Less than two weeks after it was unveiled, critics claim a Federal Deposit Insurance Corp. plan to guarantee bank debt is too narrow, expensive, and punitive for institutions that choose not to participate.

In roughly 50 letters filed in response to the interim rule, banks of all sizes argued the agency's planned 75-basis-point charge for covering unsecured debt is too high.

"I am a small institution selling funds regularly. The 75 bp fee is in my opinion extreme," wrote Don Vondra, the president of the $73.7 million-asset United Bank in Absarokee, Mont., in an Oct. 29 letter. "I would like to … stay in the program but the cost may make it difficult to."

The FDIC announced last month it would temporarily guarantee bank debt and back all non-interest bearing deposits as part of a government effort to unclog credit markets. The interim rule, released Oct. 23, detailed procedures for banks to participate and allowed them until Nov. 14 to opt out. After banks complained that was too short a time frame, the FDIC said late Monday it would extend the deadline to Dec. 5.

Bankers are lobbying for other changes, including more explicitly covering all cases where an issuer defaults and nixing a plan to publish the names of banks that opt out of the program.

Many called the 75-basis-point fee prohibitive.

"If you leave the assessed fee" at 75 basis points "in the current economic conditions, many smaller banks will opt out," Jim Murphy, a vice president at the $452 million-asset Pacific State Bank in Stockton, Calif., wrote in an Oct. 29 letter. "They may then be at a severe competitive disadvantage in terms of retaining and attracting customers."

Mitchell J. Bennett, the president and chief executive of the $90 million-asset Farmers Bank in Hardinsburg, Ky., said it was unfair that the FDIC planned to publish on its Web site a list of institutions choosing not to stay in the program.

"I interpret the opt-out and public notice requirements … to be a strong-arm tactic to encourage banks to participate whether it is necessary or not," he said in an Oct. 27 letter. "Instead of 'singling out' those banks that have operated in a sound, successful manner, especially during these difficult economic times, why doesn't the FDIC ask those banks with liquidity concerns to opt-in in order to participate in the program?"

The program only covers debt issued between Oct. 14 and June 30, and the FDIC guarantee is valid only until June 30, 2012, even if the debt matures at a later date.

Many institutions, including large banks, complained that the fee was out of whack with the current cost of borrowing certain funds, and suggested reducing it to as low as 25 basis points.

Unsecured debt between banks is typically lent at interest rates largely determined by the Federal Reserve Board's key interest rate, known as the federal funds rate. That rate now is only 1%, making the issuing of such debt attractive. But banks complained the FDIC charge would suddenly make that market more costly, because they effectively will have to raise the price of debt to account for the high premium.

"The high cost of insuring Federal Funds may lead institutions to other secured borrowing sources so that, in lieu of Federal Funds, financial institutions will … increase their utilization" of direct funding from the Fed, such as from its discount window, and from Federal Home Loan bank advances, wrote Bill Kroener, a former FDIC general counsel and a partner at Sullivan & Cromwell LLP, in an Oct. 31 letter on behalf of nine of the largest bank holding companies.

Mr. Kroener also said the FDIC should provide banks more flexibility to stay in the program but leave certain debt not guaranteed, since restricting such distinctions overlooks current market realities, including that some investors prefer riskier debt with higher yields.

"The market will understand that the decision to issue some debt on a guaranteed basis and some on a non-guaranteed basis reflects valid economic reasons," he wrote.

He said a revised rule should also more explicitly guarantee the FDIC's timely debt payments for scenarios other than bank failures, such as when a holding company that issued debt goes bankrupt.

"The FDIC should be modified to cover the payment of principal and interest when due, regardless of the reason for non-payment," Mr. Kroener wrote. "This would eliminate delay and uncertainty in payment after a default, and a potential loss of interest due to prolonged bankruptcy proceedings."

Originally published in American Banker.