More on the Prudent Versus the Profligate

Sun, 03 May 2009 12:26:56 +0000

This is a story that you can read about in many local papers. I read it in mine this morning and plucked this one from the web. Small community banks are screaming mad about having to pay higher FDIC premiums and a one-time assessment to cover the FDIC's payouts to failed banks. This excerpt will give you the main idea:

CASHMERE — Small community banks — like Cashmere Valley Bank — that had nothing to do with the excesses of big Wall Street firms that led to the finanical meltdown are now paying a price they protest is unfair.

Community bankers find themselves under tighter scrutiny from federal regulators. They say the $700 billion financial bailout has favored large institutions. And they are upset about a special assessment the government wants to charge to shore up the Federal Deposit Insurance Fund, which failed banks are draining.

"We've run a successful, safe financial institution," Ken Martin, president of the Cashmere-based bank said Tuesday. "Those of us who were responsible and still exist are getting hit with those huge premium increases. And at the same time they're giving these huge bailout amounts to the Citigroups."

In 2007, Cashmere Valley Bank paid about $89,000 in 2007 in premiums to the FDIC, the federal entity that insures bank deposits.

This year, it expects to pay $1.35 million in premiums, plus an additional $900,000 to $1.8 million "special assessment" needed because the premium increase still won't be enough to shore up the FDIC.

There are two problems here. The first is one of timing. The assessment is going to drain capital from otherwise healthy banks at a time of economic decline when every bank is struggling to maintain capital. Even if the fee is not lowered, spreading it out as (say) four equal assessments in four years would allow banks to retain some of their capital (and ability to lend) in the intervening years.

The second problem is one of perceived inequities across different types of banks. I am on the Board of one of our local banks. The bank didn't originate any subprime loans or partake of any of the other forms of financial hijinks that have led to the financial crisis. The bank is being hit by the same type of increase in premiums and this assessment. Deposit insurance is supposed to be a mechanism for transferring money from ex post winners to ex post losers in a group of ex ante identical banks. It is not supposed to be a mechanism for banks that do not engage in risky practices to give money to banks that do engage in risky practices. The difference between the winners and losers is supposed to be due to chance. The current system and these changes presume that a dollar of deposits at your local community bank is at risk to a similar extent as a dollar of deposits at the mega-banks that have caused the largest hits to the FDIC. That's clearly not the case here, and the community banks would like to see those differences recognized.

For more discussion, see this post at Scholars & Rogues.