Capitalization of the Bank Insurance Fund
Kevin P. Sheehan
Financial Economist
Federal Deposit Insurance Corporation
Division of Research and Statistics
550 17th Street, NW
Washington, DC 20429
Phone: 202-898-7366
Fax: 202-898-7149
E-mail: kesheehan@fdic.gov
FDIC Working Paper
98-1
Abstract: A two-state Markov-switching model is estimated to characterize the time
series behavior of disbursements from the Bank Insurance Fund (BIF). The estimated
model is used to project future disbursements, and these projected disbursements are used
to estimate the likelihood of insolvency as well as the likelihood of the BIF falling below
two different minimum reserve ratios. The simulation results confirm that the current
funding arrangement—an assessment rate of 23 basis points with a 1.25 percent required
reserve ratio—is sufficient to maintain BIF solvency if one assumes that the prior history
of losses is a good indicator of future losses.
The comments and suggestions of Barry Kolatch, Steven Seelig, James Marino, Lynn
Shibut, and Daniel Nuxoll are gratefully acknowledged. The views expressed are those
of the author and not necessarily those of the Federal Deposit Insurance Corporation.
Kevin P. Sheehan
Financial Economist
Federal Deposit Insurance Corporation
Division of Research and Statistics
550 17th Street, NW
Washington, DC 20429
Phone: 202-898-7366
Fax: 202-898-7149
E-mail: kesheehan@fdic.gov
FDIC Working Paper
98-1
Abstract: A two-state Markov-switching model is estimated to characterize the time
series behavior of disbursements from the Bank Insurance Fund (BIF). The estimated
model is used to project future disbursements, and these projected disbursements are used
to estimate the likelihood of insolvency as well as the likelihood of the BIF falling below
two different minimum reserve ratios. The simulation results confirm that the current
funding arrangement—an assessment rate of 23 basis points with a 1.25 percent required
reserve ratio—is sufficient to maintain BIF solvency if one assumes that the prior history
of losses is a good indicator of future losses.
The comments and suggestions of Barry Kolatch, Steven Seelig, James Marino, Lynn
Shibut, and Daniel Nuxoll are gratefully acknowledged. The views expressed are those
of the author and not necessarily those of the Federal Deposit Insurance Corporation.
1 Introduction
The FDIC is required to maintain Bank Insurance Fund (BIF) reserves of at least
1.25 percent of insured deposits; as of year-end 1996 the actual reserve ratio was 1.34
percent. In light of the BIF’s loss experience in the late 1980s and early 1990s, questions
have been raised about the adequacy of these levels. At the same time, however, given
the currently robust financial state of the banking industry, questions have also been
raised about the need for these levels.
This study, assuming losses similar to those experienced in the past, simulates the
BIF’s future reserve levels and examines the implications of different assessment rates
and required reserve ratios. The results indicate the extent to which the FDIC may have
to balance two possibly conflicting objectives when it makes decisions affecting its
ability to sustain funding losses from a future banking crisis. One of the two objectives is
the desire to minimize assessment rates. The other is the desire to avoid breaching a
specified minimum fund level.
Currently assessment rates are to some extent a function of the ratio between BIF
reserves and insured deposits at any given time. If the ratio drops below 125 basis points,
the FDIC is required by law either to assess the industry to bring the fund back to this
minimum level or to adopt a restoration plan whereby the annual assessment rate is at
least 23 basis points. (The FDIC could ask Congress to relax this requirement and afford
the agency greater flexibility in setting premium levels of less than 23 basis points.)
But while the FDIC is required to maintain a fund of at least 125 basis points, a
crisis may cause the fund to fall below this level. This matters because the FDIC would
like not only to avoid the possibility of insolvency but also to retain public confidence.
2
The FDIC is required to maintain Bank Insurance Fund (BIF) reserves of at least
1.25 percent of insured deposits; as of year-end 1996 the actual reserve ratio was 1.34
percent. In light of the BIF’s loss experience in the late 1980s and early 1990s, questions
have been raised about the adequacy of these levels. At the same time, however, given
the currently robust financial state of the banking industry, questions have also been
raised about the need for these levels.
This study, assuming losses similar to those experienced in the past, simulates the
BIF’s future reserve levels and examines the implications of different assessment rates
and required reserve ratios. The results indicate the extent to which the FDIC may have
to balance two possibly conflicting objectives when it makes decisions affecting its
ability to sustain funding losses from a future banking crisis. One of the two objectives is
the desire to minimize assessment rates. The other is the desire to avoid breaching a
specified minimum fund level.
Currently assessment rates are to some extent a function of the ratio between BIF
reserves and insured deposits at any given time. If the ratio drops below 125 basis points,
the FDIC is required by law either to assess the industry to bring the fund back to this
minimum level or to adopt a restoration plan whereby the annual assessment rate is at
least 23 basis points. (The FDIC could ask Congress to relax this requirement and afford
the agency greater flexibility in setting premium levels of less than 23 basis points.)
But while the FDIC is required to maintain a fund of at least 125 basis points, a
crisis may cause the fund to fall below this level. This matters because the FDIC would
like not only to avoid the possibility of insolvency but also to retain public confidence.
2