Ron J. Feldman - Senior Financial Specialist
Published September 1, 1998 | September 1998 issue
Policymakers and the federal insurer have always looked to reserves to judge the solvency of deposit insurance. By the 1950s, the importance of reserves became more explicit and recommendations were made to keep the fund at a targeted level, $1 billion for example.1 To keep the fund close to the preferred amount, the FDIC developed a policy of rebating some of the premium income generated by its flat-rate assessment (the FDIC charged all banks the same premium rate). In 1980, legislation formalized the connection between premium income and a reserve target. Essentially, the law required the FDIC to alter its rebate policy such that the ratio of reserves in the deposit insurance fund to the estimate of insured bank deposits was less than 1.4 percent but higher than 1.1 percent. The FDIC sought this targeting "to help rebuild the fund if abnormally high losses were experienced, and to inhibit excessive growth of the fund in periods of low losses."2
After the thrift crisis in 1989, Congress passed legislation that set more stringent restrictions on flat-rate premiums and reserve targets. The newly organized Bank Insurance Fund (BIF) had to maintain its reserves such that the ratio of reserves to insured deposits equaled 1.25 percent. Congress picked the target of 1.25 percent, which was the midpoint of the 1.1 percent minimum and the 1.4 percent maximum, because it represented the approximate historical average reserve ratio for the FDIC fund prior to 1980.3 The legislation set a schedule of flat-rate premiums to raise the reserve level to, and maintain it at, the targeted amount. Congress gave the FDIC the discretion to deviate from the rate schedule in order to keep the fund at the targeted level.4
The banking crisis led to additional legislation in 1991, altering the relation between premium setting and the targeted reserve ratio. Ostensibly, Congress required the FDIC to replace the flat-rate premiums with risk-based premiums that vary with the likelihood that a bank would fail and its depositors would make claims against the FDIC. Specifically, the FDIC had to base the assessment on "the probability that the deposit insurance fund will incur a loss with respect to the institution ... the likely amount of any such loss and the revenue needs of the deposit insurance fund."5
As long as the BIF had not reached the 1.25 percent target, the 1991 legislation required the FDIC to set risk-based premiums such that they generated the same revenue as produced by a flat-rate premium equal to 0.23 percent of assessable deposits. Once reserves reached 1.25 percent, the FDIC had to maintain the BIF at the targeted level.6 The BIF reached the 1.25 percent target by the second quarter of 1995, which led the FDIC soon after to charge 92 percent of banks the minimum allowable assessment of $2,000 per year.7 Due to the excellent banking condition over the last five yearsleading to very infrequent bank failures, minimal outflows from the BIF and few banks falling outside the lowest risk-based assessment categorythe FDIC continued charging the vast majority of banks the minimum assessment. In 1996, Congress eliminated the minimum assessment so that starting in 1997, about 95 percent of insured banks do not pay an insurance premium.8
4 Federal Deposit Insurance Corporation. 1997. History of the Eighties: Lessons for the Future. Volume 1, An Examination of the Banking Crises of the 1980s and Early 1990s. Washington D.C.: FDIC, p. 101.