December 14, 2010 – The current banking crisis has completely depleted the FDIC’s Deposit Insurance Fund which currently has a negative balance of $8 billion. In an effort to rebuild the insurance fund that protects depositors from loss when banks fail, the FDIC Board approved a rule to set the designated reserve ratio (DRR) at 2% of insured deposits.
While this is good news, the bad news is buried in the FDIC’s Final Rule on the Designated Reserve Ratio. Continued banking failures and losses in excess of reserve assessment revenues will keep the Deposit Insurance Fund dramatically underfunded for almost two decades. Even more startling is the FDIC’s dubious assumption that the we will experience a long period of economic growth after the current recession ends.
The FDIC expects $50 billion in losses on failed banks over the period 2010 through 2014. Most of these losses are projected to occur in 2010 and 2011. The approximate cost to the FDIC Deposit Insurance Fund for the 151 banking failures that occurred in 2010 is approximately $22 billion implying that the number and cost of banking failures in 2011 will substantially exceed this year’s total.
The FDIC projects that, over the period 2010 through 2014, the fund could incur approximately $50 billion in failure-resolution costs. The FDIC projects that most of these costs will occur in 2010 and 2011.
Based on current assessment rates and projected losses from banking failures, the Deposit Insurance Fund will not reach levels that safely protect depositors from bank failures for almost two decades, according to the FDIC Final Rule report.
As described in the proposed rule, the FDIC estimates that the reserve ratio will not reach 2 percent for about 17 years; that estimate assumes a long period of economic expansion after the current recession ends. After a lengthy expansion, the greater risk to the banking industry and the economy is overextension of credit, not insufficient credit.
A weakened banking industry was forced to prepay 3 years of FDIC insurance assessments totaling $46 billion in late 2009 to prop up the Deposit Insurance Fund. With the banking industry still facing major problems, the FDIC does not want to hit the banks with further large assessments that will decrease earnings and reduce the amount that banks can lend.
The very slow replenishment of the Deposit Insurance Fund carries the risk of losing public confidence in the FDIC’s basic mission should we encounter another financial crisis. The FDIC recognizes this risk despite the FDIC’s authority to borrow directly from the US Treasury if necessary.
“It is also important that the fund not decline to a level that could risk undermining public confidence in federal deposit insurance. Furthermore, although the FDIC has significant authority to borrow from the Treasury to cover losses when the fund balance approaches zero, the FDIC views the Treasury line of credit as available to cover unforeseen losses, not as a source of financing projected losses.”
The FDIC seems to be betting that the present recession will end and the US economy will enter 20 years of prosperity as revealed in the FDIC’s recently approved 2011 operating budget:
“the Board also approved an authorized 2011 staffing level of 9,252 employees, up about 2.5 percent from the current 2010 authorization of 9,029. On a net basis, all of the new positions are temporary as are 40 percent of the total 9,252 authorized positions for 2011. Temporary employees have been hired by the FDIC to assist with bank closings, management and sale of failed bank assets, and other activities that are expected to diminish substantially as the industry returns to more stable conditions.”
Given the still very unstable global financial condition, the FDIC seems to be taking a long shot bet here (see Banks May Be Facing A Tidal Wave Of Mortgage Defaults).