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TESTIMONY OF
L. WILLIAM SEIDMAN
CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION
WASHINGTON, D.C.
ON
DEPOSIT INSURANCE REFORM
BEFORE THE
SUBCOMMITTEE ON COMMERCE, CONSUMER, AND MONETARY AFFAIRS
OF THE COMMITTEE ON GOVERNMENT OPERATIONS
UNITED STATES HOUSE OF REPRESENTATIVES
9:30 A.M.
WEDNESDAY, OCTOBER 3, 1990
ROOM 2247 RAYBURN HOUSE OFFICE BUILDING
Good Morning, Mr. Chairman and members of the Subcommittee.
We appreciate this opportunity to testify on deposit insurance
reform.
Along with the other federal banking agencies and the Office
of Management and Budget, the Federal Deposit Insurance
Corporation is participating in the Treasury Department's
comprehensive study of deposit insurance.
This study was
mandated by the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989.
The Treasury Department intends to
complete the study by the end of this year.
Because the study will draw conclusions and make
recommendations regarding the subject matter of this testimony,
providing comprehensive conclusions and recommendations now would
be premature.
Since we still are studying these matters with our
colleagues, our purpose today is to report on our thinking and
define the important issues we believe are involved.
Reform requires recognition of the many interrelationships
among industry structure, the deposit insurance system, and
regulatory responsibilities.
Reform of the deposit insurance
system must include reform of the antiquated legal structure
burdening the financial industry in general and the banking
industry in particular.
A healthy deposit insurance system
depends ultimately on the existence of a healthy banking system.
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TAYTNG THE FOUNDATION FOR A SOUND DEPOSIT INSURANCE SYSTEM:
RESTRUCTURING THE BANKING INDUSTRY
The competitive environment within which banks operate is
changing significantly.
Banks and other financial institutions
have been hampered by an antiguated legal structure in their
ability to adjust to the changes.
interrelated trends:
There are three noteworthy
banking is becoming a riskier, more
volatile business; banks are encountering greater degrees of
competition; and what constitutes the business of banking itself
is undergoing a rapid evolution.
Structural reform should begin by identifying and examining
the underlying obstacles to a competitive and viable banking
industry.
These obstacles are:
1.
The Glass-Steagall Act;
2.
The ownership and product limitations of the Bank
Holding Company Act; and
3.
Geographic barriers to bank expansion.
In 1987, the FDIC considered in detail the first two of
these topics.
The results were set forth in our study titled
Mandate for Change:
Restructuring the Banking Industry.
events of the interceding three years have only served to
The
3
reinforce Mandate's conclusions that the Glass-Steagall Act and
many of the restrictions of the Bank Holding Company Act are not
only unnecessary, but also harmful to the banking industry.
Substantial benefits would accrue from eliminating the
current ownership and activity restrictions imposed by these
laws.
Risks could be diversified.
Cross-marketing activities
could enhance the profitability of the overall organizaticm, so
long as there are restrictions on the use of insured funds to
support uninsured activities.
Interstate banking restrictions also have contributed to the
increase in risk in the nation's banking industry and to the
decrease in banks' competitiveness *
Removal of these
restrictions would permit lower risk through diversification.
Banks also would be able to expand operations to match the
expansion of banking markets created by technology and economic
growth.
These archaic geographic restrictions will become even
more unpalatable in the near future as the European Community
eliminates restrictions on branch banking.
BUILDING A SOUND DEPOSIT INSURANCE SYSTEM:
THREE IMPERATIVES
In addition to removing existing obstacles to a viable and
competitive banking industry, deposit insurance reform must be
tackled.
The objectives of reform should be to reduce the
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potential liability of the government for its safety net and to
maintain the stability of the financial system.
The deposit insurance system should be designed to ensure
that the industry —
both the institutions and their customers —
bears the appropriate costs.
The deposit insurance system should
not result in a subsidy to the banking industry, particularly a
subsidy that eliminates the penalties the marketplace imposes on
reckless conduct.
Any system of supervisory controls creates costs and
benefits.
The issue sometimes comes to the fore only when
changes in the supervisory system are considered, or when a
disaster such as the savings and loan crisis sheds light on the
costs and benefits.
Changes in the deposit insurance system, and
the bank supervisory structure in general, will entail shifts in
costs and benefits.
Much needs to be done to restore the health of the banks and
their deposit insurance system.
Supervision must be strengthened.
But, three needs stand out.
Capital must be increased.
Risk must be limited.
Supervision.
The essence of prudent banking is to avoid
making bad loans and investments.
Unfortunately, all the rules
and regulations in the world are not going to prevent bankers
from making unwise lending and investment decisions.
Adequate
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supervision, however, can restrain, although not entirely
prevent, such decisions.
Adequate supervision is built upon
hands-on efforts by competent, trained examiners.
Indeed, in many ways supervision is superior to regulation.
A number of industrialized nations have been highly successful in
governing their depository institutions through systems that rely
almost solely on supervision as opposed to regulation.
In the United States, there is a partiality toward written
rules and regulations.
Fairness is viewed as requiring explicit
publicly-known standards.
Such explicitness, however, can
produce a false sense of security.
A law is passed, a regulation
is promulgated, and a problem is considered solved.
Meanwhile,
unnoticed events are occurring that will lead to future
difficulties.
Thus, supervision must occupy a central position in the
structure for governing the nation's depository institutions.
The FDIC is spearheading an effort, in conjunction with the other
banking supervisors, to improve and enhance the supervision of
U.S. banks.
This effort can proceed independently of the
deliberations on banking and deposit insurance reform.
Indeed, a
strengthened supervisory effort is necessary to protect the
insurance fund and the taxpayers during the period when
appropriate reforms are identified and implemented.
6
Among the measures being actively pursued are:
a policy of
conducting on-site examinations of all banks no less than once a
year; assignment of permanent resident examiners to all of the
larger banks; a uniform dividend policy that would apply to all
banks encountering difficulties; and a common approach to the
evaluation of loan underwriting standards.
Capital.
While the degree of risk in the banking system has
increased since the 1940s, the proportionate amount of capital
has remained relatively static.
In the 1980's, this adverse
change in the relationship between the degree of risk in the
banking industry and the level of capital support was joined by
—
perhaps even contributed to —
failures.
soaring numbers of bank
These failures in turn produced a fall in the ratio of
the deposit insurance fund to insured deposits to the lowest
level in the FDIC's history, 0.60 percent.
that the amount of capital —
The FDIC believes
the safety cushion —
in the
banking industry should be increased.
Capital serves to protect both individual banks and the
deposit insurance system.
An adequate commitment of capital on
the part of the owners of a bank can curtail the temptation to
take excessive risks with the bank's funds.
Curtailment of risky
activity at individual banks would result in a more stable
banking system and a healthier deposit insurance fund.
7
The federal banking supervisors recently reached agreement
on a minimum capital ratio for banks.
however.
This is only a minimum,
Over the long term, more capital is needed.
is needed?
How much
The amount should depend on the riskiness of the
activities insured banks are allowed to conduct.
In addition to
higher capital ratio requirements, an increase in the amount of
capital for new bank charters may be called for.
This might help
improve the staying power of new banks, which historically have
experienced a relatively higher failure rate than have
longer-established institutions.
Although the FDIC believes an increase in capital
requirements is necessary, the increase should not be imposed in
isolation.
Higher capital requirements should be accompanied by
industry structural reforms.
These structural reforms concern
the product and ownership limitations of the Glass-Steagall and
Bank Holding Company Acts and the geographic restraints of the
McFadden Act, which were discussed earlier in our testimony.
Risk.
The level of risk in the banking industry has
increased over the years because, as noted earlier, the banking
business itself has become riskier.
In addition, many bankers
with less aversion to risk have appeared on the scene.
Regarding the latter point, by the time the financially
exciting years of the 1980s arrived, the numbers of bankers who
8
remembered the devastating times of the 1930s and the cautious
times of the 1940s and 1950s were few.
The field of finance
became an arena for the robust, the daring, the adventuresome.
Concern about risk was not high on their agenda.
Perhaps the events of the last few years have restored a
healthy appreciation for, and fear of, the perils inherent in
financial activities.
If not, additional excruciating lessons
might have to be endured.
The ease of entry into the banking
industry can produce a degree of pessimism in this regard as
there is a steady influx of individuals who must relearn old
truths.
But assuming that the human aspect of the banking industry's
risk problem has been mitigated somewhat, the problem of a
generally riskier business still remains.
The best way to
approach this problem appears to be to limit the types of
activities that can be supported with insured deposits.
In other
words, what can be done in a bank should be restricted.
If a
banking organization wants to engage in riskier activities, it
should do so in nonbanking affiliates adequately separated -both legally and financially —
from the bank.
Capital flows
between the bank and its subsidiaries must be strictly limited.
This view was first put forward by the FDIC in its 1987 Mandate
study.
9
Determining the activities that could be conducted in the
bank —
and consequently that would be supported by insured
deposits —
will be difficult.
The FDIC is taking a hard look at
the issue.
One possibility is to limit the bank to making short-
and intermediate-term loans that have no attributes of equity
instruments.
All loans would be with recourse.
Other
activities, including some activities that banks now engage in,
would have to be moved to affiliates.
In such a system, a distinction might need to be drawn
between larger banks and smaller banks.
The difficulties that
smaller institutions would encounter in setting up holding
companies or separate subsidiaries, and the lesser danger they
pose to the deposit insurance system, might justify fewer
restrictions on their activities.
Supervision, capital, risk:
these are the three imperatives
that must be dealt with if the present troubles engulfing the
deposit insurance system and the banking industry are to be
overcome.
Regulatory Structure
Regulatory structure reforms should not be the tail that
wags the dog.
Regulatory structure changes should be addressed
only after structural reform of the industry and changes in the
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deposit insurance system.
How the regulatory structure should be
altered will depend on how the problems of industry structure and
deposit insurance reform are resolved.
Issues of regulatory responsibility and supervisory
authority should not be allowed to obscure the more important
need to rejuvenate banking industry competitiveness and
viability.
Nor should issues of regulatory reform be the
predominant considerations in changes to the deposit insurance
system.
Once reforms concerning banking industry structure and the
deposit insurance system are agreed upon, the difficult task of
improving the rationality and efficiency of the regulatory
structure can be tackled.
For example, if holding company
regulation is substantially eliminated, the Federal Reserve's
present role will have to be changed.
Currently the structure consists of three federal bank
regulators, one federal thrift regulator, one federal credit
union regulator, and a variety of regulators in the 50 states.
Responsibilities are often overlapping and redundant.
Functional
regulation takes second place to institutional regulation.
Elimination of many of the outdated aspects of this structure
would appear to be both possible and desirable.
11
Experience indicates that independence of financial
regulators and insurers is essential to supervising the financial
system.
Further, banking supervisors should not be subject to
conflicts that may arise if they are responsible for other
important functions and objectives, such as monetary policy,
international economic stability, and revenue production.
Supervision can be more uniform than it is today.
More
uniformity, however, would make it even more important that
supervision be kept independent of other public concerns and
political pressures.
Conclusions
A healthy deposit insurance system depends ultimately on the
existence of a healthy banking system.
To halt the deterioration
in the health of the U.S. banking system, structural reform of
the banking industry is necessary.
Measures to provide a viable and competitive banking
industry and to reform the deposit insurance system should be
considered in tandem.
Our goals must be to reduce the potential
liability of the government for its safety net and to maintain
the stability of the financial system.
To achieve these goals we
must strengthen supervision, build capital, and limit risk.
We
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also must have adequate, "workable but restricted," insurance
coverage.
The foregoing is what is needed to vastly improve the
performance of the financial system in the United States and to
improve the ability of our financial institutions to compete
successfully in the world economy.
QUESTIONS SUBMITTED BY THE SUBCOMMITTEE
1. Who will bear the risk if coverage is reduced? If
insurance coverage per depositor is reduced, how can we estimate
how much additional risk this will impose on households and firms
and which segments of the population will bear this risk?
Do we
presently have a statistical base for estimating who will bear
the additional risk? What further data surveys or analysis are
needed to derive useful estimates?
Bank deposit reporting requirements were changed following
enactment of the Paperwork Reduction Act.
The deposit data
collected by the FDIC fall under broad categories.
The annual
Summary of Deposits survey conducted by the FDIC requires banks
to report deposits, by branch, using the following breakdown:
"IPC deposits" (i.e.. deposits held by individuals, partnerships,
and corporations) and "other deposits."
In turn, certain items
on Schedule 0 of the Report of Condition ("Call Report"), which
banks must submit each June, require banks to report the number
and amount of deposits in accounts of less than $100,000 and more
than $100,000.
This information relates to the entire
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institution and is not broken down by branch.
From the June 30.,
1990 Call Report data the FDIC has calculated that the average
deposit account at BIF-insured institutions is $8,100.
However,
we cannot determine, for example, whether the account holder
might be an elderly widow or a small business owner.
To more accurately determine which depositors would be
affected if deposit coverage were reduced, the FDIC would have to
ask banks for additional data about each individual depositor,
including age, occupation, or other sensitive data.
Some banks
might already capture the necessary data as part of their
marketing strategy.
However, requiring banks to obtain such data
from customers may conflict with existing constraints on
privacy.
To the extent that banks would not have the requisite
information readily available, requiring this data would increase
the reporting burden and attendant costs on banks and ultimately
consumers.
The Subcommittee may be interested in a consumer survey
conducted in 1983 for the Federal Reserve (Attachment A) .
This
survey, which canvassed 4,000 households, produced a profile of
account holders, by size of insured accounts.
We understand that
this survey currently is being updated for the Federal Reserve by
The University of Michigan Survey Research Center.
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2. Is depositor discipline a workable concept?
key parts to this issue:
There are tvo
a. Can consumers and small business entrepreneurs pick safe
banks? If deposit coverage is reduced, can ve safely assume that
individuals who hold large liquid balances that exceed insurance
limits and who wish to avoid risk (such as elderly individuals.
lawyers keeping escrow balances, small business entrepreneurs
handling sizable transactions or payroll balances, etc.) will
know how to judge the financial safety of depository
institutions? Will they be able to choose genuinely safe
institutions for their uninsured funds, and will they be able to
"discipline" risk institutions?
b. Is depositor discipline compatible with broader
stability concerns? Will depositor discipline, in order to work
effectively, reguire the existence of large "hot money" pools of
uninsured funds that move abruptly among institutions as rumors
of trouble circulate? Is depositor discipline based on such
funding shifts a desirable element?
Depositor discipline is useful as it cuts off funding for
poor operations.
panic —
However, in excess —
and in moments of
it can seriously damage the system.
All business enterprises, including banks, are subject to
market discipline.
This discipline is enforced through the
actions of several different economic agents including:
customers, suppliers, employees, equity owners, and creditors.
Depositors can behave as customers (purchasing services from the
bank), suppliers (funding is the raw material of a bank), and
investors.
Demand deposit holders are distinctive in holding
callable debt.
This distinguishes them from most debt holders of
15
commercial firms.
Their actions will differ from those of a
commercial debt holder when the viability of the debt issuer is
questioned.
A deposit holder has an incentive to liquidate deposits from
a troubled institution if transaction costs are less than
potential losses.
The implementation of a deposit insurance
system eliminates the incentives that depositors would otherwise
have to run from troubled institutions.
Dependence on depositor
discipline to relieve the burden on the insurer can create
undesirable side effects.
These include:
1) an increase in
systemic instability; 2) a loss of flexibility in limiting the
economic damage of a major bank failure, and 3) a competitive
disadvantage for the U.S. banking industry.
In addition, it is
unclear that the bank deposit market is well suited to imposing
discipline on banks.
Systemic Instability and Depositor Discipline.
A policy
regime that mandates losses on uninsured depositors introduces
instability because it increases both the possibility of bank
runs and the ripple effects of the bank failure.
As the pool of
uninsured depositors increases, the likelihood of bank runs also
increases, as does the potential for damage in any individual
run.
When failures occur, the losses imposed on uninsured
depositors will have economic repercussions.
These include
possible impairment of correspondent banks, disruptions to the
payments system, and damage to the local economy as firms and
16
individuals adjust to their losses.
Once again, the greater the
pool of uninsured depositors, and the greater the loss at the
failed bank, the greater the economic impact will be.
It has been asserted that depositors would make better use
of evaluations published by private bank analysts.
While such a
result would be an improvement, it is important to recognize that
there are limits to the information provided by these firms.
In
many cases, analysts' forecasts are based on bank financial
statements and analyzing performance based on key ratios compared
to peer groups.
This type of analysis offers some insight into a
bank's current performance, but does not indicate as much about a
bank's prospects.
Bad loans and fraud continue to be the major
causes of bank failure.
profitable —
Bad loans look good —
and very
for a long time before they turn sour.
Only a few
years before failing, Continental Bank was hailed as a model bank
organization.
The type of analysis required to determine the
quality of a loan portfolio is so intrusive, it is doubtful that
it could be performed by agents other than bank examiners.
Even
If the bank were willing to submit to the intrusion of such
analysis, the need to maintain confidentiality of customer
information may prevent a third party from making an accurate
assessment of individual credits.
17
Regulatory Flexibility. Any policy that imposes mandatory
losses on uninsured depositors only has meaning if it is expected
to apply to all bank failures, including the largest.
"Too big
to fail" would have to be eliminated as an accepted de facto
doctrine.
However, if legislation is passed prohibiting the FDIC
from acting with discretion on large bank failures, other
government bodies —
either the Federal Reserve Board or the
Department of Treasury —
bank.
might act to support a major failing
The reality that the largest banks are more likely to
receive such treatment will continue to influence market
behavior, providing major banks with a competitive advantage over
smaller institutions and reducing the effectiveness of depositor
discipline on those large banks.
A mandatory requirement that no
agency could act when a major institution fails would be a
radical action out of step with all other major countries at this
time.
International Competitiveness.
A policy of mandatory losses
on uninsured depositors must be reconciled with policies followed
by bank regulators in other major industrialized countries.
Large depositors would have great incentive to transfer their
funds into institutions that are believed to have more government
support than others.
The FDIC hosted an international conference of bank
regulators last week.
An ultimate goal of the conference was to
start a process that will lead to international coordination of
18
failed-bank policy.
It would be better to institute mandatory
haircut proposals after international agreements are reached.
3.
Does Davments svstem intearitv recruire soecial insurance
treatment for transaction balances?
a.
How is the intearitv of the Davments svstem related to
DI?
b. In terms of the continued smooth functionina of the
Davments svstem when an institution fails, does it matter whether
that institution's transaction accounts are insured?
c.
If so, how should the deoosit insurance svstem aoolv to
transaction accounts specifically?
The Federal safety net, comprised of the deposit insurance
system and the discount window, was designed to protect the
nation's financial system and, in turn, the economy through its
ability to control systemic risk.
The purpose of deposit
insurance is to protect individual depositors and ensure a
safe-and-sound banking system.
As such, deposit insurance plays
an essential role in helping control systemic risk and providing
stability to the financial system.
The payments system's primary activities involving banks are
check clearing, automated clearing house payments and wire
transfers of funds.
Of these, wire transfers constitute the bulk
of the system in terms of dollar volume.
They are processed by
two separate electronic payments networks, FedWire and the
Clearing House Interbank Payments System (CHIPS).
It is in
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regard to these two systems that the questions of risk and
stability primarily arise.
Essentially, the systemic nature of payments system risk
arises from the speed and volume of today's electronic payments
and the interdependencies of banks using those systems.
As such,
it is feared that failure of one participating bank could lead to
disruptions for many banks.
Such a breakdown in the payments
system would have serious implications for the domestic and
international financial markets.
Therefore, in order to ensure
the integrity of the payments system, its exposure to systemic
risk must be controlled.
The design of FedWire, and to a lesser extent, CHIPS, has
built-in features to limit their exposure to systemic risk.
Payment finality and restrictions on daylight overdrafts protect
the Federal Reserve from the effects of systemic risk on
FedWire.
Similarly, restrictions on intra-day credit work in
conjunction with the system's design to lessen the systemic risk
on CHIPS.
However, it is the Federal safety net which ultimately
protects the payments system, the banking system and the general
economy from the systemic risk of bank failure.
In the absence of adequate insurance on transaction
accounts, the failure of a bank could lead to significant
disruptions in the banking system and the general economy.
Under
this scenario, the efficiency of the payments system would be
20
impaired as well.
Transaction balances must be adequately
covered so as to ensure the safe-and-sound operation of the
banking system (and more broadly, the financial system).
4. How should money market funds be treated under the
safety net? Money market mutual funds are a close substitute in
many respects for insured depository accounts, and most of them
now offer check-writing privileges that permit investors to use
them as transaction accounts for payments of a certain minimum
size. Holders of liquid balances that are eligible for deposit
insurance coverage thus have a genuine choice between insured and
uninsured demand accounts with transaction features.
a. Is it appropriate that individuals should in effect
select their own desired level of deposit insurance coverage in
this wav?
b. If so. should we extend this principle to permit banks
to offer both insured and uninsured accounts to individuals, with
the depositors being free to choose whether their accounts will
be insured or not (and presumably paving directly for the
insurance premiums on insured accounts)?
c. If not, should money market funds that resemble demand
accounts be brought under the deposit insurance system?
Money market funds recently have become an innovation of
significance to the financial system.
From $3.7 billion in
assets at the end of 1975, they have grown to over $450 billion
in assets, which equals approximately 70 percent of the $630
billion in transaction accounts at commercial banks.
There are
about 650 money market funds, with approximately 21.3 million
shareholder accounts.
Although strictly regulated by the Securities and Exchange
Commission and limited to investments in high-quality assets,
money market funds are not without risks.
Some funds invest only
21
in U.S. Treasury or agency securities, but commercial paper
accounts for 50 percent of the industry's total assets.
Since June 1989, two issuers of commercial paper held by
several money market funds have defaulted.
The issuers were
Integrated Resources, Inc., and Mortgage and Realty Trust.
The
shareholders of the funds were not affected because each fund's
investment adviser purchased the defaulted commercial paper.
If
there were more widespread problems in the commercial paper
market —
such as might occur during an economic downturn —
the
advisers and managers of money market funds might not be as
willing, or able, to offset the funds' losses.
Money market funds are also subject to interest-rate risk.
One instance in which this type of risk caused difficulties
occurred in 1980.
The fund, Institutional Liquid Assets,
believed that short-term interest rates had peaked and therefore
lengthened the maturity of its government securities portfolio to
over 70 days.
Interest rates continued higher, however, and the
fund was deluged by redemption requests of over $400 million in a
three-day period.
The sale of securities to meet the requests
resulted in a $2 million loss. The fund's distributor and
investment adviser provided monetary support.
22
To date, no money market fund shareholder has experienced a
loss.
As the preceding examples show, however, funds do entail
credit risk and interest-rate risk.
If shareholders of any one
fund ever suffered a loss, a general loss of confidence in funds
could ensue, and a classic run as experienced by banks in the
early 1930s could conceivably occur.
Turning to the question of whether individuals should be
able to select their own desired level of deposit insurance by
choosing between insured transaction accounts and uninsured money
market funds, choice is one of the hallmarks of a free market.
Individuals, businesses and the economy in general are better off
if competitive forces are free to operate, and if the various
economic actors have leeway to make risk versus reward decisions.
From this standpoint, it is appropriate that individuals have a
choice between insured transaction accounts and uninsured money
market funds.
The other side of the coin is that to offset market
imperfections and to avoid certain undesirable consequences, the
functioning of the free market is restrained in a number of ways.
Among the targets of the restraints are instability in financial
markets and disproportionate financial losses to individuals of
modest means.
The purpose of SEC regulation and supervision of
money market funds is to preclude such adverse situations and
events.
The SEC recently proposed amendments to its money market
fund rules to tighten up what are already pervasive controls.
23
In view of the SEC's extensive regulation and supervision of
money market funds, the answer to the question of whether
individuals should have a choice between insured transaction
accounts and uninsured money market funds is "yes.”
The further question of whether banks should be permitted to
offer both insured and uninsured transaction accounts to
individuals is also "yes."
However, the issue is tied to larger
issues concerning industry structure.
As stated previously, the
FDIC believes that the product and ownership restraints the
Glass-Steagall and Bank Holding Company Acts put on banking
organizations —
meaning parent bank holding companies and both
their banking and nonbanking affiliates —
are outdated.
Banks,
funding their activities with insured deposits, should be limited
in what they can do.
But their legally and financially separate
nonbank affiliates should have much more freedom than they have
now.
In such a structure, the offering of uninsured accounts
would be from the nonbanking sides of banking organizations.
practical problem to overcome is depositor awareness.
The
The
distinction between the bank-offered insured account and the
nonbank-offered uninsured account would have to be made very
clear to even the most unsophisticated depositor.
This could be
accomplished through appropriate regulatory control.
- 24 -
5. Is the present deposit insurance structure an impediment
to international competitiveness? What should Congress make of
the argument that the fees for deposit insurance and the whole
regulatory apparatus that accompanies the deposit insurance
system impair the international competitiveness of U.S. banking
firms? If there is a genuine impairment here, how should we take
that into account in looking at deposit insurance reforms?
Congress should act to revamp a structural and regulatory
deposit insurance system since it does impede our international
competitiveness.
The crux of the problem resides with the
structural obstacles that we identified at the beginning of this
testimony —
namely, the Glass-Steagall Act; the ownership and
product limitations of the Bank Holding Company Act; and
geographic barriers to bank expansion.
Further, the risks taken
with insured deposits and resulting losses has made the cost of
insurance a handicap for U.S. banks' competitiveness in world
markets.
Relative to other countries the United States has operated
for far too long with an economically irrational financial
structure.
Two examples illustrate this point.
The nations of
the European Community, which is rapidly removing internal
barriers to the movement of goods and services, have nothing that
is comparable to our Bank Holding Company Act.
Bank supervisory
systems in Europe are aimed at the bank rather than at both the
bank and any corporate owners.
Similarly, our nation's archaic
geographic banking restrictions will become even more obvious and
unpalatable in the near future as the European Community
eliminates restrictions on branch banking.
While European banks,
25
and U.S. banking organizations with subsidiaries in Europe, make
growth decisions based on market opportunities, banks operating
in the United States will make growth decisions based to a large
extent on what statutory loopholes can be found.
Therefore, if
structural reforms are not undertaken and if we do not build a
sounder banking system with an accompanying sounder deposit
insurance system, then fees will continue to rise and hamper the
international competitiveness of U.S. banks.
Another way that deposit insurance and the safety net
relates to international competitiveness is bound up with the
issue of whether some banks should be "too big to fail.”
The
term "too big to fail” is used in referring to troubled banking
organizations that supposedly are too large for the government to
handle by closing the bank and paying off deposits up to the
$100,000 insurance limit.
There are many nuances in the
resolution methods for troubled banks that are not handled
through a liquidation and deposit payoff.
To generalize, if the
deposit payoff method is not used, a troubled bank resolution is
accomplished either by arranging for the bank's liabilities, both
insured and uninsured, to be acquired by another institution, or
less often by providing direct financial assistance.
Who is aided in the various resolution methods varies.
In
the past, uninsured depositors and creditors of the troubled bank
were benefitted in most cases in which a resolution method other
than the deposit payoff method was used.
Stockholders and
26
management of the institution were benefitted much less
frequently.
FIRREA —
The FDIC's pro rata power —
which was ratified in
enables us to distinguish between categories of
uninsured depositors and creditors under all methods of resolving
failing banks.
Of more general significance, however, is the fact that "too
big to fail” is much more than a problem of the deposit insurance
system.
Altering the present regulatory structure in an attempt
to eliminate the perception of large banks being "too big to
fail” would merely shift responsibilities.
The possible failure
of a large financial organization presents macroeconomic issues
that some arm of the government must consider.
The evolution of
the economy-wide ramifications of the demise of a big bank is a
government duty.
"Too big to fail” as an issue would exist even in the
absence of an explicit deposit insurance program.
And the result
of protecting large institutions is to provide 100 percent
insurance for the deposits in such institutions.
Past experience
in all major countries supports the contention that a "too big to
fail" policy exists, de facto if not de jure.
Although the FDIC believes that the "too big to fail"
concept must be re-examined, we would caution against any
unilateral action on the part of the U.S. government to restrict
the application of "too big to fail."
Action on this issue
27
requires international cooperation.
If the U.S. were to go it
alone and formally renounce "too big to fail," the practical
effect would be to cause prudent money managers to withdraw funds
from large U.S. banks and redeposit their funds in countries that
have either a de facto or de jure "too big to fail" policy.
At
that point, the U.S. deposit insurance system would hamper the
international competitiveness of U.S. banks.
Owing to the importance of the "too big to fail" issue, the
FDIC last week convened an international conference to discuss
this problem and related issues.
One of the clearest points to
come from the conference was that other governments, regulators,
and bankers do not desire nor practice a policy of tying the
hands of those who are ultimately responsible for the resolution
of large problem banks.
Rather, the emphasis is on prevention of
problem situations through the steps we described earlier —
supervision, capital, and limiting risk.
When these measures
fail, and it happens less often in other countries, the
resolution of the situation is determined by the facts at hand;
this is what Gerald Corrigan has termed the policy of
"constructive ambiguity. it
Attachment A
C haracteristics o f A ccount H olders, By Size o f Insured A ccounts
1983 Survey o f Consum er Finances
-¡tern
Size o f largest set o f accounts at any type o f insured institution
____________________________N o account __SL-25K
S25K-50K
Î50-75K
S75K -100K M 10QK _All families
Num ber o f fam ilies in group
(m illions)
10.3
65.8
13
83.9
4.1
0.7
1.9
% o f all fam ilies in group
12.3
78.4
1.4
100.0
4.8
23
0.8
% o f all household deposits
held by group
0.0
100.0
33.5
17.4
28.6
6.6
13.9
Hb o f all deposits held by group
0.0
12.6
37.6
10.8
6.5
52
2.5
% o f all insured household
deposits held by group
0.0
19.4
100.0
37.9
15.6
73
19.6
M edian age o f head
41
39
60
65
65
65
43
M edian years o f education
o f head
9
12
12
12
12
13
15
Ho o f group in various occupations
R etired
263
15.5
36.8
41.6
44.0
19.0
45.3
O ther not w orking
35.9
13.0
13.5
16.6
153
7.9
5.7
Professionals, m anagers,
adm inistrators
5.2
26.9
223
19.4
35.1
24.6
34.9
Sales, clerical, craftsm en,
laborers, m ilitary
32.0
423
17.3
18.4
18.7
39.0
8.8
F anners
0.6
13
3.1
1.6
1.4
2.9
5.1
A ll occupations
100.0
100.0
100.0
100.0
100.0
100.0
100.0
M edian incom e (thousands)
7.1
21.0
29.8
32.4
273
50.4
193
M edian net w orth (thousands)
1.0
35.0
138.0
192.9
1833
478.7
343
M edian % o f net w orth
in insured accounts
0.0
6.4
27.4
37.6
50.0
403
5.6
M edian financial assets
(¿thousands)
0.0
2.6
45.7
78.9
1003
238.0
23
M edian H6o f financial assets in
insured accounts
0.0
100.0
94.9
88.0
92.7
903
913
% ow ning stocks/bonds
1.4
213
4 6.8
553
52.6
6 1.0
21.6
Hoow ning business
22
143
26.8
223
33 3
36.8
143
Hoow ning investm ent real estate
5.6
18.7
36.7
38.7
16.8
443
18.8
1. A polar assumption was made here to determine the size o f a household's largest body o f deposits at a given Institution. All accounts
with a particular type erf institution (e.g^ commercial banks, savings and loans, etc.) were assumed to be held at the same institution
and all accounts were assumed to be held in the same names. U ns will tend to overstate the number o f households in the top groups.
Accounts included are checking, money market, savings, IRAs and Keoghs, and CDs.
@FedFRASER