WASHINGTON — Federal Deposit Insurance Corp. Chairman Sheila Bair opened the door Thursday to extending blanket deposit insurance coverage on business accounts, but disagreed with another regulator's push to count more loan-loss reserves as capital.
Speaking at a trade group conference, Bair said her agency strongly opposes allowing more loan-loss reserves to be counted as Tier 2 capital, saying doing so would be dangerous. Her comments came a day after Comptroller of the Currency John Dugan, speaking at the same conference, endorsed the move.
"We will be holding pretty firm," Bair told an American Bankers Association meeting. "There is a lot of focus right now on capital adequacy and the quality of capital." Letting more reserves count could "dramatically, in our view, dilute the quality of capital."
At issue is a cap, put in place during the 1980s, on the amount of loan-loss reserves a bank may count toward its Tier 2 capital. The cap is equal to 1.25% of the bank's risk-weighted assets.
Speaking to the ABA on Wednesday morning, Dugan said that limit should be increased to encourage banks to fatten their loan-loss reserves.
"We … have supported lifting that cap as a way to be a further encouragement for people to make loan-loss reserves, or, the other way around, eliminating a discouragement to do it," Dugan said.
He acknowledged that other regulators don't share his view.
"I will tell you: Not all the regulatory agencies agree on that point, and that's one you can't do unless we agree," he said.
Bair referenced the late L. William Seidman, a former chairman of the FDIC, in explaining why the limit should not be increased. "Bill never understood why reserves counted as capital at all," she said. "Reserves are for expected losses and capital is for unexpected losses."
Some observers said the 1.25% limit made sense when it was created and institutions were setting aside fewer reserves. But a revision may be overdue now that reserves are so large, they said.
"When it originally came into play, your average loan-loss reserve was probably 80 basis points to 1% of your loans," said Randy Dennis, the president of DD&F Consulting Group in Little Rock. "Now it's probably 1.5% or more. … It's not always just because of bad loans. It's because people are being more cautious."
Dennis concurred that "some sort of adjustment to 1.25% would be appropriate."
Karen Shaw Petrou, the managing partner of Federal Financial Analytics Inc., said holding the limit at 1.25% made sense "in a perfect world."
"The problem is that by limiting reserves in capital and" with "so much of regulatory policy based solely on capital, you create a perverse incentive for banks to try to minimize their reserves," Petrou said.
"That is a very dangerous, perverse incentive, as we learned at extreme cost."
Bair also made by waves by saying the FDIC is considering a further extension of the Transaction Account Guarantee program, which allows banks to insure all non-interest-bearing checking deposits.
The program is slated to end June 30. Community bankers have expressed concern that its expiration will drive large depositors — particularly business customers with transaction accounts — to move their money to the largest institutions that have an implicit government guarantee.
"The key question is: Are we … out of the woods now? Or if we" end the program "are we going to see that … trigger liquidity failures?" she said. "That would end up costing us more money."
The TAG program was first offered in October 2008 as part of a broader effort to protect liquidity at the height of the crisis. It was supposed to expire at the end of last year, but the agency's board voted to extend it six months and to charge banks a higher participation fee.
(Initially, participants paid 10 cents for every $100 guaranteed, but that was raised to 15, 20 or 25 cents, depending on a bank's risk profile.)
The program has remained popular with banks. Roughly 6,500 banks continue to participate in the program after only a slight drop following the first extension. As of Dec. 31 it covered $834 billion of deposits, 9% more than a quarter earlier.
Michael Jacobson, chief executive of the $286 million-asset NebraskaLand National Bank in North Platte, told Bair that small banks fear an exodus of business customers when the program expires.
"We still have banks that are 'too big to fail.' There are financial advisers, there are title insurance companies, there are other large depositors that understand that," he said. "We're seeing a migration of dollars out of the community banks and into those 'too big to fail' banks simply because of that fact."
But William Longbrake, an executive in residence at the University of Maryland and a former vice chairman of Washington Mutual, questioned the wisdom of maintaining a program that only one segment of the industry uses. He noted that several large banks, which did not want to pay the higher fees, left the program before the end of last year.
"When the program was last extended, because of the insurance premiums attached to it, a lot of the stronger banks opted out. So you have an adverse-selection situation going on. If you extend it again, it seems to me it only accentuates the adverse-selection problem," Longbrake said.
"As the larger banks exit, is this a small-bank program, and is the FDIC — to be actuarially sound — forced to raise the premium, and does that create a further wedge between the large and the small?"
Jacobson said it is a liquidity issue for institutions like his, which need to consider costlier options for guaranteeing deposits that large banks can overlook. He mentioned one title company that keeps $1 million at his institution.
"That money will leave once the TAG program goes away or I've got to put it into a repo program, which of course is going to count against my borrowings, which is going to tie up collateral, when my competitor who's 'too big to fail' up the street can take that money" more easily, Jacobson said.
Bair said no decision has been made, but the agency will address the question promptly.
With "all these programs, there's a desire to end them as soon as you can. Congress generally is the one that determines insured deposit limits," she said. "I don't want to raise expectations, but I do think we need to make a decision over the next 30 days."
She added that she agrees smaller institutions face greater obstacles when it comes to keeping depositors, telling Jacobson, "Everything that you said about 'too big to fail' and its continuing impact on small banks being able to maintain uninsured deposits, I absolutely agree with you."
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