.

 Page 82       PREV PAGE       TOP OF DOC
    A bank failure today is rare indeed. It is a very unusual event.

    With that, the hearing is adjourned, and I thank you, gentlemen.

    [Whereupon, at 12:27 p.m., the hearing was adjourned.]