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For Release:
April
9,799"L
2:10 P.M., EDT
FINAhICIAL RMORIVT OR LOST OPFORTI,,NITY
W. Lee Hoskins, President
Federal Reserve Bank of Cleveland
Independent Bankers Association of America
'
Annual Convention
Las Vegas, Nevada
Aprïl 9,7991
FINAìTCIAL REFOR}Í OR
I
am
I¡ST
OPPORTI'NITY
sure that ny views on our current system of federal deposit
lnsurance are
well
known
to you. In fact, I
am
probably Ken Guenther's
favorite whlpplng boy and my vlews have been the subJect of several
Independent Bankers Association
of America
(IBAA) news
bulletins.
I
Because
belleve that deposit insurance reform is one of the most important issues
facing
vrith
Èhe banking
Èhe
industry today, I would llke to thank Ken for providing
opportunity to present my views to the
I,Ie have had
members
of the
IBAA
in
ne
person.
plenty of tiure to rethink the current system of bank
regulation and the slze and scope of the financial safety net. There
have
probably been as many governnent studies, academlc papers, and professional
conferences on banking reform during the past few years as there have been
bank and
chrift fallures. Unfortunately, Ehls lnterest in banking reform has
so far produced few tanglble beneflts. As currently structured, depostt
insurance and bank regulatlon have continued
to fall behind
changes Ln
financlal markets and, .as a result, have contributed to the problems that
now
face us ln Èhe banklng lndustry. Instead of meanlngful reform, the clinate of
concern
that
surrounds banklng today, coupled
with the lntense pressures to
recapitallze the federal deposit insurance system, could just as easily result
in hasty legislative actions that would make natters
Bank
combinatlon
profitability
even worse.
and franchlse values have been eroded by a
of overregulatÍon
and new courpetltfon from unregulated financial
2
services provlders who have successfully galned entry fnto tradltlonal banklng
inarkets.
Some
of the
ne\r competltlon faced by banks today
is the result of
regulatlons linlting the ab1líty of banks to Deet the needs of their
customers. One can only wonder how banks v¡ould have fared
in a less-regulated
and less-subsidlzed environment.
At the
same
tine, bank franchlse values are being
eroded by lncreased
deposlt tnsurance assessments, as the balloonlng cost of the federal safety
net for banks becomes more evident. In ny vlew, the only way to stop the
deterioratlon of bank franchise values ls to reintroduce market forces lnto
banking markets
system. Key
that
to increase the efficlency
and competitiveness
of our banking
to any regulatory reform ls meaningful deposit insurance
reduces both the size and the scope
reform
of federal deposit guarantees. I
do
not favor ellminating deposlt lnsurance altogether. llhat I propose ls limited
deposit insurance priced and adninistered ln a way that more appropriately
aligns costs with rÍsks. l,Iell-capitalized banks (the najority of whÍch are
small banks) and taxpayers should not bear a disproportíonate share of the
costs of the system, as chey currently do.
In the
remarks
that follow, I
w111 make
three points. First, the costs of
supportlng our current deposlt lnsurance system exceed the benefiÈs it
provldes. Second, as Ken Guenther and the
IBAA have
correctly pointed out,
there can be no real reform of federal deposlt Lnsurance as long as the
"Too
Blg To Let Fail" (TBTLF) policy ls adhered to by bank regulators. Third,
before proceeding to recapltallze the FDIC's bank insurance fund (FDIC-BIF),
we should specify more
clearly the obJectives of federal deposit insurance
and
3
inslst that those federal funds that are used should
come
from a direct
Congresslonal approprlation and be funded by Treasury debt. For banks,
especlally surall ones, my message ls chac continuing along the
have traveled w111 mean a
position.
to
path
we
faster and inevitable decllne Ín conpetlclve
However, meaningful reforms
would enable banks
same
to deposlt lnsurance
compete head on wlÈh nonbank
flrns
and bank regulation
and
to
remain
important players in the financial system.
Costs
of Deooslt Insurance and the
The estlmated $200
mess, along
billlon
Need
for
needed
Reform
to resolve the thrlft
insurance
wlth rapfdly rlsing estimates of the costs of recapitalizing the
FDIC-BIF, represent Just the monetary costs
of malntaining our current federal
deposit insurance system. Other costs co the economy include a less-efflcient
bankfng system, an overlnvestment
in risky assets,
and the
ineffLcient use of
soclety's savlngs.
As it ls currently structured, the federal government's deposlt
guarantee progran provides incentives
for insured depository insticutíons to
take on excesslve risks. The fixed-rate premlum penalizes safe banks
rewards
rfsky
ones
and
by subsidlzing the cost of funds for risky institutions.
Marginal banks and thrlfts pay nearly the same rate for deposlts
as
well-capltalized deposltory instltutlons because, except for large deposlts in
srnall banks, all deposits are equally lnsured and deposit lnsurance premiurns
are not based on risk.
4
The deposlt lnsurance subsidy and Ëhe attendant systeur
of
bank
iegulatlon protects weak and lnefflclent depository lnstltutlons at the
expense
of their well-capltallzed s1bIlngs. The dlrect costs of the present
system have rLsen
rapidly and, in all l1kellhood,
w111 continue
to do so.
Deposlt insurance premÍums that used to everage 4 to 5 basis points per dollar
of domestlc deposits 1n the early
1980s w111
rise to
23 basfs
polnts this
year, and may go as hlgh as 30 basls polnts. Although there has been talk of
capping the deposit Lnsurance
premLr¡m
at
30 basls points per
domestic deposits, Congress w111 always prefer
dollar of
to lncrease taxes
on banks
rather than to expllcitly allocate general taxpayer monles to recapltallze the
FDIC.BIF.
Unllmlted deposit insurance also means further govern¡Tent lnvolvement
1n the buslness decisLons
of banks, an intrusion that ultinately
reduces
banks' efficiency, profttablltty, and abtllty to compete with unregulated
financlal sen¡lces providers.
The
safety net has been, and wlll contlnue
be, used Èo Justify treating banks as public utillties.
Èo
Comnunlty Relnvestment
Act guldellnes, lifellne checklng, and assorted other consumer-oriented
measures are
addltional burdens that banks have been, or will be, asked to
bear.
In addltlon to the reductlon ln the efflciency of the flnanclal
system, the current deposft Lnsurance system exacts other economic costs.
Society's savÍngs, a scarce resource, are not efflclently used. Many proJects
were underÇaken only because mlspriced federal deposit guarantees and
regulatory capital forbearance practf.ces transferred rlsk to the
government.
5
The funding
expense
of speculative proJects by Lnsolvenü banks
of good,
sound proJects.
reduces aggregat-e economic
monles used
base and
to rebulld the
thrifts
was
at
the
This fmposes a deadrseight loss on society
efflclency. Soclety would be better off lf
to flnance speculative real
Southwest had been used
and
estaËe booms
in the Northeast
and
the
and
to finance the nodernizatLon of the U.S. lndustrial
decaying
public lnfrastructure.
Gettlng Rld of the Too Blc To Let Fall Doctrlne
"I rsonder 1f we rnlght have been better off today lf we had
decided to let Continental fail, because many of the large
banks that I was concerned rnlght fall have falled anyway,
.... And they probably are costing the FDIC more money by
being allowed to continue several more yeers than tþey
would have had they failed in 1984." Wlllian Isaac'
The "To Blg To
Let FaiI" doctrlne arose out of the regulatory handling
of the insolvency of the Continental llllnols
Chicago
in
May L984.
defended the
llnited
Bank and
Trust
Company
In the fall of that year, the Comptroller of the
ballout of Continental by asserting that Continental
number
of
of banks that
was "Too Big To
Currency
was one
Fafl." I refer to this
of
a
mlsguided
regulatory philosophy as "Too Blg To Let Fa1l" rather than "Too Blg To Fail"
to
enphasize
that the rationale for
TBTLF
ls political rather than
Policymakers and bank regulators have
risk of systemic fallures ln the financial
economic.
relied on the specter of
system
to Justify
the
TBTLF. Regulators
************
1
t¡tttlam Isaac, quoted Ín Robert Trigaux, "Isaac
p. 6 (July 31, 1989).
Ballout,n @!qBan@,,
Reassesses Gontinental
6
have argued
that the failure of a large bank could result in a loss of
confidence 1n the banklng system as a whole and thereby produce runs on
solvent banks. You w111 recognLze this explanatlon as a reference to the Great
Depresslon, a perlod
failures
have been
in whlch the actual losses to depositors from
greatly exaggerated. Regulators have argued that the
fallure of a large bank w111 cause the collapse of a great
banks because
bank
of the lnterbank exposure that arlses from
nu¡nber
of snall
normal
efficiency-produclng correspondent banklng relationshlps. 2 fin" flnal
currently most cited argument for contfnuing
Some
and
TBTLF 1s paymenÈs system
rfsk.
fear that the default of a large bank on the Federal-Reser:ve-operated
paJments system could
result ln the fallure of other large
system exposure
to the bank that falled,
pa1¡ments system
ltself
and
banks
with
palments
possibly 1n the collapse of the
.
Although the aforementioned argunenÈs for TBTLF have considerable
polltical appeal 1n that they allow regulators to avoid the uncomfortable task
of closlng a large bank,
none
of these arguments
can be
justified on economíc
************
2
lr,t"rbank exposure arguments were lnitlally used by the FDIC to defend
the ballout of Contlnental llllnols. In tesÈlnony before Congress in October
L984, then FDIC Chalrman Isaac stated that allowlng Continental llllnois to
fall would have caused the fallure or capltal fmpaírment of hundreds of snall
correspondent banks. Ihis argument rvas refuted by a Congressional staff report
to the same Congressional committee that, using reasonable estlmates of
Continental's portfollo losses, found that few lf any of Continental's 2300
correspondent banks rsould have failed or been seriously affected. See United
States Gongress [Hearlngs]. House of Representatives. 1985. Committee on
BankÍng, Finance and Urban Affairs, Subconmittee on Financial Instltutions,
Superrrision, Regulation, and Insurance. Inquiry into Continen l..a'l Tl l ínní c
Corp. and Continental Illlnois Natlonal Bank. October 4. 1984 (98th Congress,
2nd Sessfon). I.Iashington, D.C.: Government Prlnting Office. Staff report clted
above 1s at pp. 418-445: testlnony of l,liIl1an M. Isaac 1s at pp. 457-49L.
7
grounds. For example, there Ls no reason
should cause deposltors
that the fallure of a large bank
to run on solvent banks.
Should such runs occur, they
could be handled both through approprlate open-market operations to protect
the econony's llquldtty Ln general, and through use of the Federal Reserve's
"lender of last resortrr facility to lend dlrectly to solvent banks. Moreover,
lf
bank regulators adhere
to strlct closure rules for all banks,
then
deposltor confldence should noÈ be affected by the fallure of a bank of any
size.
Ihe current hlgh level of rlsk ln the flnancial system, which Ls used
to Justlfy
TBTLF, 1s 1n a
expanding size
very real sense a
The
of
TBTLF and the
of the flnanclal safety net. A reductlon 1n the financlal
safety net and the elinlnation of
counterparÈies
consequence
of both
TBTLF would
increase the rlsk to
inÈerbank holdlngs and pa¡rnents system transactlons.
effect of prlvatizing thls risk
exposure would be closer counterparty
scrutlny by banks in correspondent dealings and ln
pa1¡ments system
transactions. Interbank exposure rlsk and palments system risk would
managed
carefully,
and
be
thls 1n turn would mininlze the effects of the fallure
of a slngle large bank on other
banks and on the pa¡rments system. Furthermore,
the Federal Reserve's provfslon of liqutdity to the flnancial system through
open-market operations and
minlmize
or
dlrectly to
banks through the discount wlndow could
even elfuninate any dfsruptfons caused by the
indivldual bank or even a smalI number of
I
agree
with
Ken Guenther
that
an
banks.
TBTLF
deposit insurance coverage should be the
failure of
ls lnequltable
same
and thaÈ de facto
for all banks, regardless of
B
slze. I also
agree
with the
IBAA
positlon that there can be no meaningful
deposit insurance reform as long as bank regulators subscrlbe to the
doctrlne. I.ltrere I part
company
TBTLF
wlth the IBAA positlon ls on how to level the
playfng field between large and snall banks. The IBAA's bellef that the
facto
de
100 percent deposlÈ lnsurance coverage norù enJoyed by TBTLF banks should
be extended to all banks would mean a contlnuatlon of burdensome regulation,
increased deposit Ínsurance premfulms, and a
further erosion in bank franehise
values.
The solutlon
to
TBTLF Èhat
I advocate is
Èo
linit regulatory
discretion to deal with failing banks ín a manner that elÍminates
TBTLF
as
a
regulatory policy. Instead of extending large bank coverage to small banks, I
would reduce the protectlon afforded
to large
banks by
llnltlng federal
deposit Lnsurance to $25,000. I r¡ou1d have the FDIC provide 90 percent
colnsurance
for
deposlÈs frorn $25,000 co $50,000, and 70 percent coinsurance
for deposlts 1n excess of that
insurance
an
to cover
some,
amount. Prlvate fnsurance markets rnight
or all, of the deductible.
To do
thls, there
offer
must be
expllclt, statutory prohibition against the FDIG or the Federal Reserve
fron taking actlons to protect uninsured deposltors. Only Congress, with full
polltical accountablllty, should be allowed to approprlate caxpayer funds to
protect uninsured claimants of financial institutlons.
I also urge statutory linitatlons on regulatory discretlon ln handling
bank
fallures r¡hlch would lnclude the adoptlon of
mandatory solvency-based
closure rules and cofnsurence haircuts (deductfbles) for uninsured depositors
ln
banks
of all slzes. I
ruould phase
in these
changes
gradually, but according
9
to a definlte timetable, so that they do noÈ themselves
uncertalnty. Ihese reforms would glve the
TBTLF
become
a source of
doctrine the decent burial it
deser¡¡es.
Recapitallzlng the FDIC-BIF
Another idea that deser¡¡es a qulck burlal fs che proposal
recapitallze the
magnltude
FDIC
wlth Federal
Reserrre funds.
of the FDIC-BIF's fundlng
lreasury and the
co
Official estinates of
the
needs seem to be growing alnost da1ly. The
FDIC have requested $70
b11llon 1n borrowing authority,
blIlion of which would be direct borrowing frour the Federal
llhlle 1t ls lmportant that the FDIC be recapltallzed
$25
Reserve Banks.
and glven the resources
to resolve more banklng problems, the urgency of the FDIC-BIF funding-needs
should not overwhel¡n the need
to clarlfy the principles that v¡ill guide
the
admlnistratlon of che program. Otherrvise, we will Just perpetuate the
undesirable staËus quo, with billions more belng spent before we deal with the
fundamental problems
that face the
There are two aspects
presenÈ system.
of the varlous proposals that
have surfaced to
deal wlth the FDIC-BIF solvency crlsis that are of partlcular concern to
Flrst, there is great reluctance to adnit that taxpayer funds will
me.
be
requlred. It nay be politically convenient to avold the appearance that publlc
funds w111 have to be tapped. But
thls will be costly
because
it will delay
recognltlon of the problem and, as the thrifÈ crlsis taught us, a1low the
problen Èo worsen further, lncreaslng fuÈure and flnal cosËs. One cannot help
but remember the reluctance, as late as 1987, to admit that thrift lndustry
10
resources could noc posslbly handle the
deflcft ln the FSLIC fund,
even though
the size of the hole ln that fund was several tlnes the industry's book
capital. I
am noÈ suggestlng
that the shorÈfall today in the
large. But 1t is becoming LncreasLngly elear that, under
FDIC-BIF
is
as
some clrcunstances,
the FDIC-BIF deflclt could be large enough that increased taxes on banks
be unable
to
make up
w111
the difference. The federal government has always acted
as 1f lts full faith and credit stood behind the thrlft and bank deposlt
insurance systems. Now
that the banklng lndustry's capacity to shore up
system may be exhausted,
lt is time for the federal
government co meet
the
lts
responsibilitles openly.
Even more
troubllng ls the desire to use the Federal Reserr¡e
System to
recapitalize the FDIC-BIF. I,lhlle this would delay direct Congressional
appropriatlons to resolve the FDIC-BIF solvency crisls, Lt would do no
than malntaln the facade
of taxpayer nonlnvolvement.
The repercussions
more
of not
deallng directly and openly wlth the fundlng problem are straightforward.
Effectlve control of the
money supply
will
mean
to the FDIC nust be offset by sales of other
portfollo.
income
government
Any losses on Federal Reserrre lendlng
securlties from its
to the
FDIC would mean less
for the Systen to turn over to the Treasury. This 1s yet
example
to be
that Federal Reserr¡e lending
of the kinds of policy proposals that
done
another
cone along rshen something needs
in a hurry.
I thlnk that thls ldea ls
unsound
in another very
fundamental way. The
Federal Reserr¡e System !¡as sec up expllcitly to be separate from the Treasury
in order to preclude central
bank financing
of Treasury operatlons.
1
Large-scale, long-term loans to governnent agencies l1ke the FDIC are a clear
vlolation of this important prlnclple,
and today's
violatlons ere likely to
lnvlte further violatlons in the future. Thls could put us on the sllppery
slope of monetlzí:ng government outlays through central bank flnancing rather
than through Congresslonal approprlations.
The
prlnary responslbtltty of any central bank 1s to protect the
purchaslng power
Reserve
of the natlon's currency.
to take on the addltlonal task of
busLness cycle balk
Even people who want
smoothing out the bumps
at the prospect of uslng the central
to print
money
to support
of
bank as a
fiscal finance. The lnflatlon experlence of countries in whlch
bank has been reguired
the Federal
the
tool of
Èhe central
government outlays has been
extremely dlsappolntlng. Furthermore, extenslve monetlzlng of governmenc
expendltures can
result in a breakdown in flscal dlsclplíne, which 1n turn
requires further rellance on the central bank to monetlze governmenc debt.
This can become a vicious cycle that eventually produces excremely high levels
of lnflati-on. Breaching the barrier that separates the monetary function of
the central bank from the constltutionally based appropriation process could
have
dire
consequences
for the future
f.ndependence
of
monetary
poltcy and for
the conÈrol of lnflatlon.
Conclusion
The tiure
passed us
to enact flnancial reform outslde of a crlsis
by. Legislation inevitably
w111 have
environment has
to take a bow in the direction
of expediency. But we stlII nust decide what course our flnanclal
system
I
should take. Do we move toward more government lnvolvement
sector, or do !Íe
move toward
in the financial
a more market-orlented banklng systeur? To me, the
choice is clear. Financlal markeÈs w111 contLnue to evolve and clrcumvent
governmental attempts
at regulation. As financial lnnovation continues to
break down the barrlers between banklng and co¡nmerce, banks will continue to
have one hand
McFadden and
and bank
tied behlnd thelr
backs by outdated regulatlons such as the
Glass-Steagall restrlctions. I.IlÈhout reforms to deposlt insurance
regulation, banks will slowly disappear from the financÍal
as unregulated firms take more and more
landscape
of their busfness. I{ith reforms, banks
will be able to retain a place ln thelr markets, alongside nonbank fírrns,
and
provlde value to our economy through the ffnancf-al system.
For small banks, the message 1s clear: Continuing along the
we have traveled means
same path
a continulng decllne. Both hlgher deposit insurance
assessments and burdensome regulations w111
further reduce the abilíty of
small banks to meet the competitive challenge posed to them by the large
regional and super-regional banks, credlt unions, and unregulated
firns l1ke
Gl'fAC, General
Electrlc Credit Corporation,
Amerlcan Express. OnIy through
manner
that is equitable
AT&T, Sears, and
real reform of our systen of bank regulation
and federal deposlt insurance can the
Flnally, the fundlng
nonbank
needs
slide be halted.
of the
and produces
FDIC-BIF should be addressed
fn
a
a sound insurance fund. Unfortunately,
the solutions currently belng consLdered appear to be as
much concerned
with
papering over the losses ln order to avoid Èhe appearance of a taxpayer
ballout as they are with producing a sound, well-capixalLzed insurance
fund.
@FedFRASER