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FOR IMMEDIATE RELEASE PR-92-83 (12-6-83) An address by William M. Isaac, Chairman Federal Deposit Insurance Corporation Washington, D.C. before the Management Conference of the Nat ionaI Counc i I of Savings Institutions The Waldorf-Astoria Hotel New York, New York December 6, 1983 1+ is a pleasure to be here today to address the newly formed National Council of Savings Association League, years; of made Institutions. Mutual Savings important Your Banks two and contributions to predecessors, the National financial the Savings legislation National and Loan over the I know the Council will continue to provide leadership in the ever- changing financial services marketplace. During the past six-to-nine months, the FDIC's principal focus has shifted from savings bank problems to commercial bank failures and various regulatory and legislative issues. today discussing the I would like to spend most of my time legislative package, S. 2103, to Congress last month. submitted by the FDIC I will then turn briefly to the net worth certifi cate program. The FDIC's legislative package study we submitted to Congress derives last April. from the deposit In that study we pointed out that while deposit insurance has worked extraordinarily well depositor confidence in the banking system, in the financial has been the larger ones, marketplace. provided in Because connection depositors with the same risk-restraining de facto most pressure loss. in maintaining it has also eroded discipline 100% bank and other general not been subjected to any risk of insurance insurance coverage failures, particularly creditors ordinarily have Consequently, banks do not feel from creditors as other firms. Our proposed legislation is designed to improve this situation and to strengthen the FDIC's ability to limit its exposure. Most concluded who have looked closely at deposit that there are two ways to make the insurance have generally system work more fairly 2 - and impose more discipline: (I) - price insurance premiums according to bank risk and/or (2) expose large depositors and other creditors to greater risk of loss. Risk-Related Assessment Credits Our proposed legislation would allow us to vary the assessment rebate according to the risk a bank poses to the deposit insurance fund. the current scheme, all banks pay the same flat-rate premium and receive the same assessment rebate, are operated. the inequity Under irrespective of how well or how poorly they Relating the assessment rebate to risk would in the current system, under which both reduce low-risk banks subsidize the activities of high-risk banks, and discourage excessive risk-taking. Despite overzealous claims in the academic literature, we recognize that an ideal risk-related premium system is simply not feasible at present. It would advanced require risk unrealistic quantification kinds and amounts techniques than of are data and currently much more available. We have proposed a more modest system based on sound, objective measures of risk. Initially, there would be three risk classes of banks, based on such considerations as capital, risk banks — asset quality and probably about 85% of all banks — rebate, which would be somewhat above the Riskier ered interest-rate risk. institutions to be the most would receive risky would remain the same as under current half receive law, would receive the full level authorized by law today. the rebate, none. and The total those consid rebate would but the distribution of banks would vary according to their risk characteristics. Normal- it among -3- The cost difference between the best and worst banks would not be more than four or five basis points on deposits — enough to bring down an already weak bank. not trivial, but not The FDIC would, refine the criteria for measuring risk and, possibly, over time, later request author ity for greater variations in assessments. We have also proposed that banks be charged for all above-normal costs of supervision, such as the more frequent examinations that problem banks require. Requiring problem of spreading them among all banks banks in the as we do now -- would provide a small to correct These are their not problems drastic promptly. proposals, to but pay these form of instead lower premium rebates important It would costs also incentive for banks be more but they represent steps equitable. in the right d irect io n . Market D isc ipIi ne One of the most effective ways to control excessive risk-taking is to expose banks to the discipline of the market, which has been undermined by the working of the deposit source of market discipline $100,000 insurance limit. insurance system. A promising is depositors with balances potential in excess of the Although we refer to them as "uninsured” deposi tors, in practice we have for years provided them with de facto 100% cover age in most bank failures, especially large ones. This is a consequence of our preference by merger. National any money for handling bank failures Prior to the fai lure and payoff of the $500 mi II ion Penn Square Bank last year, no depositor or other general creditor had lost in the fai lure of an FDIC-insured bank of $100 million or more. -4- While the Penn Square failure has raised the threshold suppliers of funds undoubtedly still off deposits in a big bank. level, most believe that the FDIC will large not pay If these large creditors are to have sufficient incentive to monitor bank risk, then the risk exposure of uninsured deposi tors must be increased and equalized for banks of all sizes. One way this could be done is for the FDIC to pay off insured deposi tors in all failed banks. significant problems. tors typically their claims. must However, a payoff of a large bank can create Most notably, uninsured depositors and other credi wait several years before they receive payment of The bigger the bank, the more disruption this would cause. To alleviate this problem, the FDIC is considering combining a payoff of insured deposits with a cash advance to uninsured depositors and other general creditors based on the by the receivership. These present value of anticipated collections liabilities could be transferred or sold to another bank so that banking services are not interrupted. of transaction could be effected quickly, markets would be kept to a minimum. a strong incentive to in the financial At the same time, uninsured depositors would be exposed to some risk of loss. have disruptions If th is type select As a result, bank customers would the soundest institutions, not just the largest ones or those paying the highest interest rates. In the proposal for FDIC's deposit exposing insurance larger study, depositors we discussed an alternative to the risk of loss through a coinsurance plan that would set coverage at 75% of balances above $100,000, even when a bank failure is handled through a merger. the same result can be achieved, We have concluded without statutory change, by combining -5- a payoff wFth the cash advance scheme I just discussed. Consequently, our legislative proposal does not include a coinsurance provision. Our legislative package FDIC more flexibility discipline. ures and so includes two provisions that will in paying off banks or otherwise encouraging market We have proposed to define creditor preferences in bank fail that holders certain of contingent standby more importantly, claimants, letters relative to general creditors. and, give the of credit, including loan participants would have a junior position This would simplify our costing procedures would require a particular class of sophisticated bank customers to be more selective in its choice of banks. In addition, we have proposed to expand the authority of a so-called Deposit Insurance National Bank depositors of a closed bank. is very limited. provides for a (DINB), an institution Under current used to law the authority of a DINB It cannot take new deposits or make loans. DINB with pay off fullbanking powers. Our proposal This would enable us to pay off a bank, make a cash advance to uninsured depositors and transfer deposits to a DINB, which could purchase assets of the failed bank and continue to operate and serve the bank's customers. the DINB would be soldto another would give the FDIC an fashion and where market liabilities or in a public offering. option for handling a conditions, other bank or failed bank uncertainties complexities make As soon as practical, it about the virtually This in an orderly bank's assets impossible to consummate a transaction over a weekend. We believe our proposals would increase depositor discipline and introduce more private sector restraint on banks. Some argue — correctly — deposits will frustrate that increased use of fully insured brokered - 6 - our efforts to reduce de facto full insurance coverage. This is one of the reasons we are seeking comment on the desirability and means of reducing insurance coverage on brokered funds. deposits indicate that while their Data recently collected on brokered aggregate volume is modest today, a disproportionate share is concentrated in poorly rated banks. Some contend that it simply will not be feasible to pay off a large bank, regardless of cash advance or DINB procedures. If that turns out to be the case, then we would consider urging Congress to impose a mandatory minimum capital requirement on depository institutions, a portion of which could be met by subordinated debt. This would be tantamount to "throw ing in the towel" on depositor discipline and relying on capital markets to provide the necessary restraining influence on bank behavior. Combining Deposit Insurance Funds As most of you know, the FDIC's deposit insurance study urged combining the FDIC and FSLIC that a combined into a single insurance fund. fund would acquisitions of troubled be stronger, within both the in our draft facilitate inter-industry banks and thrifts and would provide for a more evenhanded treatment of depository lated environment. would We continue to believe institutions in an increasingly deregu Given the opposition to a merger that currently exists banking legislation. and thrift industries, We believe, we have not proposed however, it is essential it for the FDIC and the FSLIC to move toward common capital and accounting standards and, to note that the extent feasible, in these areas — common examination and a number of procedures. others, I should including deposit -7- brokering — the FDIC and the FSLIC are working together more closely than ever. The FDIC's Role After hearing about our legislative and other proposals we have made, you may make have some it clear. system, question about where the FDIC Deposit insurance is extremely manner should be the FDIC's so let me important in our financial and we believe that providing adequate evenhanded is heading, insurance coverage principal role. That in an requires monitoring our risk and keeping it within reasonable bounds. We do not believe the FDIC should divert its resources to consumer compliance, securities disclosure, antitrust enforcement and other matters that can be handled by other government agencies already performing similar functions. We have made President's Task Group, recommendations and in our along these draft lines to the legislation we have Vice proposed elimination of the requirement for FDIC approval of branch applications. In order to control our risk exposure and obtain the information needed to properly handle failures, we must be able to examine any troubled FDIC-insured bank (and a small enforcement actions. number of others) and to take appropriate We currently have the requisite examination authority; the proposed legislation would give us the needed enforcement action author ity. In implementing our authority, we seek workable, cooperative arrange ments with other regulators. We are participating with the Federal Home Loan Bank Board in a joint examination program for federal savings banks, and we believe the Federal similar Reserve and the Comptroller of the Currency for state member and national banks. arrangements can be worked out with the states, - 8 - At the same time, we are cutting back substantially on examinations of nonproblem, insured nonmember banks. Our objective our resources to their most efficacious use — tions and problem situations. We will is to reallocate that is, to larger institu behave more like an insurer than a reguIator. Savings Bank Performance and Survival Before concluding I would like to comment briefly on thrift perfor mance and the net worth certificate program. While it is true reforms and other lately and than commercial that performance, the we still failures, deposit closely monitor industry’s problems apparent that the easy earnings thrifts. bank insurance issues have been of more immediate concern to the FDIC thrift recognize that have not gone savings banks away. It is improvement has already occurred for many The cost of funds at savings banks increased in the third quarter and aggregate earnings, while still positive, were down a bit, after several successive improving quarters. to show earnings improvement. in the present range, increase The strongest institutions have continued If interest rates and deposit costs continue we expect a slow upgrading of asset yields would interest margins and earnings over time — but the key words are ” if" and "slow”. What about our weakest institutions, the 25 or so that have outstanding net worth certificates? program, we — future. tion. As we move into the second year of a three-year the FDIC and the participating banks — must plan for the Not all recipients of net worth assistance are in the same situa A few are now operating close to break-even and may be able to -9- sell stock to improve their position. a combination of expense reduction, In other instances, it will take lower interest rates, a very receptive capital market and considerable good fortune to achieve a turn-around. What other alternatives exist? with a strong, are some potentially we II-capitaIized institutions on our value to another institution. net worth certificate institution to go stock on their own. today. Weak institutions might look to merge even though they I suspect there list which would add do not have the strength A number of savings banks are doing quite well They have good earnings to stock and be very well and surplus or the potential capitalized. to convert It would not be too difficult, on paper, to pair off some strong and weak savings banks, factor the combined forma institution could raise by going stock and come up with pro earnings even have some immediate to strong in what and capital some savings benefit institutions numbers that would banks paying by acquiring could also federal a weaker assist be very respectable. We income tax that would get institution. the Branch sales recapitalization of weak savings banks. The FDIC is not in the business of putting together unassisted mergers. Whether management and trustees at incentive to get bigger and go public, profitable mutuals I do not know. have sufficient We have seen thrifts convert to stock or start the process where additional capital is essential to survival. And we have seen a few cases where essentiality does not appear to have been the motive: to improve their situations where comparatively strong banks wanted and obtain the benefits that potentially go - with stock ownership. 10 - We will be very interested in monitoring what happens over the next year or so, particularly in New York now that legal hurdles to conversion are out of the way. Title II of Garn-St Germain, which includes the net worth certificate program, expires in two years. Stock conversion or merger negotiations take time, and we believe it is important that savings banks participating in the net worth certificate program develop specific plans to strengthen their institutions. For that reason, we now require savings bank Title II applications (including renewal applications) to include a full discus sion to of merger strengthen plans, capital. stock We conversion plans want to know what or other pending actions is being considered and, at least equally important, we want to see some hard thinking and concrete actions by boards of trustees and management. Concluding Comment Banks and thrifts are undergoing an enormous amount of change today — in what they can do and turmoil in how they are to be regulated. over the past few years able reason for optimism. The economy has moved This ahead in financial markets, there is consider has been a good year well, the inflation interest rates have been relatively stable. are operating Despite the rate in many has been respects. low and The majority of savings banks in the black and their outlook is much improved over that of a year ago. For some thrifts seriously weakened by losses in recent years, survival is not assured. Nearly all of their time and effort must, of necessity, be focused on enhancing earnings and capital time frame for planning is comparatively short. or arranging a merger. The For the vast majority, luxury your of longei— range planning process initiatives will near-term survival planning is available. is not the issue, and the An important element is the future regulatory environment. likely be debated in the next session in Three major of Congress: expanded powers for banks and thrifts, deposit insurance reforms and reorga nization of the regulatory system. If I could All three are critically needed. leave only one message with you today, devote some time and serious thought to these closely with the National or inaction on these many years to come. Council items will on them. affect your it would be to legislative issues and work For better or worse, action institution and industry for
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