Order Code RS20724
Updated December 13, 2002
CRS Report for Congress
Received through the CRS Web
Federal Deposit and Share Insurance:
Proposals for Change
William D. Jackson
Specialist in Financial Institutions
Government and Finance Division
Summary
Legislators, regulators, interest groups and academics are examining proposals for
changes in the federal deposit insurance system for banks and savings associations and
the share insurance program for credit unions. In the 107th Congress, measures sought
to change the pricing of insurance, how much coverage should exist for customers’
accounts, and operations of the insuring agency. Changes would have affected the
financial condition of insured institutions, the financial strength of the insurance funds,
and competitive equality among participating institutions, making deposit insurance
reform a complex issue. Signs of increasing risk, leading some to suggest that deposit
insurance generally may need reform, became dramatized with the collapse of several
banks, shrinking the Bank Insurance Fund of the FDIC. One measure, H.R. 3717,
passed the House, while a Senate measure, S. 1945, received a hearing. Interest in the
policy questions these measures raised seems likely to continue into the 108th Congress.
CRS will update this report as warranted. See the Electronic Briefing Book: Banking
and Financial Services [http: //www.congress.gov/brbk/html/ebfin1.shtml] for more
information on financial services issues.
What is Deposit Insurance and How is It Administered?
The full faith and credit of the United States stands behind more than $3 trillion of
insured deposits at banks and savings associations. This insurance guards savers’
accounts up to $100,000, providing stability to banks and to the economy. Congress
legislated deposit insurance in the 1930s, modifying it in 1989 and 1991 in response to
financial crises. Congress now requires all banks and savings associations to carry federal
insurance. The independent agency implementing this program, the FDIC, has not
formally insured amounts greater than the limits set by law, nor foreign office deposits,
although very large banks rely upon them. Smaller institutions find deposit insurance a
very valuable competitive factor in attracting funding, in contrast.
Pursuant to P.L. 101-73 and P.L. 102-242, the Federal Deposit Insurance
Corporation (FDIC) provides federal deposit insurance through two funds. The FDIC’s
Congressional Research Service ˜ The Library of Congress

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two funds are accounts maintained with the U.S. Treasury that the agency may call upon
in case of need. Both earn interest income for the FDIC. The Bank Insurance Fund (BIF)
dates from 1934. Congress intended it and its ancestor the Permanent Insurance Fund to
cover commercial bank deposits. BIF members are predominantly commercial and
savings banks supervised by the FDIC, the Office of the Comptroller of the Currency, or
the Federal Reserve. The Savings Association Insurance Fund (SAIF) is the successor to
a failed fund (“Federal Savings and Loan Insurance Corporation”) covering savings
institution deposits for more than 50 years prior to its collapse in 1989. SAIF members
are predominantly thrift institutions supervised by the Office of Thrift Supervision. Many
institutions have deposits that the “other” Fund insures, because of mergers and other
corporate developments, thus complicating administration and financing.
Institutions do not “own” either Fund. BIF and SAIF balances are on-budget assets
of the government. BIF’s balance is $31.4 billion and SAIF’s balance is $11.6 billion, as
of 9/02. Interest on these amounts, capital appreciation on securities held, and income
from assessments on covered institutions has been generally more than enough to cover
costs of the FDIC’s operations, including closing failed institutions.

The FDIC requires banks and savings associations to pay semiannual assessments
to reflect their own risk and other factors, although the premiums may be essentially zero
for many, and, by statute, it must make premiums reflect the relative sizes of BIF and
SAIF. Both Funds have target ratios of 1.25% ($1.25 per $100) of their balance against
insured deposits. That percentage is the statutorily targeted Designated Reserve Ratio
(DRR). The resulting DRR carries large consequences. When either Fund exceeds that
value, then its members do not have to pay assessments into it, unless low capital or
managerial deficiencies make them individually risky. Institutions regard fund balances
much above 1.25% as “excess deposit insurance” which the FDIC should refund to them.
Institutions argue that, in the general spirit of tax cuts, institutions that paid into the
respective Fund should get back their “surplus.” In the other direction, should either Fund
fall below its DRR, institutions must pay (at a general rate of up to 23 cents per $100 of
insured deposits) to fill the fund’s shortfall. That jump would greatly increase the near-
zero cost of federal insurance, which is a necessity for doing business. Many prefer to
smooth out assessments over time as needed to maintain adequate fund balances. The
FDIC is considering whether to charge BIF-insured banks for their insurance. At 1.25%,
BIF is just at the so-called cliff point below which assessments are called for by law;
while SAIF is better capitalized at 1.39%, as of 9/02.
A separate Fund insures “share” accounts at credit unions: the National Credit Union
Share Insurance Fund (NCUSIF), created in 1970. The National Credit Union
Administration (NCUA) administers it. While all federally chartered credit unions must
belong to NCUSIF, state-chartered ones may or may not choose to join it. Insured credit
unions fund NCUSIF by placing 1% of their total “shares” (deposits) into it, effective as
of 1985. Their contributions remain assets on the books of the credit unions, representing
their investment in that Fund. NCUSIF invests in government obligations. NCUA may
also levy a premium if needed, but has charged only one premium, in 1992. No federal
tax dollars have ever been placed in NCUSIF. It has met its target ratio of 1.30% of
insured shares for years, with a recent balance of about $5 billion.

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Background: The Purpose and Problem of Deposit Insurance
The purpose of deposit insurance is twofold: it is, first, to protect depositors against
risks they cannot control, and, second, to enhance economic stability. In exchange for
these benefits, however, the insurance also entails some hazards for the government.
Purpose. Deposit insurance, as provided by the government, makes deposits safe
by assuring depositors that they can get their money even if their bank fails. It protects
the depositors from a sudden and unforeseen loss of wealth. It also protects the economy
against sudden contractions due to a loss of liquidity in the banking system.
The current federal deposit insurance program commenced during the Depression
years, in response to just such a loss of liquidity. When some banks failed, depositors
who were not first in line to withdraw their money lost much or all of their balances.
Depositors in other banks, fearing further failures, “ran” to withdraw funds from their
own, otherwise-healthy banks while cash was still on hand.
Even a sound bank cannot withstand a run. Deposits are used to make loans which
banks cannot immediately call in to pay off depositors. If an entity with deep pockets
cannot stem the run, more banks fail through contagion. The overall effect is to shrink
the money supply, curtail lending for business and other economic activity, and thus to
contract the economy.
Deposit insurance stops such contractions, so that bank runs have not occurred on
the national level since its inception. They have occurred locally, when federal deposit
insurance was absent, with effects ranging from inconvenience to genuine hardship.
Taxpayers of affected states eventually bore much of the burden of cleaning up after
failures of institutions insured by state instrumentalities.
The Problem of Moral Hazard. A problem for policymakers is the tradeoff
between protection and the loss of market discipline in financial institutions that comes
from the insurance. Observers know it in the industry as “moral hazard.” That is,
depositors have no reason to be concerned about the risks a bank takes with their funds
since government insurance protects them. Banks, knowing that depositors have no
reason to care, have a financial incentive to take on greater risks than they otherwise
might, in the expectation of earning greater returns. Bankers retain profits from risky
investments. Catastrophic losses fall on government should the investments mostly fail.
If a deep-pocket insurer has not insured depositors, they and other bank creditors
have every reason to monitor a bank’s riskiness. If they perceive that their funds are not
well handled, they may require higher interest rates on their monies to compensate for the
extra risk. That brings down the returns from risky investments for a bank and, therefore,
discourages risk-taking. The behavior of uninsured, but presumingly knowledgeable,
depositors gives regulators another way of monitoring the complex activities of banks and
of protecting against serious systemwide problems. Such monitoring theoretically
facilitates the regulation of very large banks, funded mainly by uninsured large deposits,
that present systemic risks to the nation’s financial system. It is of less value as applied
to the vast majority of smaller institutions whose funding comes mainly from insured
deposits and whose financial position is not followed closely on Wall Street.

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Issues
The 106th Congress saw a resurgence of interest in federal deposit insurance.
Congressional consideration of possible changes in federal deposit and share insurance
began in February 2000 when the House Banking Subcommittee on Financial Institutions
held hearings on the FDIC-related problems of depository institutions, and on a possible
merger of BIF and SAIF. Interest was evident in asking:
—Should Congress increase the $100,000 coverage for deposits at banks and savings
associations, and shares at credit unions? Should inflation, perhaps retroactively since
1980, and in future years, be used to “index”the FDIC coverage to preserve the purchasing
power of deposits?
—Should the FDIC insure deposits of municipalities at a greater level?
—Should the FDIC insure retirement and pension accounts at a greater level?
—What should institutions pay for deposit insurance coverage and associated
regulation? Should premiums be smoothed out over time?
—If the fund balances in BIF and SAIF exceed the amounts necessary to provide
adequate coverage, what should be done with the excess? Would refunds leave the FDIC
in weakened condition?
—Is free or low-cost deposit insurance an unwarranted subsidy to banks in their
competition with nonbank financial firms? Or does it offset costs of complying with
bank-only regulations?
—Should Congress merge BIF with SAIF, as a 1996 statute planned?
—Are there better avenues to monitor and restrain risk-taking before it results in the
FDIC making payouts? Must large institutions be deemed too-big-to-fail: posing such
systemic risk to the economy that America must prop them up rather than close them?
—Should rapidly-growing banks, who have paid little or no assessments, be assessed
premiums to compensate the FDIC for its increased exposure to payouts and the
downward change in fund reserve ratios?
—What changes affecting the FDIC’s operations might apply to credit unions?
Policy Considerations
Policymakers must weigh many factors in considering possible changes. A key issue
is how to provide the benefits of deposit insurance without lessening the incentives for
managements to engage in prudent operating practices. Owners and managers at covered
institutions may take on greater risks, in the expectation of greater rewards, if they know
that customers are unlikely to withdraw their deposits, as described above. The
effectiveness of examination and supervision arrangements thus has an important bearing
on the exposure of the insurance funds. Regulation of banks and savings associations to
prevent failure ideally would prevent the FDIC from having to make good on its
guarantee. Government can make no system failure-proof, however. In a competitive
economy, business decisions resulting in closure guide future capital investment away
from practices that failed. Banks and savings associations are not exempt from this truth.

Tradeoffs exist among proposals for change. For example, increased account
coverage at banks and savings associations could require more reserves at BIF and SAIF,
making it less likely that the costs of the FDIC’s insurance remain low. Should risk
increase even further in financial markets, or the Funds’ coverage of insured deposits

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become thin, institutions might have to make larger payments. Competitive equality
based on account coverage and insurance cost is an important consideration for different
institutions (large versus small, banks and savings associations versus credit unions, for
example). Any expansion of the federal safety net through the FDIC has to be paid for,
and since appropriations are not generally viewed as appropriate, means of payment
necessarily would come from covered institutions.
FDIC Recommendations and Congressional Activity
At a House Financial Institutions Subcommittee Hearing in May 2001, outgoing
FDIC Chairman Tanoue said the agency would like the 107th Congress to make statutory
improvements to its practices, policies, and structure. It sought to merge the BIF and
SAIF funds. It sought to charge regular premiums based on institutions’ risks, whatever
the level of the reserve ratio of the fund(s). It suggested adjusting premiums gradually up
or down as the health of the fund(s) might change. If it would make rebates, the agency
would base them on past contributions to building up the fund(s). It suggested indexing
the basic account coverage, to keep pace with future inflation, not necessarily boosting
standard minimum account coverage to $130,000. The agency believed that its
recommendations would produce a stronger system of deposit insurance.
Current FDIC Chairman Powell carried forward much of the FDIC’s reform effort.
Regulators and Administration officials endorsed many of the FDIC’s recommendations
at a House Financial Services Subcommittee hearing, July 26, 2001. They approved of
merging the two Funds, charging premiums to all institutions, and replacing the DRR and
associated premium pricing with a more flexible approach giving the FDIC greater
discretion. They disagreed somewhat over the FDIC’s proposal to index coverage to
inflation, and some opposed increasing the basic dollar amount coverage per account.
The next day saw closure of the undercapitalized $2.3 billion Superior Bank. With
that collapse as backdrop, the Senate Banking Committee held its hearing on deposit
insurance reform, August 2, 2001. Regulators repeated their views on policy issues.

Another House hearing explored reforms on October 17. In it, FDIC Chairman
Powell expressed support for merging the two funds, indexing future account coverage
to inflation, raising coverage for retirement accounts, and changing the pricing of the
FDIC’s insurance to reflect risks rather than through statutory formulas.
Legislation of 2001
H.R. 557, Deposit Insurance Fairness and Economic Opportunity Act, would have
provided payments for, and to, insured institutions if the FDIC funds accumulate excess
amounts. S. 128, Meeting America’s Investment Needs in Small Towns Act of 2001,
would have made periodic cost of living adjustments to basic insurance of $100,000. The
measure would retroactively start adjustments as of 1980, increasing coverage to about
$200,000 per account, and would make future adjustments for inflation every three years.
S. 227, Municipal Deposit Protection Act of 2001, would have provided full FDIC
coverage to within-state deposits of governmental bodies. H.R. 746 is similar to S. 128.
H.R. 1293, Deposit Insurance Stabilization Act, would have merged the BIF and SAIF
insurance funds, and have permitted the FDIC to impose fees on institutions if their

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activities cut the deposit insurance fund(s) below the DRR. It sought to repeal the
automatic assessment of 23 cents per $100 that the FDIC must charge when the insurance
funds(s) become undercapitalized. H.R. 1355, Deposit Insurance Funds Merger Act of
2001, would have similarly merged BIF and SAIF into one Fund. The House version of
the Municipal Deposit Insurance Protection Act of 2001, H.R. 1899, would have fully
insured deposits of within-state municipal depositors up to the total equity capital of
banks holding them.
Legislation of 2002: House-passed and Senate
H.R. 3717, the Federal Deposit Insurance Reform Act of 2002, was marked up by
the House Subcommittee on Financial Institutions and Consumer Credit on March 7,
2002. It was then further approved by the House Financial Services Committee on April
17 with a 52-2 favorable report. With several changes made to increase its appeal, H.R.
3717 passed the House by 408-18 under a suspension of rules, May 22, 2002.
H.R. 3717 sought to do several basic things. (1) Create a range of reserve ratios,
rather than the existing Designated Reserve Ratio minimum of 1.25%. (2) Merge BIF with
SAIF, into a single Deposit Insurance Fund. (3) Increase standard account protection to
$130,000. (4) Index future basic coverage to inflation every five years. (5) Double
coverage of many retirement (IRA and “401(k)”) accounts, that is, to $260,000. (6)
Increase insurance coverage of municipal deposits. (7) Give parity in account coverage
to federally insured credit unions. (8) Allow the FDIC to charge a small premium to
institutions that do not currently pay premiums. S. 1945, the Safe and Fair Deposit
Insurance Act of 2002, had generally similar objectives but somewhat different details
for several aspects of proposed reform. The House-passed H.R. 3717 largely resembled
its Senate counterpart. S. 1945 received a hearing in the Senate Banking Committee on
April 23, 2002. CRS Report RL31343 compares provisions of the two measures for
historical reference since, of course, no legislation became enacted.
Administration and some bank resistance remained to increasing standard coverage
per account to $130,000 and retirement accounts to twice as much with consequent public
and private-sector costs and risks; while other portions of the FDIC-related bills were less
contentious. Safety of wealth in light of unsettled securities markets, an increasingly
aging population, and the implosion of retirement savings plans of Enron and other
entities have raised important risk concerns for congressional consideration. Competitive
considerations remain important. Industry groups are far from united in their views on
desirability of reforms: some providers seek to avoid having to pay for changes in the
ways the FDIC does business and, especially, for increasing its formal protection on
accounts. The 108th Congress seems likely to explore these issues further.
For further discussion, see CRS Report RS20724, Federal Deposit and Share
Insurance: Proposals for Change; CRS Report RL31343, Deposit Insurance Reform:
Comparison of H.R. 3717 and S. 1945, 107th Congress; CRS Report RL31463, Deposit
Insurance: Raising the Coverage Limit; CRS Report RL31552, Deposit Insurance: the
Government’s Role and its Implications for Funding, and CRS Report 97-723, Bank and
Thrift Deposit Insurance Premiums: The Record from 1934 to 2002.

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