Future Premium Fight Looms as FDIC Fund Thrives

WASHINGTON — Somewhat forgotten in recent years, what banks pay for deposit insurance is about to get more notice.

The Deposit Insurance Fund has been humming along for a while now, leaving behind its crisis-era losses. But as the fund keeps growing, the Federal Deposit Insurance Corp. faces a critical decision about how to implement a Dodd-Frank Act reform that could hike large-bank premiums.

For now the agency has time. Dodd-Frank's deadline for a new DIF minimum is 2020. But the law left the agency with a puzzle to solve: the extra cost to bring the fund up to 1.35% of insured deposits cannot fall on community banks. Observers say the difficulty of that, coupled with the fact that the fund is already approaching 1%, makes it likely the FDIC is already weighing options.

"I am sure they have already run projections about what they need to get back in assessments on an annual basis, in addition to the normal assessments, to reach the target, and I am sure they will want to move forward relatively soon," said Michael Krimminger, a partner at Cleary Gottlieb Steen & Hamilton and a former general counsel at the FDIC.

The FDIC has given no signal about its plans. But experts say potential options for the agency run the gamut, from charging large institutions a special fee to hoping that a rate cut for community banks still brings in enough income before the deadline.

"In the current environment there is absolutely no political problem with raising rates or a special assessment on the large banks," said Robert DeYoung, a finance professor at the University of Kansas. "Raising rates on the smaller banks of course is always a political issue."

The agency is in effect focused on two different targets for the DIF. The first is a previous benchmark of 1.15%, which it is still trying to reach. But when Dodd-Frank passed in 2010, it raised the ultimate minimum by 20 basis points.

The provision was meant partly to meet congressional budget rules for new legislation, but it also addressed FDIC officials' desire for a larger DIF to avoid deficits in a crisis. At the time of the bill's enactment, when failures were peaking, the ratio had fallen sharply to negative 0.38%.

The fund is now at 0.89%, and the FDIC projects hitting the 1.15% threshold in 2019. But once that benchmark is reached, the law requires banks with over $10 billion in assets to bear the cost of reaching the new higher minimum.

Premiums always tend to be controversial, and how the FDIC does the math is a potentially sticky issue. Large banks — which have already faced separate premium requirements and other regulatory hurdles since the crisis — will likely be the most concerned. (The agency, which declined to comment for this story, has said it will issue a proposal for comment before making a final decision.)

"The large banks would be particularly grumpy to get another assessment after living wills and raising deposit insurance rates on them anyways. You can imagine it is not going to be a fun situation," said Paul Kupiec, a resident scholar at the American Enterprise Institute and former associate director in the FDIC's Division of Insurance and Research. "It is also the case that under the normal assessments the large banks pay more, so I can imagine they are not happy about it."

In the past, when the FDIC faced funding needs, it charged special assessments on top of banks' normal premiums, such as the industrywide fee in the spring of 2009 to deal with the then-onslaught of failures.

Observers said such a move, just for larger institutions, could fulfill the Dodd-Frank requirement. But if that fee were charged over a single year, it may be significant. Therefore the agency could alternatively opt for a more gradual approach.

"I think they would try and minimize the impact, particularly with institutions already under pressure to raise capital and everything else," said Robert Eisenbeis, vice chairman at Cumberland Advisors.

The FDIC could try to spread the extra charge out over time particularly if the fund were to hit 1.15% before 2019, which would give the agency more breathing room to reach the higher level.

"Probably what they will try to do is introduce some additional gradual assessment focused on institutions above a certain size threshold and apply it over a period of years," Krimminger said.

But another factor in the FDIC's plans is the potential for some premium cuts as the fund balance grows higher. Most of the industry now pays a base rate somewhere between 5 and 9 basis points per assets minus capital, with a bank's actual rate reflecting its risk.

But as the agency gets closer to its fund targets, it has pledged to ease up on the gas pedal. Under a 2011 rule, the FDIC will lower the base fee range to between 3 and 7 basis points once the ratio hits 1.15%.

Some observers predict the reserve ratio will hit 1.15% before the FDIC's 2019 projection.

"My hunch is that they will" hit the target "sooner than that," said William Longbrake, executive-in-residence at the University of Maryland. "The normal tendency would be to be conservative on those projections."

Bert Ely, an independent consultant based in Alexandria, Va., agreed that "given the recent rate of growth in the ratio and the recent initiative by large banks to get rid of deposits, I now believe it is possible that they DIF ratio could hit 1.15% by the end of 2016 or early 2017."

If that happened, rather than charge larger banks an added fee to hit the higher fund target, the FDIC could simply keep those banks' premiums constant — which might be more palatable than a surcharge — and allow community banks to enjoy the discount.

"Let's suppose they hit" 1.15% "in 2017 or 2018. Then the big banks suddenly have a huge reduction on what they pay on a normal basis. You could simply at that point phase in the special assessment so they continue to pay at the same rate or a little higher to phase in the difference," said Longbrake, who was at one time the FDIC's chief financial officer.

Still, officials want the fund to grow even higher longer-term. Dodd-Frank established the 1.35% ratio only as a minimum. The FDIC retained the authority to establish a "designated reserve ratio," which is a less binding target but what the agency determines is a prudent level for the DIF to handle volatility in the industry. The current target is 2%.

"The FDIC has a goal to get the fund higher than it ever has been before. … If they keep the fund much higher they will be able to maintain assessments and let the fund dip and still stay quite healthy to keep public confidence," said Robert Strand, a senior economist at the American Bankers Association. That "makes a lot of sense," he said.

Observers said the FDIC may issue a proposal on how it will implement the Dodd-Frank provision relatively early to give the industry signals about its thinking and allow time for comments.

"I would guess the process would start well before 2020," Longbrake said.

Chris Cole, executive vice president and senior regulatory counsel for the Independent Community Bankers of America, said community banks "are interested from the standpoint of, 'Is it going to work or not?'

"They want to make sure that it is done right and there is no problem getting to 1.35%," he said.

If the ratio gets close to 1.15% "over the next two years," Cole added, the agency "really needs to come out with a proposal for the next step."