Public Comment, Large Bank Deposit Insurance Determination, FED -Minneapolis

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Public Comment, Large Bank Deposit Insurance Determination, FED -Minneapolis

Mafor - Mbarham

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Federal Reserve Bank of Minneapolis 90 Hennepin Avenue, P.O. Box 291 Minneapolis, Minnesota 55480-0291 Phone 612 204-5444 1-800-553-9656 ext. 5444 Fax 612 204-5430 E-mail: gary.stern@mpls.frb.org GARY H. STERN PRESIDENT February 7, 2005 Mr. Robert E. Feldman Executive Secretary Federal Deposit Insurance Corporation th550 17 Street, N.W.Washington DC 20429 Mr. Feldman: The Federal Deposit Insurance Corporation (FDIC) has requested comments on its Advance Notice of Proposed Rulemaking (ANPR) for a “Large-Bank Deposit Insurance Determination Modernization Proposal.” This letter transmits my comments (which do not necessarily reflect the views of others in the Federal Reserve System). In this comment, I make five points. They are: • The FDIC must reform current insurance determination procedures which hinder its ability to carry out the least-cost resolution of a large bank. • The FDIC’s Board of Directors should focus on net benefits when evaluating the comments received on the ANPR and choosing which option to implement. • The features of Option 2 are necessary but may not prove sufficient to correct weaknesses in the insurance determination process. • The FDIC should give serious consideration to implementing Options 1 and 3. • A reformed insurance determination regime should apply to all large banks for whom the current regime could prevent a least cost resolution; the same insurance determination scheme need not apply to ...

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Publié par	Mafor
Nombre de lectures	18
Langue	English

Extrait

Federal Reserve Bank of Minneapolis

GARY H. STERN

PRESIDENT

90 Hennepin Avenue, P.O. Box 291

Minneapolis, Minnesota 55480-0291

Phone 612 204-5444

1-800-553-9656 ext. 5444

Fax 612 204-5430

E-mail: gary.stern@mpls.frb.org

February 7, 2005

Mr. Robert E. Feldman

Executive Secretary

Federal Deposit Insurance Corporation

550 17

Street, N.W.

Washington DC 20429

Mr. Feldman:

The Federal Deposit Insurance Corporation (FDIC) has requested comments on its Advance

Notice of Proposed Rulemaking (ANPR) for a “Large-Bank Deposit Insurance Determination

Modernization Proposal.”

This letter transmits my comments (which do not necessarily reflect

the views of others in the Federal Reserve System).

In this comment, I make five points.

They are:

•

The FDIC must reform current insurance determination procedures which hinder its ability to

carry out the least-cost resolution of a large bank.

•

The FDIC’s Board of Directors should focus on net benefits when evaluating the comments

received on the ANPR and choosing which option to implement.

•

The features of Option 2 are necessary but may not prove sufficient to correct weaknesses in

the insurance determination process.

•

The FDIC should give serious consideration to implementing Options 1 and 3.

•

A reformed insurance determination regime should apply to all large banks for whom the

current regime could prevent a least cost resolution; the same insurance determination

scheme need not apply to all covered institutions.

I now discuss these five points in greater detail.

(1) To ensure effective use of society’s resources, the FDIC must reform current insurance

determination procedures which potentially could hinder its ability to carry out the least-cost

resolution of a large bank.

The ANPR identifies a serious limitation in the FDIC’s current

ability, under certain circumstances, to resolve a large institution in the least cost manner.

The

problem facing the FDIC results from the interaction of two distinct issues.

First, as I understand

the ANPR, the FDIC could face material, technical challenges in (a) determining which deposits

are insured and which are uninsured at a large bank and (b) segregating the insured from the

uninsured immediately prior to and after failure.

These problems are most acute at large banks

with multiple, unintegrated deposit tracking systems, a category which may include many large

and systemically important institutions.

Second, for reasons noted below, the FDIC expects to

resolve a large bank through its bridge bank authority.

This authority allows it to keep the

operations of the failed bank up and running without providing assistance to a wide array of

creditors.

The segregation problem seems particularly serious; some large banks’ deposit tracking systems

would not facilitate the FDIC’s need to put “holds” on uninsured deposits transferred from a

failed bank to a bridge bank.

Absent such holds, depositors would have free access to uninsured

deposits transferred to the bridge bank.

The inability to determine which deposits are insured arises from the absence of two variables in

banks’ deposit tracking systems.

First, banks may not have a single unique identifier for all

deposit accounts associated with a depositor.

Second, banks do not have systems that readily

allow the FDIC to determine the insurance category in which each deposit account falls.

Faced with these limitations, the FDIC could restrict depositors’ access to their funds at the

bridge bank in order to ensure that only insured deposits receive government backing.

In the

extreme, without a mechanism to place automatic holds on uninsured deposits, the FDIC could

decide to release deposits to depositors only after manual review.

Given the time a manual

review would consume, such an approach could lead to the lapse of several days between bank

closure and bridge bank opening.

Such a response, however, would negate the essential reasons for using the bridge bank.

As the

ANPR notes, bridge banks minimize the chance of spillover failures, and resulting government

bailouts aimed at containing spillovers, by maintaining the operations of the failed bank and

providing depositors with ample liquidity.

Bridge banks also allow the FDIC to maximize the

value obtained from the failed bank’s assets and franchise.

As a result, imposing tight

restrictions on access to depositor funds is neither attractive nor particularly practical.

In the face of insufficient technology to segregate deposits or information to determine the

insurance status of deposits, therefore, the FDIC would likely prefer to provide depositors with

access to deposits even if they might be uninsured.

This preference, even if understandable,

undercuts least cost resolution and puts pressure on policymakers to invoke the systemic risk

exception of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA).

Murton, Arthur J. 2005. “Resolving a Large Bank: The FDIC’s Perspective.”

In Douglass D. Evanoff and George

G. Kaufman, eds.,

Systemic Financial Crise: Resolving Large Bank Insolvencies

. World Scientific, pp. 415-420.

The FDIC would not have to apply holds on deposits to the degree that other creditors absorb all resolution losses.

While not implausible, history suggests that large bank depositors will likely face some loss—albeit a potentially

smaller one relative to that experienced by depositors of failed small banks—after resolution.

Invoking the systemic risk exception due to limitations in the resolution process (as opposed to

preventing a true systemic crisis) could contribute to substantial resource misallocation in the

economy over time.

(2) The FDIC’s Board of Directors should focus on the net benefits of reform options when

evaluating comments received on the ANPR and choosing one to implement. The ANPR asks

commentators for their views on the marginal costs of implementing three options to address

current determination weaknesses.

Banks and software providers have the information and

experience to identify these costs. And given their informal feedback to date, these firms may

suggest that Options 1 and 3 consume more resources than Option 2.

These costs should certainly be kept to a minimum, but costs are only one side of the equation.

The FDIC Board of Directors acts on behalf of taxpayers and society as a whole.

Thus, it will

surely review the costs and benefits of the options and focus on net benefits.

As already noted,

creating the conditions for imposition of least cost resolution of a large bank is the first and most

important benefit of the options.

This outcome, in turn, should increase market discipline/reduce

moral hazard. More market discipline and less moral hazard means a higher standard of living,

as resources flow to their best uses.

This benefit is difficult to quantify but the limited evidence

available suggests that it is potentially large.

Transferring as much of the risk of bank failure to uninsured creditors has rightly driven bank

resolution policy since the turbulence of the 1980s and early 1990s.

Expansive creditor coverage

during those years, as the FDIC has noted, “fostered the belief that all deposits of large banks

were 100 percent insured. This belief severely limited the discipline that depositors might

otherwise have exerted on the behavior of banks.”

FDICIA’s least cost mandate has, in fact, led to a significant reduction in the percent of

uninsured deposits of failed banks that have received full protection.

But the reduction in

uninsured coverage at failed banks has come in the context of small bank failures.

A second

benefit of the proposal, therefore, is to instill equity in the resolution process.

The probability

that an uninsured bank creditor receives coverage should not depend on what are apparently

correctable and technical features of the resolution process.

A third benefit of reforming the insurance determination process, particularly via the public

regulatory process, concerns its “signaling effect.”

Large bank insolvency in the United States is

an extremely rare event and so, fortunately, policymakers do not have many opportunities to take

actions that credibly put large bank creditors at risk of loss.

The insurance determination

proposal, therefore, offers a particularly important opportunity to convince creditors of their

exposure. While these creditors may not expect full coverage, available evidence suggests they

currently expect some government protection.

Stern, Gary H. and Ron J. Feldman. 2004.

Too Big to Fail:

The Hazards of Bank Bailouts

. Brookings Institution

Press.

Federal Deposit Insurance Corporation. 1997.

History of the Eighties:

Lessons for the Future

. December. p. 40.

For a recent example, see Morgan, Donald P. and Kevin J. Stiroh.

2005.

“Too Big to Fail After All These Years.”

Federal Reserve Bank of New York Staff Report Number 220. September.

(3) The features of Option 2 are necessary but may not prove sufficient to correct weaknesses in

the insurance determination process. After deciding to correct weaknesses in the current

insurance determination regime, the FDIC Board must choose one of the many reforms

available. Option 2 would address current limitations on the FDIC’s ability to put holds on

deposits. Any reform worth implementing must allow for segregation of uninsured deposits; the

absence of this capability underlies the need to reform the insurance determination process in the

first place.

Clearly Option 2 represents a necessary change.

There are reasons to question, however,

whether it sufficiently addresses failings with the insurance determination process.

As already

noted, the FDIC currently must use incomplete data to determine which deposits are likely

insured and which are not. Options 1 and 3 would generate the information (e.g., the unique

owner identifier and insurance category for each account) the FDIC requires to more accurately

and promptly make that determination.

As the ANPR notes, “Without these data the FDIC

would have to identify account owners and each account’s insurance category based primarily on

the name and address fields and tax identification numbers, as is the case with the current

process.”

As an outsider, and without the experience of a large bank failure, it is difficult for me to

determine the precise degree to which this additional information reduces the likelihood that

policymakers will invoke the systemic risk exception.

I cannot rule out that by making use of

information already available on bank systems, the FDIC could still manage to impose a least-

cost resolution. That said, in certain cases, it also seems plausible that the additional insurance

category and unique identifier data would generate material benefits.

For example, where a

bank’s failure is rapid and unexpected, its deposit base large by number of accounts, as a relative

source of funding, and concentrated among less common forms of insurance categories, and its

deposit records fragmented across a number of systems, the FDIC may be challenged using

current methods to determine which deposits are insured.

(4) The FDIC should give serious consideration to implementing Options 1 and 3. Option 1

follows the model of Option 2 but builds on it by addressing both the segregation weakness and

challenges in sorting deposits into insured and uninsured status.

Thus, if Option 2 proves

insufficient for the reasons noted above, then the extra benefits offered by Option 1 could offset

the extra costs. That is, Option 1 may be the minimum reform needed to address what ails the

process of identification of insured deposits.

Once the FDIC decides that Option 1 is a minimum standard, then it seems reasonable that the

FDIC give Option 3 serious consideration. The difference in benefits between Option 3 and

Option 1 appear to be of a different nature then the difference between Options 1 and 2.

Specifically, by having insurance determination assessment tools reside on the information

technology of the bank, Option 3 would provide something closer to a “real time” measure of the

insured/uninsured deposit split. More ready assessments of the split may prove helpful in the

crisis environment likely to accompany a large bank failure. The more accurate data generated

under Option 3 might also free the FDIC from having to impose temporary holds; under Option 3

Federal Deposit Insurance Corporation. 2005.

“Large-Bank Deposit Insurance Determination Modernization

Proposal.” December 13

p. 73,658.

the FDIC could more confidently debit depositors’ accounts based on the amount of their

uninsured deposits. Option 3 would also seem to reduce operational risk by limiting the number

of data/software transfers between the FDIC and the failing bank and by better integrating the

insurance determination program into the day-to-day processes of the bank.

(5) The reformed insurance determination regime should apply to all large banks for whom the

current regime significantly raises the likelihood of invoking the systemic risk exception; the

same insurance determination scheme need not apply to all covered institutions. The benefits of

insurance determination reform come from increasing the odds of imposing least cost resolutions

on large banks.

Thus, on benefit/cost grounds, the FDIC is correct in limiting these reforms to a

small number of the nation’s largest banks.

The question is how small should this group be?

Underlying any decision on which banks should fall under the new insurance determination

regime is the potential for that banks’ failure to lead to invocation of the systemic risk exception.

If the FDIC has confidence that under the current determination regime, it can carry out a least

cost resolution on a particular bank, then that bank should not face the new determination

process. There are likely several proxies for determining which banks pose the greatest risk of

invocation of systemic risk, including number of deposits, fragmentation of deposit systems,

dependence on uninsured deposits, use of deposits whose insured status is difficult to ascertain,

etc…Perhaps all these proxies are correlated with a simple measure such as dollar value of

deposits. Certainly using such a simple metric has desirable features such as low cost of

implementation and reduction of “private information” that could be transmitted to the public.

However, the FDIC must make sure that it minimizes the number of institutions identified as

“not covered” that could end up with insurance determination issues.

Society will incur a

significant cost if policymakers have to invoke the systemic risk exception in these

circumstances for a relatively small institution.

Moving from which banks receive coverage to the type of coverage they receive: The

benefit/cost analysis noted above should determine which banks receive which reform.

Option

3, for example, may have a positive benefit/cost ratio for the largest institutions and not for

smaller ones.

Sincerely,

Gary H. Stern

President

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