funding paradox, The

Northwestern Financial Review, Sep 15, 2001 by Bengtson, Tom

The debate over deposit insurance reform is exposing a paradox: On the one hand, it looks like there is little support for increasing the deposit insurance coverage level, and on the other hand there are rumblings that community bankers are relying too heavily on Federal Home Loan Bank advances. Community bankers need to remain engaged in the deposit insurance reform debate or they may find themselves caught between a rock and a hard place with no place to go.

Sheila Bair, an assistant Treasury secretary, recently testified that banks relying heavily on Home Loan Bank advances may be posing additional risk to the Federal Deposit Insurance Corp. "In the event of bank failure, secured liabilities have a higher claim than domestic deposits on bank assets. Thus increased reliance on secured liabilities by depository institutions may increase the FDIC's loss exposure," Bair said in July 26 testimony before a U.S. House subcommittee. She further commented that the Gramm-Leach-Bliley Act "accentuated our concerns about these potential risks" because the Act gives community banks greater access to Home Loan Bank advances.

Most community bankers would love to be able to fund more of their loans with core deposits, and increasing the deposit insurance coverage level may lead to increases in deposit levels. So you would think that anyone concerned about excessive Home Loan Bank borrowing would support raising the deposit insurance coverage level. But the U.S. Treasury opposes the idea! The Treasury's position on FDIC reform has the potential to squeeze community banks right out of business.

The FDIC assessment process already discriminates against community banks because premiums are based on domestic deposits, which make up a much higher percentage of the balance sheet at a small bank than at a large bank. One survey notes that banks with less than one billion dollars in assets fund 83 percent of their loans with domestic deposits, while banks with more than one billion in assets fund only 50 percent of their loans with domestic deposits.

To alleviate the Treasury's concern, perhaps the FDIC should look at its assessment base. Instead of limiting it to domestic deposits, perhaps it should include other liabilities, such as foreign deposits, wholesale borrowings and repurchase agreements. Broadening the assessment base would give the FDIC the funds to cover secured liabilities in the event of a bank failure. In addition, it would balance the assessment process fairly among small and large banks.

My point is, even if it looks like an increase in individual account coverage is not in the cards, community bankers need to remain engaged in the FDIC reform debate because there are other important considerations at stake.