The bank failures of the 1980s and early 1990s led to reforms in the supervision and regulation of banks; these included the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991, which introduced several nondiscretionary rules. In particular, the FDICIA required the FDIC to set risk-based premiums, whereby premiums differed according to three levels of bank capitalization (well capitalized, adequately capitalized, undercapitalized) and three supervisory rating groups (ratings of 1 or 2, a rating of 3, ratings of 4 or 5). However, the new rules have not been as effective as possible in differentiating between banks; indeed, from 1996 to 2006, more than 90 percent of all banks were categorized in the lowest risk category (well capitalized, with a rating of 1 or 2). Furthermore, the FDICIA and the Deposit Insurance Act of 1996 specified that if DIF reserves exceed the 1.25 percent DRR, the FDIC is prohibited from charging insurance premiums to banks in the lowest risk category. During the 1996-2006 period, DIF reserves were above 1.25 percent of insured deposits and, because the majority of banks were classified in the lowest risk category, these banks did not pay for deposit insurance. So, after subsidizing risk through deposit insurance that charged all banks the same rates from the great depression until the early 1990s, the federal governments reform to differentiate between risky and less risky banks decided that 90% of banks were not only relatively safe, but were actually completely riskless and thus didnt have to pay *anything* for the insurance. Thats going *backwards* in making deposit insurance account for risk. Is it any surprise that a government that felt that 90% of banks posed *zero* risk somehow failed to foresee the housing boom-bust and the resulting recession?
Posted on: Sat, 10 Jan 2015 23:03:53 +0000
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