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FDIC insurance plan is no long-term solution

A plan that regulators proposed Tuesday to have banks prepay $45 billion in insurance premiums won’t provide a long-term fix for the shrinking fund that insures bank deposits.
/ Source: The Associated Press

A plan that regulators proposed Tuesday to have banks prepay $45 billion in insurance premiums won’t provide a long-term fix for the shrinking fund that insures bank deposits.

But the Federal Deposit Insurance Corp.’s proposal would spare ailing banks the immediate cost of an alternative idea: paying an emergency fee for the second time this year. And most banks would likely be able to prepay their premiums without having to reduce lending to businesses and consumers.

Regulators said they expect the cost of bank failures to grow to about $100 billion over the next four years — up from an estimate of $70 billion earlier this year. Faced with that sobering news, they voted to require banks to prepay $45 billion in premiums to replenish an insurance fund that will start running dry on Wednesday.

The FDIC board’s proposal to require early payments of premiums for 2010-2012 could take effect after a 30-day public comment period. Depositors’ money is guaranteed — up to $250,000 per account — by the FDIC. It would be the first time the agency has required prepaid insurance fees.

The increased loss estimate underlines the short-term nature of the prepayment solution. The agency will be able to continue paying depositors when banks fail. But banks will have to pay tens of billions more in coming years to keep the fund solvent.

Still, the shortfall won’t likely make it harder for consumers and businesses to get loans. Most banks still have adequate funds available for lending. In a sluggish economy, fewer people and businesses are seeking loans. And investors wary of stocks and bonds have funneled more of their deposits to banks.

“What the FDIC is effectively doing is borrowing from the banking industry, and they can afford it,” said independent banking consultant Bert Ely.

The FDIC’s plan would draw on banks’ ready cash. Instead of charging them a one-time fee that would deplete their capital reserves, it would spread the costs of the refunding over three years.

But the expected cost of hundreds more bank failures means banks will likely face higher premiums and more fees in the long run.

“Any way you slice it, the banking industry will pay the cost of these failures over time,” said James Chessen, chief economist with the American Bankers Association. “It will be a burden that healthy banks will have to shoulder over the next seven or eight years.”

Banks pay for the deposit insurance program through regular premiums. The fund has been sapped by a rash of bank failures since mid-2008. Without additional special fees or increases in regular premiums, the insurance fund — at $10.4 billion at the end of June — will become “significantly negative” next year and could remain in deficit until 2013, the FDIC now projects.

Ninety-five banks have failed so far this year as losses have mounted on commercial real estate and other soured loans amid the most severe financial climate in decades. That has cost the fund about $25 billion, the FDIC said Tuesday.

The $10.4 billion already was the fund’s lowest point since 1992, at the height of the savings-and-loan crisis. That is equivalent to 0.22 percent of insured deposits, below a congressionally mandated minimum of 1.15 percent.

Most of the $100 billion in costs are expected to come from failures this year and next, the agency said. -

Given those rising costs, some analysts said increased premiums or another fee are inevitable.

“You pull this forward once, but if the gap is large, you’ll have to charge (an extra fee) anyway,” said Jaret Seiberg, an analyst with Concept Capital’s Washington Research Group.

Banks are limited in their lending by the amount of capital they hold in reserve. Capital provides a cushion to protect against loan defaults and other losses. Banks that lack enough capital can’t extend new credit.

Some banks have had to tighten lending since the financial crisis struck because regulators say their capital buffers are too low. The FDIC plan preserves bank capital by spreading the cost of replenishing the fund over three years. Because the fees were expected, banks’ long-term financial outlook doesn’t change.

The agency had considered several options for propping up the fund. They included tapping a $100 billion credit line at the Treasury Department, or charging banks a special fee for the second time this year.

The Treasury plan would have raised bank premiums in the long run as the agency paid down its debt. A one-time fee would have drawn down banks’ capital abruptly. That would have limited their ability to lend and endangered banks that are already short on cash.

“What the FDIC has realized is that another special assessment like that would do more harm than good,” Chessen said.

The plan the FDIC settled on amounts to an “early collection” of money the fund would need over the next three years, Seiberg said. He called the move a “one-time accounting gimmick.”

FDIC Chairman Sheila Bair said it struck “a good balance,” requiring the banking industry “to step up” while spreading the cost over a number of years.

An insurance payment by the industry of $45 billion “is not going to constrain lending,” she said.