Chairman Donald E. Powell
Federal Deposit Insurance Corporation
Deposit Insurance: The Business Case for Reform
Financial Services Roundtable
September 12, 2002
Good afternoon. It is a pleasure to be here today.
It is nice to see so many familiar faces. Many of you have been kind enough to invite me
into your offices over the past several months. You have been gracious hosts, and for
that, I am deeply grateful. Getting to know you, your business, and the challenges you
face has been a priority of mine - and a priority of the FDIC's - this year. I often remind
our staff that more than 70 percent of the money in the deposit insurance funds was
paid by the top 100 banking organizations in America. You all help pay a good portion of
our salaries at the FDIC, and for this reason alone, it makes sense for us to get better
acquainted. I hope we can continue to do so.
I'd like to kick off our discussion today with a little business proposition. I'm a
businessman at heart and I know this room is full of people who are ready to do deals.
So let's take a minute and put together a deal.
I'm thinking about starting a new insurance company and after I've laid out our business
model, I'll ask for you all to sign up as investors and principal shareholders. I think my
new company will revolutionize how we provide insurance in America. Here's my idea:
• First, our new insurance company will be built around the novel concept that
more than 90 percent of our customers will not pay any premiums and get the product
for free - and will only be charged when they are least able to pay.
• Next, we will adopt rules to ensure we do not distinguish between our customers
based on risk. In fact, we'll make sure the high-risk customers pay just about the same
price as our low-risk customers.
• In yet another bold innovation, we will hold a static reserve that will bear no
relation to our risk exposure. This will cut down on the complications of such 'old
economy' insurance techniques like measuring risk exposure and holding dynamic
reserves.
I think my idea is pretty innovative. How many want to invest? Show of hands?
Let me break it to you gently: You already have invested in this company. It is called the
Federal Deposit Insurance Corporation, and - as I mentioned earlier - you've contributed
more than 70 percent of our operating capital.
I've provided this illustration today because part of what I want to accomplish as FDIC
Chairman is to give you a sense of the business environment we operate in. I realize
we're not on the top ten list of things you worry about every day. I know this is true
because I was a banker in Texas for 30 years. For 27 of those years deposit insurance
Federal Deposit Insurance Corporation
Deposit Insurance: The Business Case for Reform
Financial Services Roundtable
September 12, 2002
Good afternoon. It is a pleasure to be here today.
It is nice to see so many familiar faces. Many of you have been kind enough to invite me
into your offices over the past several months. You have been gracious hosts, and for
that, I am deeply grateful. Getting to know you, your business, and the challenges you
face has been a priority of mine - and a priority of the FDIC's - this year. I often remind
our staff that more than 70 percent of the money in the deposit insurance funds was
paid by the top 100 banking organizations in America. You all help pay a good portion of
our salaries at the FDIC, and for this reason alone, it makes sense for us to get better
acquainted. I hope we can continue to do so.
I'd like to kick off our discussion today with a little business proposition. I'm a
businessman at heart and I know this room is full of people who are ready to do deals.
So let's take a minute and put together a deal.
I'm thinking about starting a new insurance company and after I've laid out our business
model, I'll ask for you all to sign up as investors and principal shareholders. I think my
new company will revolutionize how we provide insurance in America. Here's my idea:
• First, our new insurance company will be built around the novel concept that
more than 90 percent of our customers will not pay any premiums and get the product
for free - and will only be charged when they are least able to pay.
• Next, we will adopt rules to ensure we do not distinguish between our customers
based on risk. In fact, we'll make sure the high-risk customers pay just about the same
price as our low-risk customers.
• In yet another bold innovation, we will hold a static reserve that will bear no
relation to our risk exposure. This will cut down on the complications of such 'old
economy' insurance techniques like measuring risk exposure and holding dynamic
reserves.
I think my idea is pretty innovative. How many want to invest? Show of hands?
Let me break it to you gently: You already have invested in this company. It is called the
Federal Deposit Insurance Corporation, and - as I mentioned earlier - you've contributed
more than 70 percent of our operating capital.
I've provided this illustration today because part of what I want to accomplish as FDIC
Chairman is to give you a sense of the business environment we operate in. I realize
we're not on the top ten list of things you worry about every day. I know this is true
because I was a banker in Texas for 30 years. For 27 of those years deposit insurance
meant very little to me. But for three years - during the worst years of the banking crisis
- that FDIC sign on the door meant the difference between life and death for my
business. I got up and polished it every morning. So I hope you'll remember - as I do -
that financial stability is truly a precious commodity.
As my example illustrated earlier, we have some problems with how we provide deposit
insurance in America. I'd like to spend a few minutes today sharing our views on how to
fix them. We've got a plan, and it is called deposit insurance reform. It is moving in
Congress and I need your help getting it passed this year.
Let me take a few minutes and run through the challenges we face in our business and
outline how deposit insurance reform will help us address them. First of all, we cannot
price our product in a way that makes sense. By law, we have to give away deposit
insurance to more than 90 percent of the banks and thrifts in America. Such an
inefficient pricing scheme only serves to increase the moral hazard concerns so often
associated with deposit insurance. Using plain old business sense, if the FDIC is going
to provide a guarantee to banks, then it ought to get something in return for it. This is no
different than the philosophy you operate under every day as you run your business. I
strongly believe deposit insurance - and financial stability - has value in America. And I
believe the FDIC should have the flexibility to charge for the value we add.
Next, I believe we should be able to better distinguish between our customers based on
the risks they pose to the financial system. By the mandate of law, our current risk-
based premium system is crude and outdated. More than 90 percent of banks fit into
our 'least risky' category. This isn't a true picture of the business environment we're
underwriting. We need the flexibility to draw more reasonable distinctions between the
institutions that use deposit insurance, and to price our product accordingly. And we
have some hard data to go on. We know that institutions with a CAMELS rating of '2'
are two and a half times more likely to fail than those with a '1' rating, for example. We
should be able to make distinctions that are not arbitrary and that are truly reflective of
our risk. As far as I am concerned, if you are a well-run institution with appropriate
capital for your risk, you should be able to get your deposit insurance for a pittance. If
you have a riskier business model, you should pay more. I know you have concerns
about this, and we have committed to every bank in America that we will work
constructively, with the industry, to design a pricing system that is both fair and that
does not discriminate against institutions on the basis of their size. I give you my word
that we will work with you to make sure the new risk-based premium system for deposit
insurance is both effective and fair - indeed, I believe we are already doing just that.
Next, we have problems with the statutory reserve ratio - in fact, the statutory reserve
ratio would not pass muster with any bank examiner in the land. We should - as a
matter of principle - be able to agree that the FDIC should have a reserve ratio that
bears some relationship to the actual risk on our balance sheet. Today, by law, we must
keep at least 125 basis points worth of funds in reserve relative to the overall insured
deposits in the system. This translates into about $41 billion dollars today. Over the
course of the economic cycle, that number may need to be higher or lower - depending
on the overall health and performance of the industry. Those will be debates for another
day. But I think we can all agree that there is nothing 'magic' about 125 basis points - it
- that FDIC sign on the door meant the difference between life and death for my
business. I got up and polished it every morning. So I hope you'll remember - as I do -
that financial stability is truly a precious commodity.
As my example illustrated earlier, we have some problems with how we provide deposit
insurance in America. I'd like to spend a few minutes today sharing our views on how to
fix them. We've got a plan, and it is called deposit insurance reform. It is moving in
Congress and I need your help getting it passed this year.
Let me take a few minutes and run through the challenges we face in our business and
outline how deposit insurance reform will help us address them. First of all, we cannot
price our product in a way that makes sense. By law, we have to give away deposit
insurance to more than 90 percent of the banks and thrifts in America. Such an
inefficient pricing scheme only serves to increase the moral hazard concerns so often
associated with deposit insurance. Using plain old business sense, if the FDIC is going
to provide a guarantee to banks, then it ought to get something in return for it. This is no
different than the philosophy you operate under every day as you run your business. I
strongly believe deposit insurance - and financial stability - has value in America. And I
believe the FDIC should have the flexibility to charge for the value we add.
Next, I believe we should be able to better distinguish between our customers based on
the risks they pose to the financial system. By the mandate of law, our current risk-
based premium system is crude and outdated. More than 90 percent of banks fit into
our 'least risky' category. This isn't a true picture of the business environment we're
underwriting. We need the flexibility to draw more reasonable distinctions between the
institutions that use deposit insurance, and to price our product accordingly. And we
have some hard data to go on. We know that institutions with a CAMELS rating of '2'
are two and a half times more likely to fail than those with a '1' rating, for example. We
should be able to make distinctions that are not arbitrary and that are truly reflective of
our risk. As far as I am concerned, if you are a well-run institution with appropriate
capital for your risk, you should be able to get your deposit insurance for a pittance. If
you have a riskier business model, you should pay more. I know you have concerns
about this, and we have committed to every bank in America that we will work
constructively, with the industry, to design a pricing system that is both fair and that
does not discriminate against institutions on the basis of their size. I give you my word
that we will work with you to make sure the new risk-based premium system for deposit
insurance is both effective and fair - indeed, I believe we are already doing just that.
Next, we have problems with the statutory reserve ratio - in fact, the statutory reserve
ratio would not pass muster with any bank examiner in the land. We should - as a
matter of principle - be able to agree that the FDIC should have a reserve ratio that
bears some relationship to the actual risk on our balance sheet. Today, by law, we must
keep at least 125 basis points worth of funds in reserve relative to the overall insured
deposits in the system. This translates into about $41 billion dollars today. Over the
course of the economic cycle, that number may need to be higher or lower - depending
on the overall health and performance of the industry. Those will be debates for another
day. But I think we can all agree that there is nothing 'magic' about 125 basis points - it