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before the
March 4, 2003
Room 2128, Rayburn House Office Building

Oral Statement
Chairman Oxley, Representative Frank, and members of the Committee, it is a pleasure
to appear before you this afternoon to discuss deposit insurance reform. This remains
the top priority of the Federal Deposit Insurance Corporation and I appreciate the
Committee's continuing interest in pursuing reform.
The fact that the Committee was able to write legislation last year that attracted more
than 400 votes in the House of Representatives was an admirable accomplishment. I
especially want to thank again Chairman Oxley, Representative Frank, Representative
Bachus, and Representative Waters for introducing H.R. 522, and to thank their
colleagues who are supporting the legislation.
An effective deposit insurance system contributes to America's economic and financial
stability by protecting depositors. For more than three generations, our deposit
insurance system has played a key role in maintaining public confidence.
While the current system is not in need of a radical overhaul, flaws in the system could
actually prolong an economic downturn, rather than promote the conditions necessary
for recovery. These flaws can be corrected only by legislation.
Today, I want to emphasize three elements of deposit insurance reform that the FDIC
regards most critical-merging the funds, improving the FDIC's ability to manage the fund
and pricing premiums properly to reflect risk. These changes are needed to provide the
right incentives to insured institutions and to improve the deposit insurance system's
role as a stabilizing economic factor, while also preserving the obligation of banks and
thrifts to fund the system. There is widespread general agreement among the bank and
thrift regulators for these reforms.

The Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF)
should be merged. There is a strong consensus on this point within the industry, among
regulators and within Congress.
A merged fund would be stronger and better diversified than either fund standing alone.
From the point of view of the insured depositor, there is virtually no difference between
banks and thrifts. Moreover, many institutions currently hold both BIF- and SAIF-insured
deposits. More than 40 percent of SAIF-insured deposits are now held by commercial
In addition, a merged fund would eliminate the possibility of a premium disparity
between the BIF and the SAIF. As long as there are two deposit insurance funds, with
independently determined assessment rates, the prospect of a premium differential
exists. Such a price disparity has led in the past, and would inevitably lead in the future,
to wasteful attempts to circumvent restrictions preventing institutions from purchasing
deposit insurance at the lower price. The potential for differing rates is not merely
theoretical. The BIF reserve ratio on September 30, 2002, stood at 1.25 percent, the
absolute minimum required by law, while the SAIF reserve ratio stood at 1.39 percent.
For all of these reasons, the FDIC has advocated merging the BIF and the SAIF for a
number of years. Any reform plan must include merging the funds.
Two statutory mandates currently govern the FDIC's management of the deposit
insurance funds. One of these mandates can put undue pressure on the industry during
an economic downturn. The other prevents the FDIC from charging appropriately for
risk during good economic times. Together, they lead to volatile premiums.
When a deposit insurance fund's reserve ratio falls below the 1.25 percent statutorily
mandated designated reserve ratio (DRR), the FDIC is required by law to raise
premiums by an amount sufficient to bring the reserve ratio back to the DRR within one
year, or charge mandatory high average premiums until the reserve ratio meets the
DRR. Thus, if a fund's reserve ratio falls slightly below the DRR, premiums need not
necessarily increase much. On the other hand, if a fund's reserve ratio falls sufficiently
below the DRR, the requirement for high premiums could be triggered.
The statutory provisions requiring a 1.25 percent DRR and mandatory high premiums
when a fund falls sufficiently below the DRR were designed to protect the taxpayers and
prevent the deposit insurance funds from becoming insolvent, as the Federal Savings
and Loan Insurance Corporation (FSLIC) became during the 1980s. However, these
provisions, intended as protections, could cause unintended problems. During a period
of heightened insurance losses, both the economy in general and depository institutions
in particular are more likely to be distressed. High premiums at such a point in the
business cycle would be pro-cyclical and result in a significant drain on the net income
of depository institutions, thereby impeding credit availability and economic recovery. As

I will discuss later, there are ways to protect the taxpayers while avoiding some of the
pro-cyclicality of the present system.
When a fund's reserve ratio is at or above the 1.25 percent DRR (and is expected to
remain above 1.25 percent), current law prohibits the FDIC from charging premiums to
institutions that are both well-capitalized, as defined by regulation, and well-managed
(generally defined as those with the two best CAMELS examination ratings).1 Today, 91
percent of banks and thrifts are well-capitalized and well-managed and pay the same
rate for deposit insurance - zero. Yet, significant and identifiable differences in risk
exposure exist among these 91 percent of insured institutions. To take just one
example, since the mid-1980s, institutions rated CAMELS 2 have failed at more than
two-and-one-half times the rate of those rated CAMELS 1.
This provision of law produces results that are contrary to the principle of risk-based
premiums, a principle that applies to all insurance. The current system does not charge
appropriately for risk, which increases the potential for moral hazard and makes safer
banks unnecessarily subsidize riskier banks. Both as an actuarial matter and as a
matter of fairness, riskier banks should shoulder more of the industry's deposit
insurance assessment burden.
In addition, the current statute also permits banks and thrifts to bring new deposits into
the system without paying any premiums. Essentially, the banks that were in existence
before 1997 endowed the funds, and newcomers are not required to contribute to the
ongoing costs of the deposit insurance system. Since 1996, almost 1,000 new banks
and thrifts have joined the system and never paid for the insurance they received. Other
institutions have grown significantly without paying additional premiums.
These problems can be addressed by eliminating the existing inflexible statutory
requirements and by giving the FDIC Board of Directors the discretion and flexibility to
charge regular risk-based premiums over a much wider range of circumstances than
current law now permits.
Fund Management
The FDIC recognizes that accumulating money in the insurance fund to protect
depositors and taxpayers means less money in the banking system for providing credit.
The current system strikes a balance by establishing a reserve ratio target of 1.25
percent. The existing target appears to be a reasonable starting point for the new
system-with a modification to allow the reserve ratio to move within a range to ensure
that banks are charged steadier premiums. The point of the reforms is neither to
increase assessment revenue from the industry nor to relieve the industry of its
obligation to fund the deposit insurance system; rather, it is to distribute the assessment
burden more evenly over time and more fairly across insured institutions.
Under the FDIC's recommendations, the reserve ratio would be allowed to move up and
down within a specified range during the business cycle so that premiums can remain

steady. The key to fund management would be to maintain the fund within the statutory
range and to bring the fund ratio back into the range in an appropriate timeframe when it
moves outside in either direction. As the reserve ratio moves, the Board should have
the flexibility to use credits, rebates, or surcharges in order to keep the ratio within the
range. Moreover, the greater the range over which the FDIC has discretion to manage
the fund, the more flexibility we will have to eliminate the system's current pro-cyclical
The FDIC would prefer to steer clear of hard triggers, caps and mandatory credits or
rebates. Automatic triggers that "hard-wire" or mandate specific Board actions are likely
to produce unintended adverse effects, not unlike the triggers in the current law. They
would add unnecessary rigidity to the system and could prevent the FDIC from
responding effectively to unforeseen circumstances. To manage the insurance fund
effectively, the Board must have the flexibility to respond appropriately to differing
economic and industry conditions.
While I believe that the FDIC Board needs greater discretion to manage the fund, we
are not suggesting the FDIC be given absolute discretion - there is a need for
accountability. The FDIC will work with Congress to develop parameters for an
appropriate range for the fund ratio. The FDIC also will work with Congress to provide
direction for the FDIC Board's management of the fund ratio levels and to develop
reporting requirements for the FDIC's actions to manage the funds.
Charging Premiums Based upon Risk
How would premiums work if the FDIC could set them according to the risks in the
institutions we insure? First, and foremost, the FDIC would attempt to make them fair
and understandable. We would strive to make the pricing mechanism simple and
straightforward. The goals of risk-based premiums can be accomplished with relatively
minor adjustments to the FDIC's current assessment system.
I am aware of the concern about using subjective indicators to determine bank
premiums. We will be sensitive to that issue and work to ensure that objective indicators
are used to the extent possible to measure risk in institutions. Any system adopted by
the FDIC will be transparent and open. The industry and the public at large will have the
opportunity to weigh in on any changes we propose through the notice-and-comment
rulemaking process.
Using the current system as a starting point, the FDIC is considering additional objective
financial indicators, based upon the kinds of information that banks and thrifts already
report, to distinguish and price for risk more accurately within the existing least-risky
(1A) category. As the result of many discussions with bankers, trade-group
representatives and other regulators, as well as our own analysis, we are looking at
several possible pricing methodologies. We actively seek input from the industry and
Congress regarding possible pricing schedules that are analytically sound.

For the largest banks and thrifts, it will be necessary to augment the financial
information banks report with other information, including market-based data. The final
risk-based pricing system must be fair and must not discriminate in favor of or against
banks merely because they happen to be large or small.
In short, the right approach is to use the FDIC's historical experience with bank failures
and with the losses caused by banks that have differing characteristics to create sound
and defensible distinctions. However, we will not follow the results of our statistical
analysis blindly-we recognize that there is a need to exercise sound judgment in
designing the premium system.
One result of the FDIC's current inability to price risk appropriately is that the deposit
insurance system today is almost entirely financed by institutions that paid premiums
prior to 1997. Almost 1,000 newly chartered institutions, with more than approximately
$80 billion in insured deposits, have never paid premiums for the deposit insurance they
receive. Many institutions have greatly increased their deposits since 1996, yet paid
nothing more in deposit insurance premiums.
New institutions and fast-growing institutions have benefited from the assessments paid
by their older and slower-growing competitors. Under the present system, rapid deposit
growth lowers a fund's reserve ratio and increases the probability that additional failures
will push a fund's reserve ratio below the DRR, resulting in an immediate increase in
premiums for all institutions. One way to address the fairness issue that has arisen and
to acknowledge the contributions of the banks and thrifts that built up the funds during
the early 1990s is to provide transitional assessment credits to these institutions.
A reasonable way to allocate the initial assessment credit would be according to a
snapshot of institutions' relative assessment bases at the end of 1996, the first year that
both funds were fully capitalized. Each institution would get a share of the total amount
to be credited to the industry based on its share of the combined assessment base at
yearend 1996. For example, an institution that held one percent of the industry
assessment base in 1996 would get one percent of the industry's total assessment
credit. Relative shares of the 1996 assessment base represent a reasonable proxy for
relative contributions to fund capitalization, while avoiding the considerable
complications that can be introduced by attempting to reconstruct the individual
payment histories of all institutions.
Institutions that had low levels of deposits on December 31, 1996, but subsequently
experienced significant deposit growth would receive relatively small assessment
credits to be applied against their higher future premiums. Institutions that never paid
premiums would receive no assessment credit. Institutions that made significant
contributions to the deposit insurance funds would pay a lower net premium than
institutions that paid little or nothing into the fund. Such an assessment credit would

provide a transition period during which banks that contributed in the past could offset
their premium obligations through the use of credits.
The combination of risk-based premiums and assessment credits tied to past
contributions to the fund would address the issues related to rapid growers and new
entrants. Regular risk-based premiums for all institutions would mean that fast-growing
institutions would pay increasingly larger premiums as they gather deposits. Fast
growth, if it posed greater risk, also could result in additional premiums through the
operation of the FDIC's expanded discretion to price risk.
The reforms just described are critical to improving the deposit insurance system. Let
me conclude my discussion with the most controversial, but least critical, of the FDIC's
recommendations, the recommendation on coverage. The FDIC's recommendation is
simple: whatever the level of deposit insurance coverage Congress deems appropriate,
the coverage limit should be indexed to ensure that the value of deposit insurance does
not wither away over time. If Congress decides to maintain deposit insurance coverage
at its current level, indexing will not expand coverage or expand the federal safety net. It
will simply hold the value of coverage steady over time. In addition, without arguing
about the causes and contributing factors of the thrift crisis, indexing the limit on a
regular basis may prevent possible unintended consequences of large adjustments
made on an ad hoc basis in the future.
Federal deposit insurance was created in a period of economic crisis to stabilize the
economy by protecting depositors. By any measure, it has been remarkably effective in
achieving its goals over the years. It is no less important today.
Deposit insurance reform is not about increasing assessment revenue from the industry
or relieving the industry of its obligation to fund the deposit insurance system. Rather,
the goal of reform is to distribute the assessment burden more evenly over time and
more fairly across insured institutions. This is good for depositors, good for the industry
and good for the overall economy.
The responsibility of prudently managing the fund and maintaining adequate reserves
are taken very seriously by the FDIC-I reiterate: it is extremely important to depositors,
the industry and to the financial and economic stability of our country. We have only to
look back at the bank and thrift crises of the 1980s and 1990s to understand this. The
existing deposit insurance system has served us well, and we must be mindful of this in
contemplating changes.
The FDIC's recommendations would retain the essential characteristics of the present
system and improve upon them. While Chairman, I will ensure that the FDIC manages

the insurance fund responsibly and is properly accountable to Congress, the public and
the industry. Our recommendations will ensure that future Chairmen will do so as well.
Congress has an excellent opportunity to remedy flaws in the deposit insurance system
before those flaws cause actual damage either to the banking industry or our economy
as a whole. The FDIC has put forward some important recommendations for improving
our deposit insurance system. We appreciate the Committee's leadership on this issue
and look forward to working with each of you to get the job done this year.
1 CAMELS is an acronym for component ratings assigned in a bank examination:
Capital, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk.
The best rating is 1; the lowest is 5. A composite CAMELS rating combines these
component ratings, again with 1 being the best rating.

Last Updated 02/27/2003