Assessments; Adjustment of Assessment Rate Schedule for BIF- Assessable Deposits

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 327

Assessments; Adjustment of Assessment Rate Schedule for BIF-

Assessable Deposits

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Adjustment of assessment rate schedule.

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SUMMARY: On November 14, 1995, the Board of Directors of the FDIC

adopted a resolution to reduce to a range of 0 to 27 basis points the

assessment rates applicable to deposits assessable by the Bank

Insurance Fund for the semiannual assessment period beginning January

1, 1996. The reduction represents a downward adjustment of 4 basis

points from the BIF assessment rate schedule currently in effect for

the second semiannual assessment period of 1995.

EFFECTIVE DATE: January 1, 1996, through June 30, 1996.

FOR FURTHER INFORMATION CONTACT: Frederick S. Carns, Chief, Financial

Markets Section, Division of Research and Statistics, (202) 898-3930;

Christine Blair, Financial Economist, Division of Research and

Statistics, (202) 898-3936; Claude A. Rollin, Senior Counsel, Legal

Division, (202) 898-3985; Martha L. Coulter, Counsel, Legal Division,

(202) 898-7348; Federal Deposit Insurance Corporation, 550-17th Street

NW., Washington, D. C., 20429.

SUPPLEMENTARY INFORMATION:

I. Adjustment of Existing BIF Assessment Rate Schedule

On August 8, 1995, the Board of Directors of the FDIC (Board)

adopted a new assessment rate schedule for

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deposits subject to assessment by the Bank Insurance Fund (BIF). 60 FR

42680 (August 16, 1995). The new schedule (codified as Rate Schedule 2

at 12 C.F.R. 327.9(a)) provided for an assessment-rate range of 4 to 31

basis points and became effective retroactively on June 1, 1995, the

beginning of the month following the month in which the BIF reached its

designated reserve ratio (DRR) of 1.25 percent of total estimated

insured deposits.

In adopting that rate schedule, the Board took into account the

factors required by the assessment provisions of section 7(b) of the

Federal Deposit Insurance Act (FDI Act), 12 U.S.C. 1817(b). Those

factors include the requirement for a risk-based assessment system that

is based on the risk of loss posed to BIF by each BIF-insured

institution, taking into account different categories and

concentrations of assets and liabilities and other relevant factors;

the likely amount of any such loss; and BIF's revenue needs. (Section

7(b)(1)). They also include the requirement that rates be set to reach

or maintain the DRR, taking into account BIF's expected operating

expenses, case resolution expenditures and income, the effect of

assessments on members' earnings and capital, and any other factors the

Board may deem appropriate. (Section 7(b)(2)).

At the same time the Board adopted the current rate schedule, it

also amended the FDIC's assessment regulations to permit the Board to

make limited adjustments to the schedule without notice-and-comment

rulemaking. Any such adjustments can be made as the Board deems

necessary to maintain the BIF reserve ratio at the DRR and can be

accomplished by Board resolution. Under this provision, codified at 12

CFR 327.9(b), any such adjustment must not exceed an increase or

decrease of 5 basis points and must be uniform across the rate

schedule.

The amount of an adjustment adopted by the Board under 12 C.F.R.

327.9(b) is to be determined by the following considerations: (1) the

amount of assessment revenue necessary to maintain the reserve ratio at

the DRR; and (2) the assessment schedule that would generate such

amount of assessment revenue considering the risk profile of BIF

members. In determining the relevant amount of assessment revenue, the

Board is to consider BIF's expected operating expenses, case resolution

expenditures and income, the effect of assessments on BIF members'

earnings and capital, and any other factors the Board may deem

appropriate.

Having considered all of these factors, the Board has decided to

adopt an adjustment factor of 4 basis points for the semiannual

assessment period beginning January 1, 1996, with a resulting adjusted

schedule as follows:

BIF Rate Schedule as Adjusted for the First Semiannual Period of 1996

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Supervisory subgroup

Capital group -----------------------------

A B C

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1......................................... \1\ 0 3 17

2......................................... 3 10 24

3......................................... 10 24 27

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\1\ Subject to a statutory minimum assessment of $1,000 per semiannual

period (which also applies to all other assessment risk

classifications).

The basis for the Board's decision is discussed below.

II. Basis for the Adjustment

A. Maintaining at the Designated Reserve Ratio

On June 30, 1995, the BIF reserve ratio stood at nearly 1.29

percent, and all indications are that it continued to grow during the

third quarter of 1995. If the rates in effect for the current

semiannual assessment period were to continue in effect, it is likely

that, absent large increases in insurance losses and deposit growth,

the reserve ratio would continue to grow during the first half of 1996.

BIF operating expenses and insurance losses have been lower than

anticipated and are projected to remain low in the near term due to the

strong economy and high capital levels in the banking industry. Even

taking into account the possibility of large increases in insurance

losses and deposit growth that currently appear highly unlikely, it is

still probable that the reserve ratio would remain at or above the

target reserve ratio of 1.25 percent in the near term. Accordingly, the

Board has determined that a reduction in the BIF assessment rate

schedule is necessary to comply with the statutory requirements for

setting assessment rates, including the requirement that the FDIC

maintain the reserve ratio at the target DRR.

B. Determination of the Adjustment Factor

1. Amount of Assessment Revenue Needed

The FDIC determined in August that an effective average BIF

assessment rate at the low end of a range beginning at around 4.5 basis

points was appropriate to achieve a long-term balance of BIF revenues

and expenses (where expenses include monies needed to prevent dilution

due to deposit growth). This determination was based on a thorough

historical analysis of FDIC experience and consideration of recently

enacted statutory provisions that may moderate deposit insurance losses

going forward.

The Board has not altered its view that, in setting rates, it

should look beyond the immediate time frame in estimating the revenue

needs of the fund. However, under the law, the current balance in the

BIF also is directly relevant to determining the appropriate assessment

level for the first semiannual period of 1996. In light of the

favorable existing conditions and outlook for the next several months,

it is anticipated that even an adjustment sufficient to reduce the rate

for the least-risky institutions essentially to zero for the next

assessment period would still provide assessment revenue in an amount

that is expected to maintain the BIF reserve ratio at or above the

target ratio of 1.25 percent in the near term.

In deciding upon a rate schedule for the second semiannual

assessment period of 1995, the Board considered high-growth and low-

growth scenarios for the BIF balance and the anticipated reserve ratio

at year end. Current information suggests that the BIF balance and

reserve ratio at year end will correspond more closely to the high-than

the low-growth scenario, as indicated below.

The BIF reserve ratio stood at nearly 1.29 percent as of June 30,

1995, the latest date for which complete data are available. Assuming

annualized insured deposit growth of between 0 and 2 percent during the

third quarter, the BIF reserve ratio may have achieved 1.30 to 1.31

percent as of September 30, 1995.1 All indications are that the

reserve ratio will continue to rise for the remainder of 1995.

\1\ The BIF reserve ratio as of September 30, 1995, cannot be

determined precisely until Call Report data showing BIF-assessable

deposits for that date are processed and analyzed. This process is

expected to be completed by mid-December 1995.

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Insurance losses and operating expenses for the second half of 1995

are expected to total under $400 million, while assessments plus

investment income will exceed $1 billion for this period. Insured

deposit growth for the second half of 1995 likely will be moderate; the

annualized growth rate was 1.5 percent for the year ending on June 30,

and preliminary estimates suggest that deposit growth will be near zero

or possibly negative for the third quarter. Table 1 indicates that the

reserve ratio is likely to reach 1.31 to 1.34 percent by year-end 1995,

reflecting a range of insured deposit growth from +2 to -2 percent

annually for the second half of the year.

[[Page 63402]]

With a forecast horizon exceeding six months, large unexpected

changes in the reserve ratio are possible, given the historical

volatility in deposit growth and insurance losses. However, the outlook

for the first semiannual assessment period of 1996 is for continued

growth in BIF and its reserve ratio. Little change is expected in the

pace of insurance losses or operating expenses, with the result that

investment income is expected to be sufficient to fund BIF expenditures

through June 30.

Table 1 indicates that, under the current assessment schedule, the

BIF reserve ratio would exceed 1.25 percent as of June 30, 1996, even

assuming a severe negative growth scenario for the reserve ratio. For

example, the reserve ratio at June 30 likely would be at least 1.28

percent even if losses plus new provisions for future losses total $600

million for the first half of 1996 and insured deposits grow at an

annual rate of 6 percent from mid-year 1995 through mid-year 1996.

Table 1 indicates that under these same extreme assumptions, an

assessment rate schedule of 0 to 27 basis points annually (4 basis

points lower for all risk categories than the existing schedule) likely

would maintain the reserve ratio at 1.25 percent through June 30.

In short, the FDIC's best estimate is that the BIF reserve ratio is

highly likely to remain well above 1.25 percent for the first

semiannual period of 1996 even if assessment revenue is minimal. Given

these circumstances, it is the Board's view that assessment rates

should be reduced by a substantial amount. The data reviewed above

support a reduction in BIF assessment rates to the lowest levels that

are consistent with an effective risk-based assessment system.

Finally, the Board notes that this reduction of BIF assessment

rates is likely to have a positive impact on earnings and capital of

insured institutions having deposits assessable by BIF.

2. Maintaining a Risk-Based Assessment System.

The FDI Act requires a risk-based assessment system. In adopting

the current rate schedule, the Board explained its view that, to be

effective, the risk-based assessment system must incorporate a range of

rates that provides an incentive for institutions to control risk-

taking behavior while at the same time covering the long-term costs of

the obligations borne by the deposit insurer. 60 FR 42683 (August 16,

1995). The Board's decision to adopt a 4-point adjustment to the

current rate schedule, thereby retaining rate differentials among the

various assessment-risk classifications, continues to reflect this

view.

It should be noted that, under existing statutory provisions, BIF

members are subject to a minimum assessment of $1,000 for each

semiannual period. (FDI Act section 7(b)(2)(iii)). Under this

requirement, even those institutions posing the least risk of loss to

BIF are statutorily required to pay semiannual assessments of at least

that amount.

In light of its decision to reduce to zero the explicit assessment

rate for those institutions in the most favorable assessment risk

classification, the Board recognizes two concerns associated with the

statutory minimum assessment: (1) the absence of an explicit assessment

rate combined with a minimum semiannual assessment of only $1,000

suggests that the risk posed to the insurance fund by such institutions

is insignificant, but FDIC experience suggests otherwise; and (2) the

marginal cost of deposit insurance for such institutions is zero (that

is, insurance is provided on new deposits at zero additional cost).

The first concern arises because, historically, a significant

percentage of failed institutions might have qualified for the most

favorable assessment risk classification two or three years prior to

failure. Figure 1 shows that, of the insured institutions that failed

in the period beginning with 1980 and extending through 1994, nearly 35

percent were rated CAMEL 1 or 2 as of two years prior to failure, and

approximately 55 percent were rated CAMEL 1 or 2 as of three years

prior to failure. Moreover, of the BIF members that failed from the

beginning of 1987 through 1994, 80 percent were well capitalized as of

three years prior to failure (see Figure 2).

An argument for imposing only the minimum assessment on the least-

risky institutions is that the reserve ratio is intended to provide for

insurance losses arising from these types of failures; because BIF has

been recapitalized through assessments, the protection received during

periods when only the minimum assessment is paid may be viewed as

``prepaid insurance.''

An alternative view supports an explicit, risk-based assessment

rate for even the least-risky institutions as an important element of a

risk-based assessment system. However, as the Board noted in adopting

the existing BIF assessment rate schedule in August, the FDIC is

required by statute both to have a risk-based assessment system and to

maintain the reserve ratio at the target DRR. The Board cannot ignore

one in favor of the other but must, instead, balance the two in an

appropriate manner. The Board believes that the 4-point adjustment

strikes such a balance.

Regarding the second concern noted above, among the implications of

a zero marginal cost for deposit insurance is that the best-rated new

institutions would receive insurance protection essentially premium-

free without having contributed to the existing reserve ratio. The FDIC

is analyzing this issue to determine whether new institutions should

receive special assessment treatment for a period of time after they

initially become insured. Without any operational track record and with

no previous contribution to BIF, there is a question as to whether an

essentially zero marginal rate is justified.

Another implication of a zero marginal assessment is that the

largest institutions in the best category would pay the same dollar

amount for deposit insurance as the smallest institutions. For example,

an institution with $10 billion in BIF-assessable deposits would pay

the same amount ($1,000 per semiannual period) as an institution with

$10 million in BIF-assessable deposits.

The Board does not minimize the foregoing concerns. Rather, given

current industry conditions, the financial health of the BIF, low

projected losses, and the statutory requirement to maintain the BIF

reserve ratio at the target DRR, it is the judgment of the Board that

the institutions posing the lowest risk to BIF should be assessed only

the statutory minimum assessment. In particular, this decision does not

reflect a judgment that such institutions pose a near-zero risk to BIF

but instead a recognition that the existing BIF balance, in excess of

$25 billion, represents the significant prepayment BIF-assessable

institutions have made for deposit insurance.

III. Board Resolution

The Resolution by which the Board adopted the adjustment to the

current rate schedule is set out below.

Resolution

Whereas, section 7(b) of the Federal Deposit Insurance Act (``FDI

Act'') requires the Board of Directors (``Board'') of the Federal

Deposit Insurance Corporation (``FDIC'') to establish by regulation a

risk-based assessment system; and

Whereas, section 7(b) of the FDI Act requires that when the reserve

ratio of the Bank Insurance Fund (``BIF'') reaches the designated

reserve ratio (``DRR'') of 1.25 percent of estimated insured deposits,

the Board shall set semiannual assessments for BIF

[[Page 63403]]

members to maintain the reserve ratio at the DRR; and

Whereas, section 7(b) further requires that, in setting BIF

semiannual assessments, the Board consider the following factors: (1)

expected operating expenses; (2) case resolution expenditures and

income; (3) the effect of assessments on members' earnings and capital;

and (4) any other factors the Board may deem appropriate; and

Whereas, Part 327 of the FDIC's rules and regulations, 12 CFR Part

327, entitled ``Assessments,'' prescribes the rules governing the

assessment of institutions insured by the FDIC; and

Whereas, on August 8, 1995, the Board adopted, by regulation, a

rate schedule for deposits assessable by BIF of 4 to 31 basis points,

set forth as Rate Schedule 2 at section 327.9(a) of the FDIC's rules

and regulations, to become effective at the beginning of the month

after BIF reached the DRR; and

Whereas, said rate schedule became effective on June 1, 1995, and

continues in effect for the second semiannual assessment period of

1995; and

Whereas, section 327.9(b) of the FDIC's rules and regulations, also

adopted by the Board on August 8, 1995, permits the Board, by

resolution, to adjust said rate schedule upward or downward by a

maximum of 5 basis points, as the Board deems necessary to maintain the

reserve ratio at the DRR; and

Whereas, section 327.9(b) requires that any such adjustment shall

be determined by (1) the amount of assessment revenue necessary to

maintain the BIF reserve ratio at the DRR, and (2) the assessment

schedule that would generate that amount of revenue considering the

risk profile of BIF members; and

Whereas, in determining that amount of revenue, the Board is

required to take into consideration (1) expected BIF operating

expenses, (2) case resolution expenditures and income, (3) the effect

of assessments on BIF members' earnings and capital, and (4) any other

factors the Board may deem appropriate; and

Whereas, the BIF's operating expenses and insurance losses have

been lower than anticipated and are projected to remain low in the near

term due to the strong economy and high capital levels in the banking

industry; and

Whereas, the BIF reserve ratio currently exceeds the target DRR

and, absent unexpectedly large insurance losses or deposit growth, is

expected to remain above the DRR for the first semiannual period of

1996 and beyond if the current rate schedule remains in effect without

adjustment; and

Whereas, reducing BIF assessment rates is likely to have a

favorable impact on earnings and capital of insured institutions having

deposits insured by the BIF; and

Whereas, the Board has therefore determined that a downward

adjustment to the current rate schedule is necessary to comply with the

statutory requirements for setting assessments, including the

requirement that the FDIC maintain the BIF reserve ratio at the DRR;

and

Whereas, in determining the amount of the downward adjustment, the

Board has considered the factors specified in section 327.9(b), as

reflected in the attached Federal Register notice document.

Now, therefore, be it resolved, that the Board does hereby adjust,

for the semiannual period beginning January 1, 1996, through June 30,

1996, BIF rate schedule based on Rate Schedule 2 at section 327.9(a) of

the FDIC's rules and regulations by a reduction of 4 basis points to be

applied uniformly across the schedule to each assessment risk

classification represented in the schedule.

Be it further resolved, that the Board hereby directs the Executive

Secretary, or his designee, to cause the aforementioned Federal

Register notice document to be published in the Federal Register in a

form and manner satisfactory to the Executive Secretary, or his

designee, and the General Counsel, or his designee.

By order of the Board of Directors.

Dated at Washington, D.C., this 14th day of November, 1995.

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Deputy Executive Secretary.

Table 1.--BIF Assessment Rates Factors To Be Considered First Semiannual

Assessment Period, 1996

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Current rate Adjusted rate

schedule of 4 to 31 schedule of 0 to 27

basis points basis points

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BIF Ratio at December 31, 1.31 to 1.34........ 1.31 to 1.34.

1995 \1\ (Percent).

Expected Income ($Millions). 1,171............... 677.

Assessment Income 546................. 52.

($Millions).

Interest Income 625................. 620.

($Millions).

Expected Insurance Losses -100 to +600........ -100 to +600.

and Change in Provisions

for Future Losses

($Millions) \2\.

Expected Operating Expenses 215................. 215.

($Millions).

Estimated BIF-Insured 1,877 to 2,032...... 1,877 to 2,032.

Deposits at June 30 \3\

($Billions).

BIF Ratio at June 30, 1996 1.28 to 1.40........ 1.25 to 1.37.

\4\ (Percent).

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\1\ Range reflects annual insured growth rate of +2 percent versus-2

percent for second half of 1995.

\2\ Range based on FDIC experience, as reviewed in Federal Register

notice of August 16, 1995, 60 FR 42680.

\3\ Lower bound assumes annual growth of insured deposits of -2 percent

for second half of 1995 and first half of 1996. Upper bound assumes

annual growth of 6 percent for these same four quarters. Range based

on quarterly volatility evidence from 1984:Q2 to 1995:Q1.

\4\Reflects ranges for all preceding items in Table 1.

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