TAG Actually Gives Big Banks the Advantage

In the depths of the financial crisis, the FDIC under Chairman Sheila Bair extended 100% insurance coverage to non-deposit transactions balances of all banks. Known as the Transaction Account Guarantee program, this extraordinary extension of FDIC insurance coverage to all transaction balances was a good idea at the time, but should be allowed to expire at the end of the year.

The first and most important argument against TAG is the cost to community banks. While everyone from Cam Fine at the Independent Community Bankers of America to various state regulators have called for the extension of this subsidy, nobody wants to talk about the cost to community banks. Here's the question: why should community banks, those with assets below $1 billion, spend roughly $100 million in insurance assessments (calculated by Institutional Risk Analytics), when they could acquire private market coverage for a tenth of the cost?

In a recent BankThink piece, John P. Ducrest, the chairman of the Conference of State Bank Supervisors, talks about the supposed competitive harm to small banks of allowing TAG to expire. But what about draining $100 million per year in pretax dollars out of community banks? In 2011, all banks under $1 billion in assets reported just $2.1 billion in net income, according to the FDIC, so assuming a 30% tax rate, we are talking about roughly 5% of the pretax income of community banks going to the FDIC in the form of additional insurance premiums.

Question for my friend Cam Fine at ICBA: How does draining $700 million in pretax income from all U.S. banks make sense? Remember that all banks, large and small, can write letters of credit with the Federal Home Loan Banks to back transaction balances 100% for less than $100 million. Likewise, private insurers would also be ready and willing to provide 100% coverage. The cost to community banks would fall to less than $10 million annually.

Once you look at the cost of TAG and the alternative forms of insurance available, the obvious conclusion is that there is no economic reason to extend TAG. But it gets better. When you look at the banks which are benefitting from TAG, community banks (i.e., banks with less than $1 billion in assets) hold a disproportionately small share of the current TAG balances — far smaller than their deposit base or cumulative assets would imply — while the nation's largest institutions hold a far larger share.

So who is TAG helping? The community banks or the large money center banks? The answer is large banks, the very zombie institutions bailed out by Washington which now prey upon community lenders via their monopoly cartel control over the secondary market for home loans. When you guarantee transaction balances, you are really helping large zombie banks such as JPMorgan, Citigroup and Wells Fargo. The last is the bank most hated and despised by community bankers.

The small bank members of the ICBA ought to ask Mr. Fine why he is helping their most deadly enemy. The fact is that 75% of all TAG balances are held by large banks above $100 billion in assets. These are the true beneficiaries of the TAG program. Indeed, another issue you won't see either the ICBA or other proponents of TAG address is the issue of FHLB advances.

Among community banks, TAG funding has merely offset traditional Federal Home Loan Bank advances. Over the past several years, community banks have run down their FHLB advances by amounts greater than total TAG balances. FHLB advances have fallen by more than 50% in all bank asset size categories since the TAG program began in the fourth quarter of 2008. You could argue that FDIC's TAG program has merely supplanted one government funding assistance program for another, albeit at far greater cost to the industry overall.

Now some observers have argued that the TAG program should be terminated for all banks except the community banks, but frankly TAG is a very expensive way to solve this problem — if a problem really exists. But my view is that TAG, far from helping small banks, is merely strengthening the monopoly power of larger institutions.

The funding advantage between large and small banks shifts with the demand for funds, but the balance has shifted drastically in favor of the largest banks coincident since TAG's inception. This shift appears to have occurred because the largest banks attracted a larger amount of TAG deposits and thus benefit to a greater extent from the zero-cost funding. If TAG was meant to preserve the funding advantage of small banks, it has failed miserably while the big banks have expanded market share.

Indeed, when you look at the actual trends in terms of deposit growth, it is pretty clear that the TAG program is strengthening the largest banks and weakening smaller institutions. The advantage once held by smaller banks in terms of funding costs has narrowed considerably since the TAG program started. So tell me again how this program is helping community banks? TAG is merely a subsidy for the largest banks and needs to be ended as soon as possible.

Christopher Whalen is senior managing director of Tangent Capital Partners in New York. He is co-founder and vice chairman of Institutional Risk Analytics, the Los Angeles based provider of bank ratings, risk management tools and consulting services.