FDIC screws community banks

Posted on May 2, 2009

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fdiclogoThe Federal Deposit Insurance Corporation (FDIC), the very organization created to guarantee deposits against bank runs and failures, is instead about to guarantee that their services are in greater demand. They’re doing this by requiring all banks, large and small, to pay a one time charge of 20 cents per $100 of deposits (aka 20 “basis points”). In the process, this unbudgeted expense will likely cause some otherwise stable and profitable smaller banks to fail while larger banks, with the assistance of federal TARP funds, will likely be able to survive.

The FDIC is a federally-chartered insurance company, and as such they charge their member banks a fee to provide deposit insurance. In the 2007-2008 federal fiscal year, the insurance charges ranged from five to 43 basis points, with an industry average of 6.3 basis points. As of April 1, however, the FDIC not only increased their rates to between seven and 77.5 basis points, but they also significantly changed the method by which banks are categorized according to risk. The rates paid by banks increased dramatically for nearly all risk categories, with some increasing over 100%. The worst increase was from 10 basis points to a maximum of 43, an increase of 330%.

But as bad as those increases were, the proposed new rates and the new rate calculation method were both published October 7, 2008. This amount of advance notice should have permitted banks to plan for an significant increase in their rates even though the final rates were not known until March 4, 2009.

The bigger deal is that the FDIC has chosen to implement a 20 basis point “special assessment” charge specifically to increase their own monetary reserves and to ensure that the public has confidence in the FDIC. In addition, the FDIC Board has given themselves the option to add an additional 10 basis points atop the first 20 if they feel that additional confidence-building measures are required. These special assessments were not in the proposed rule published in October of 2008, and as such the banks would not have been able to prepare and budget for the increased costs of keeping the FDIC financially solvent.

The Federal Reserve publishes a list of the largest commercial banks in the country – essentially every bank with over $300 million in combined assets – in order from largest to smallest as determined by the banks’ total assets. From this data, it’s clear that the top five banks hold 40.6% of total assets and 57.8% of all domestic assets held by banks. The top 25 banks hold 60.4% and 91.7% of total and domestic assets respectively. For comparison, the top five banks also recieved 35.1% of the TARP bailout money committed to date, or $152.5 billion.

In other words, the largest banks hold the most assets and have needed the most federal help.

The 1722 “large” banks identified by the Federal Reserve will need to pay a combined total of $19.9 billion to the FDIC by September to accomodate the 20 basis point special assessment. If the FDIC Board boosts the special assessment to 30 basis points, then the combined total will be $29.8 billion instead. Put another way, that represents a $2-3 million reduction in operating revenue for a bank with $1 billion in total (domestic) assets.

According to the Federal Reserve, Cashmere Valley Bank of Cashmere, Washington is just such a bank – it has nearly exactly $1 billion in total assets, all of which are domestic assets. It has a total of eight locations (nine according to their website). According to the bank’s unaudited financial statement for 2008, the bank had a total income of $12.216 million. Cashmere Valley Bank will have to pay a $2-3 million in September, or 16.7% to 25% of their entire 2008 income. This will make the bank less profitable and may hurt the perception of its stability in the Washington communities it serves.

Furthermore, if the bank’s shareholders demand that Cashmere Valley Bank keep their stock value up, then the bank might choose to cut staff and close branches instead of taking a hit to profits. According to the 2008 financial statement, Cashmere spent $19.845 million on building leases, office equipment, salaries and benefits, etc., of which just over half was salaries and benefits. Cutting this number by $2-3 million could require Cashmere to close an entire branch and its staff, possibly hurting the community where the branch is located. Or Cashmere could cut staff by 20-30% across all branches instead.

What’s perhaps the most devastating, however, is that the entire amount is due by the end of September and the final rule was only announced in March, giving banks only two full quarters in which to make enough money to cover their special assessment charge. Cashmere Valley Bank made about $4 million after taxes in the first quarter of 2009, so they may well be able to pay the charge. But a $2-3 million charge all at once will cut total income by 50-75%, depending on the economy of the communities that Cashmere Valley Bank serves.

Bank of America will have to pay $2.75 or $4.13 billion in special assessment charges. In 2008, their total income was only about $4 billion, so this is a comparably much larger percentage of income than Cashmere will have to pay. But Cashmere doesn’t appear to have been given TARP funds (or if so, not enough to hit the ProPublica bailout tracking radar) while BofA has received $52.5 billion in bailout money to date. Only AIG has received more bailout money.

So what does this all mean? It means that the largest banks in the industry, banks like JPMorgan Chase and Bank of America, banks that are “too big to fail,” will feel little pain from the FDIC special assessment. The Treasury has already decided that these large banks will not collapse, and so the banks will be given (or have already been given) the billions of dollars needed to pay their portion of the FDIC special assessment. And so money will leave the Treasury, go trough the bank, and then come back to another part of the Treasury Department, the FDIC. Smaller banks, on the other hand, will be forced to take lower profits, cut staff, and close branches in order to afford the special assessment. In extreme cases, the special assessment designed to help keep banks alive may even force some to close their doors.

While the biggest banks will be propped up, smaller banks that are more financially sound will become less so. Added to the fact that these very same banks were were forced to take TARP money order to spread out expected Treasury losses from the bailout and we have a situation that will ultimately result in the failure of more small community banks that could have survived before the FDIC’s special assessment.

And this is less damaging to the country and economy than nationalizing huge banks and then gradually deconstructing them how, exactly?

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