Remarks
By
Donna Tanoue
Chairman
Federal Deposit Insurance Corporation
Before
the
Federal Reserve Bank of Chicago
Conference on Bank Structure and Competition
Chicago, Illinois
May 4, 2000
I am delighted to speak at this 36th Conference on Bank Structure and Competition.
Part of the long and proud history of this Conference has been an ongoing dialogue
about deposit insurance pricing. Indeed, the first papers discussing risk-based deposit
insurance were presented at the Structure Conference in 1980. From 1980 until the
FDIC implemented risk-based premiums on January 1, 1993, more than 20 papers that
had deposit insurance pricing either as their main subject or as an important subtext
were presented. And doubtless, during that time, many more Structure Conference
papers made at least a passing mention of what -- by the early 1990s -- had become
the generally accepted academic wisdom: that is to say, the importance of risk-based
premiums in mitigating the moral hazard problems that can attend any deposit
insurance system.
In 1991, that accepted academic wisdom enjoyed a moment in the sun, being given the
force of law when FDICIA required the FDIC to implement a risk-based premium
system. Since the FDIC implemented the new premium system in 1993, the number of
Structure Conference papers that have had deposit insurance pricing as their main
subject has dropped to zero. The dialogue has moved on to other topics. For those who
advocate more fundamental changes-such as the complete privatization of the deposit-
insurance system, the use of cross-guarantee arrangements, a more formal use of co-
insurance to promote market discipline, or the use of bank subordinated debt or FDIC
Capital Notes to price risks-the debate is now less about deposit insurance premiums
than it is about deposit insurance paradigms. And by adding momentum to the trend
toward larger and more complex financial institutions, the Gramm-Leach-Bliley Act
should lead us to consider new approaches to regulation, to supervision-and to deposit
insurance.
And yet, if depositors are protected fully or partially from loss, the appropriate pricing of
that protection will always be an important subject under any financial regulatory
paradigm that emerges.
Today, I want to talk about deposit insurance pricing. First, I want to ask how well we
are meeting the goals laid down by FDICIA, and the challenges introduced by Gramm-
By
Donna Tanoue
Chairman
Federal Deposit Insurance Corporation
Before
the
Federal Reserve Bank of Chicago
Conference on Bank Structure and Competition
Chicago, Illinois
May 4, 2000
I am delighted to speak at this 36th Conference on Bank Structure and Competition.
Part of the long and proud history of this Conference has been an ongoing dialogue
about deposit insurance pricing. Indeed, the first papers discussing risk-based deposit
insurance were presented at the Structure Conference in 1980. From 1980 until the
FDIC implemented risk-based premiums on January 1, 1993, more than 20 papers that
had deposit insurance pricing either as their main subject or as an important subtext
were presented. And doubtless, during that time, many more Structure Conference
papers made at least a passing mention of what -- by the early 1990s -- had become
the generally accepted academic wisdom: that is to say, the importance of risk-based
premiums in mitigating the moral hazard problems that can attend any deposit
insurance system.
In 1991, that accepted academic wisdom enjoyed a moment in the sun, being given the
force of law when FDICIA required the FDIC to implement a risk-based premium
system. Since the FDIC implemented the new premium system in 1993, the number of
Structure Conference papers that have had deposit insurance pricing as their main
subject has dropped to zero. The dialogue has moved on to other topics. For those who
advocate more fundamental changes-such as the complete privatization of the deposit-
insurance system, the use of cross-guarantee arrangements, a more formal use of co-
insurance to promote market discipline, or the use of bank subordinated debt or FDIC
Capital Notes to price risks-the debate is now less about deposit insurance premiums
than it is about deposit insurance paradigms. And by adding momentum to the trend
toward larger and more complex financial institutions, the Gramm-Leach-Bliley Act
should lead us to consider new approaches to regulation, to supervision-and to deposit
insurance.
And yet, if depositors are protected fully or partially from loss, the appropriate pricing of
that protection will always be an important subject under any financial regulatory
paradigm that emerges.
Today, I want to talk about deposit insurance pricing. First, I want to ask how well we
are meeting the goals laid down by FDICIA, and the challenges introduced by Gramm-
Leach-Bliley. Second, I want to point to some areas where we may be able to do better.
And, third, I will talk about how the FDIC intends to move forward on deposit insurance
reform.
It is important to address deposit insurance reform now, before the long economic
expansion we have all enjoyed turns - as it surely will. An increase in some banks'
appetite for risk and a decrease in attention by some to sound banking practices could
combine with a potentially more volatile economic environment to increase our
insurance losses beyond what the financial statements, the examination ratings, and the
premiums being paid by insured institutions might suggest.
How will history judge the effectiveness of the risk-based premium system in achieving
the goals for which it was established? In particular, did the premium structure price
risk-taking appropriately? Did it promote the sharing of the costs of the deposit
insurance system in a fair and equitable manner? Did it adjust to fundamental changes
in banking industry structure? These are questions by which future presenters at this
Conference may someday judge our deposit insurance pricing arrangements.
It is true that the FDIC's premium system does not price nor differentiate risk as
aggressively as a private insurer would. Nevertheless, it does provide a financial
stimulus for banks to achieve a well-rated, well-capitalized status. And although this
stimulus is only one among many regulatory sanctions that 3-, 4-, and 5-rated banks
face, we should not be too quick to dismiss the importance of bank management's
desire to report to the Boards of Directors that they are paying the lowest FDIC
insurance premium. And because the system uses well-established risk measures,
there have been relatively few complaints over the years that the system is arbitrary or
unfair.
It is my hope that history will count these features among the strengths of the current
risk-based pricing structure - but let's look at some of the weaknesses and where we
can do better, as well.
Most banks today pay nothing for deposit insurance. One of the striking consequences
of our current price structure is that both new and existing institutions can grow rapidly,
thereby lowering their fund's reserve ratio and increasing the need for premium income
from all other institutions, at no premium cost to themselves. And as institutions grow
larger, the potential movements in the fund reserve ratio resulting from deposit
injections are becoming more dramatic as well. Further, and ironically, another example
of the effects of a zero price for insurance is that we may see the banking industry
paying -- through the insurance funds -- for the failures of banks that never paid an
FDIC insurance premium.
This ability of some banks to impose costs on the system at no cost to themselves - as
well as the lack of a financial benefit to those banks that choose to reduce the exposure
they impose on the rest of the industry - do raise questions about the equity and
fairness of our deposit insurance pricing structure, and about its ability to influence bank
And, third, I will talk about how the FDIC intends to move forward on deposit insurance
reform.
It is important to address deposit insurance reform now, before the long economic
expansion we have all enjoyed turns - as it surely will. An increase in some banks'
appetite for risk and a decrease in attention by some to sound banking practices could
combine with a potentially more volatile economic environment to increase our
insurance losses beyond what the financial statements, the examination ratings, and the
premiums being paid by insured institutions might suggest.
How will history judge the effectiveness of the risk-based premium system in achieving
the goals for which it was established? In particular, did the premium structure price
risk-taking appropriately? Did it promote the sharing of the costs of the deposit
insurance system in a fair and equitable manner? Did it adjust to fundamental changes
in banking industry structure? These are questions by which future presenters at this
Conference may someday judge our deposit insurance pricing arrangements.
It is true that the FDIC's premium system does not price nor differentiate risk as
aggressively as a private insurer would. Nevertheless, it does provide a financial
stimulus for banks to achieve a well-rated, well-capitalized status. And although this
stimulus is only one among many regulatory sanctions that 3-, 4-, and 5-rated banks
face, we should not be too quick to dismiss the importance of bank management's
desire to report to the Boards of Directors that they are paying the lowest FDIC
insurance premium. And because the system uses well-established risk measures,
there have been relatively few complaints over the years that the system is arbitrary or
unfair.
It is my hope that history will count these features among the strengths of the current
risk-based pricing structure - but let's look at some of the weaknesses and where we
can do better, as well.
Most banks today pay nothing for deposit insurance. One of the striking consequences
of our current price structure is that both new and existing institutions can grow rapidly,
thereby lowering their fund's reserve ratio and increasing the need for premium income
from all other institutions, at no premium cost to themselves. And as institutions grow
larger, the potential movements in the fund reserve ratio resulting from deposit
injections are becoming more dramatic as well. Further, and ironically, another example
of the effects of a zero price for insurance is that we may see the banking industry
paying -- through the insurance funds -- for the failures of banks that never paid an
FDIC insurance premium.
This ability of some banks to impose costs on the system at no cost to themselves - as
well as the lack of a financial benefit to those banks that choose to reduce the exposure
they impose on the rest of the industry - do raise questions about the equity and
fairness of our deposit insurance pricing structure, and about its ability to influence bank