FDIC To Bolster Insurance Fund With Prepaid Bank Assessments

FDIC To Increase DIF  By $45 Billion

The FDIC announced today a proposal to increase the deposit insurance fund (DIF) by requiring financial institutions to prepay three years of assessments.   The collection of prepaid assessments will allow the FDIC to cover the cost of future banking failures without tapping their credit line with the US Treasury (see FDIC Seeks To Avoid Treasury Bailout).  The FDIC’s plan is expected to raise $45 billion.

The Board of Directors of the Federal Deposit Insurance Corporation today adopted a Notice of Proposed Rulemaking (NPR) that would require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The FDIC estimates that the total prepaid assessments collected would be approximately $45 billion. The FDIC Board also voted to adopt a uniform three-basis point increase in assessment rates effective on January 1, 2011, and extend the restoration period from seven to eight years.

FDIC Chairman Sheila Bair said “It’s clear that the American people would prefer to see an end to policies that look to the federal balance sheet as a remedy for every problem. In choosing this path, it should be clear to the public that the industry will not simply tap the shoulder of the increasingly weary taxpayer. This proposal is a vote of confidence for the banking industry’s resilience and will continue to recover its strength as we work through the significant challenges ahead.”

Prepayment of assessments will allow the industry to strengthen the cash position of the Deposit Insurance Fund (DIF) immediately, while allowing the capital impact of deposit insurance assessments to be felt gradually over time as the industry improves its own financial position. The banking industry has substantial liquidity to prepay assessments. As of June 30, FDIC-insured institutions held more than $1.3 trillion in liquid balances, or 22 percent more than they did a year ago. Prepaying assessments will put the industry’s liquid balances to good use in conserving capital and helping to maintain the capacity of banks to lend while they rebuild the DIF. FDIC analysis indicates that this arrangement is much less likely to impair bank lending than a one-time special assessment.

FDIC Treasury Bailout May Ultimately Be Necessary

The FDIC’s proposal to bolster the DIF with prepaid assessments buys  some time and avoids the politically unacceptable measure of requesting a Treasury bailout.  The FDIC theory seems to be that “time cures all” but this may turn out to be wishful thinking unless the banking industry sees a dramatic profit recovery.   Until we see a strong rebound in the economy with a simultaneous recovery in asset values and  incomes, the FDIC proposal will likely be inadequate.   Consider the following assessment of the banking industry:

But the bottom line is “$50 billion is nice but it’s a down payment compared to size of problem in front of us,” says Christopher Whalen, managing director at Institutional Risk Analytics, which estimates the FDIC is going to need $300 billion to $400 billion before the current crisis ends. “That’s not the end of the world but the hole is very big — far larger than in the 1990s.”

Whalen believes the FDIC will ultimately have to tap its credit line with Treasury but says the industry is trying to prevent (or at least delay) that inevitability. “The tension here is between going to Treasury and the industry’s desire to keep FDIC independent and away from Treasury,” he says.

The latest FDIC Quarterly Banking Profile seems to support the view that a banking industry turnaround is not imminent.  The FDIC Problem Bank List increased to 416 institutions with assets of $220 billion.  For 2009 to date, 95 insured financial institutions with assets of $105 billion have failed at a cost to the FDIC of $26 billion, or 25% of assets.  Chairman Bair has acknowledged that the US banking industry has many “severe challenges” to overcome.  An extra $45 billion in the DIF fund will help, but it may turn out to be only a fraction of what is ultimately needed to handle future banking failures.