The massive number of bank failures this year has drained FDIC’s insurance fund to critical levels.
So now the FDIC is going to borrow money from the very banks it insures in order to bolster the fund.
The board of the FDIC has voted today to require banks to prepay about $45 billion in fees to replenish its insurance fund.
In some sense, this looks like a tax on banks. But, in reality, it is more like a risk free loan that banks will be all too happy to make. Structuring the fee as a prepayment means that banks will book the prepayments as if they had used the cash to buy an asset against which they will have no capital reserve requirements. This is because the FDIC insurance is ultimately backed by the US government. What’s more, the prepayments reduce future payments, which is why this is pretty much a loan.
An even bigger gift to banks is that the new rule will treat the roughly $300 billion worth of FDIC-guaranteed bonds issued under a special financial crisis program as having zero risk. Previously, the bonds have been deemed “high-quality” debt, which meant banks had to keep $1.6 million of capital in reserve for each $100 million of the bonds they own. The change will result in an instant boost to available capital of banks.
This mess has exposed a huge flaw in the FDIC system. During the boom years, the FDIC kept the fees that banks paid very low. This would allow them to accumulate enough money to finance the fund through a crisis. This was in part because of lobbying by banks. But regulators weren’t exactly fearful of a downturn. The ‘it’s different this time’ ideology dominated. Now that the bank failure crisis is unfolding, the FDIC cannot increase fees because too many banks are already short of capital. So we wind up with this kind of contortionist policy.