JIM JONES
Hurts ‘bottom line’
The free ride is over, and from here on it appears as though banks will be charged a premium for coverage from the Federal Deposit Insurance Corp.
Having enjoyed free deposit insurance for the past decade, financial institutions across the country now are going to be forced to pay premiums. Just how much banks will be required to pay remains uncertain. However, on Tuesday, July 11, the FDIC is expected to vote on new risk assessment scale proposals that it would use to assess banks and determine how much would be charged under new regulations. Several possible formulas are expected to be released to bankers and the public following the Tuesday meeting.
“It will be a proposal, and we will be seeking comments on it,” said David Barr, spokesman for the FDIC. “It has the potential to touch every single bank out there. I would expect a lot of interest.”
The deposit insurance legislation was included in S. 1982, the Deficit Reduction Omnibus Reconciliation Act of 2005. It was signed into law by President Bush on Feb. 8 this year.
The final rules and procedures need to be in place by Nov. 5, and the first round of invoices charging for deposit insurance coverage is expected to go out at the end of November or early December, said Barr.
The FDIC began assessing banks based on the level of risk they posed in 1993. Before that time there was a flat fee instated. However, since 1996, banks deemed as low risks have not been charged for receiving deposit insurance.
According to Barr, 92 percent of banks fall into the least risky category also known as category 1A, and currently are not charged for insurance. That is expected to change dramatically under the new system. Barr, who would not release any specific details about what purposed changes are coming, said that the new system will be set up so that the majority of banks are not all in one category like they are now. However, at present it’s unclear whether a smaller number of lowest-risk banks could still receive free deposit insurance.
John Skarin, director of federal regulations and legislative affairs for the Massachusetts Bankers Association, said there is some anxiety running through the local banking community caused in large part by not knowing exactly how banks will be affected and how massive the changes will be.
“We recognize everyone is going to have to pay going forward,” he said. “I think everyone is a little anxious at this point. It’s an added expense. It’s a difficult [interest] rate environment right now. Everyone is a little concerned about where their institution is going to end up in terms of their assessed risk.”
Prior to 1996, however, banks regularly expected to be charged for deposit insurance.
“At some point every bank was paying something for deposit insurance,” said Barr.
Following several bank crashes in the late 1980s and early 1990s, the FDIC in 1992 attached a 23-basis-point – 23 cents for every $100 insured – premium for its insurance. Once the insurance fund was built back up again the charge for deposit insurance was dropped for almost all banks. It was the first time since the fund was established in 1933 that banks were given the luxury of not paying for deposit insurance. The 1996 legislation prevented the FDIC from charging a premium to those banks that posed the least amount of risk, and even for the banks that did have to pay, the fees were very small at that time, said Barr.
‘Dramatic Change’
The FDIC’s insurance fund reserve ratio was required to be 1.25 percent of all insured deposits. The new legislation calls for the fund to stay between 1.15 percent and 1.5 percent. However, there are provisions in place to keep the fund from just growing in perpetuity. If the fund reaches 1.35 percent of the total insured deposits, banks will be looking at a 50 percent refund. If the fund reaches 1.5 percent, banks would be eligible for a 100 percent refund. As of March 31, the fund was at 1.23 percent of all FDIC-insured deposits. Under the new legislation the insurance funds for commercial banks and savings banks have merged.
Jim Jones, president and founder of First Wellesley Consulting, a management advisory firm that specializes in the financial service industry, said going from paying nothing to something is something to which bankers nationwide will have to adjust.
“This will be a dramatic change for perhaps all banks,” said Jones.
He called it poor timing for such a change given that banks already are facing a hike in health care costs and the price of regulatory compliance these days.
“Those will all reduce the bottom line for bankers,” said Jones. “This is not a cost increase in isolation. We are not talking about an insignificant cost increase to a small bank. This becomes a mandatory expense they are not looking forward to. For a community bank, I do believe it becomes a larger issue. ”
Jones also notes that the cost to a small bank could be the equivalent of a full-time teller position and therefore quite a substantial expense. He said he believes it will be quite a challenge for community banks in Massachusetts to manage and take on the increase in deposit insurance coupled with the other expenses that are on the rise and out of the bank’s control.
Right now bankers are waiting to see just how the FDIC will proceed. When the comment period opens up, it is expected that several bankers will weigh in on the proposed changes, said Jones.
The good news is many long-established banks will receive a credit that could let them skip an estimated one to three years of insurance payments. According to Barr, the insurance fund currently stands at $49.2 billion and $4.7 billion is available in credit.
Peter Conrad, executive vice president and treasurer of the Co-operative Central Bank in Boston, said the credits are intended to level things out between well-established banks that worked to build up the fund and the newer intuitions that are yet to contribute to the insurance fund. Banks that were established after the premiums were dropped in 1996 will not receive a credit unless they merged with or acquired a bank that would be entitled to one.
“The [institutions] that are going to feel it the most are the banks that have grown the most rapidly or the ones that were more recently established,” said Conrad. The credits will be based on a bank’s size and its contributions to the fund 10 years ago.
“The assumption is [the premiums] are going to come at a time when the industry is less profitable,” he said.
However, Conrad said the true impact of this change could be postponed for a few years depending on exactly how the final version of the new process is created.
It is harder for banks to be profitable now that interest rates are rising and the yield curve is flattening, Conrad said. Intense competition for deposits has also taken its toll on the industry, he added.
Conrad said by the time most banks are making their first payments to the FDIC, the banking environment could improve. And for those banks receiving credits, there should be time to plan and budget for the change. However, the change is something that bankers may resent since it means paying for something that was once free, he said.
“Ten years is a pretty long stretch, and nobody wants to pay for anything they don’t have to,” Conrad said.
