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Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 1 Galo Cevallos Senior Internationl Advisor, International Affairs Federal Deposit Insurance Corporation International Association of Deposit Insurers 4 th Latin America Regional Committee Meeting Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region Challenges Faced by the FDIC as Deposit Insurer

Challenges and Experiences

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International Association of Deposit Insurers 4 th Latin America Regional Committee Meeting Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region Challenges Faced by the FDIC as Deposit Insurer. - PowerPoint PPT Presentation

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Page 1: Challenges and Experiences

Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007 1

Galo CevallosSenior Internationl Advisor, International Affairs

Federal Deposit Insurance Corporation

Galo CevallosSenior Internationl Advisor, International Affairs

Federal Deposit Insurance Corporation

International Association of Deposit Insurers4th Latin America Regional Committee Meeting

Challenges and Recent Experiences of the Deposit Insurance Systems

in the Latin American Region

Challenges Faced by the FDIC as Deposit Insurer

Page 2: Challenges and Experiences

2 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Challenges and Experiences

ProgramOutline

FDIC – 75 Years of Challenges and Experience

• Overview of US Banking and Regulatory Systems

• Key Challenges to FDIC as Deposit Insurer

Reducing the cost of failed banks Improving the design of the deposit insurance system Insuring effective interagency coordination

Page 3: Challenges and Experiences

3 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Overview of U.S.Banking System

Key Functions of the FDIC

Large, diverse and complex

Well Regulated

Financially Sound

• 8,861 insured institutions; US $11.8 Trillion in assets; US $4.2 Trillion in insured deposits; Median bank size US $140 million; largest bank – US $1.2 Trillion in assets

• Four Federal and 50 State supervisors

• ROA: 1.21%; ROE: 11.58%; NIM: 3.20%; Equity/TA: 10.52%Data as of December 31, 2006

Deposit Insurance

Bank Supervision

Resolutions and Receiverships

• Deposit insurance reform; revised risk-related premium system; US $50.1 billion in deposit insurance fund

• Primary federal supervisor for 5,220 banks; examined every 12 – 18 months; 7,400 risk management and specialty exams conducted in 2006

• February 2007 - First bank failure in almost three years; claims modernization project; large bank failure contingency planning

FDIC: Challenges and ExperienceOverview of Banking and Regulatory System

Page 4: Challenges and Experiences

4 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

FDIC: Challenges and ExperienceReducing the Cost of Bank Failures

In the aftermath of the US Savings and Loan Crisis – several weaknesses came to light

Moral HazardResulted in $153 billion cost to the deposit insurer and tax payers.

Regulatory Forbearance

Page 5: Challenges and Experiences

5 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Addressing Moral Hazard and Regulatory Forbearance

Prompt Corrective Action (PCA) is intended to minimize the cost of resolving bank failures and limit regulatory forbearance by requiring more timely closure of failing institutions and earlier intervention in problem banks.

FDIC: Challenges and ExperienceReducing the Cost of Bank Failures

The Least-Cost approach compels the FDIC to use the least costly method to the deposit insurance fund when resolving a failing institution. Prior to 1991, the FDIC was not required to determine the least costly resolution and could pursue any resolution alternative, as long as it cost less than liquidating the institution.

Page 6: Challenges and Experiences

6 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Prompt Corrective Action (PCA)

PCA requires supervisory intervention at an early stage as indicated by a bank’s capital position. Supervisory actions escalate in proportion to the bank’s capital level. Some of these actions are mandatory, while others are discretionary.

A key point is that supervisors are required to intervene while the bank has positive regulatory capital and is believed to have positive economic capital, which lessens the cost to the insurer.

Practices that Minimize Losses

FDIC: Challenges and ExperienceReducing the Cost of Bank Failures

Page 7: Challenges and Experiences

7 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

• Resolution method chosen must represent the least cost to the FDIC of all possible alternatives.

• FDIC must document its selection, which will be evaluated by the inspector general.

• An exception to the least-cost requirement may be made for systemically important banks.

Minimizing Cost of Bank Failures

The Least-Cost Requirement

The least cost test requires the FDIC to perform cost-benefit analyses on all possible resolution alternatives, based on the best available information at the time, when deciding how to resolve a failed financial institution.

Immediate Impact

of Least Cost Requirement

1991

Pre FDICIA

1993

Post FDICIA

Percent of closed banks where uninsured depositor lost money

17% 88%

FDIC: Challenges and ExperienceReducing the Cost of Bank Failures

Page 8: Challenges and Experiences

8 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

FDIC: Challenges and ExperienceDesign Improvements

A Commitment to Continuous

Redesign

A sign of an effective deposit insurance system is that it is continuously changing to account for its experiences and to keep up with a changing environment.

The Federal Deposit Insurance CorporationReform Act (February 2007)

Principal Reform Features Included:

• Improved management of the fund• Improved risk pricing• Preserving the value of deposit insurance

protection

Page 9: Challenges and Experiences

9 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Problem One Law restricts the FDIC from charging premiums to most banks that are well capitalized and highly rated by bank supervisors as long as the Deposit Insurance Fund’s Designated Reserve Ratio is above 1.25 percent of insured deposits.

****• 95 percent of banks do not pay for

deposit insurance (9/30/2007);

• 1,100 newly established banks never made contributions to the deposit insurance fund (2005)

Improved Fund Managment

Twin Problems with

Funding Design

Problem Two Law requires the FDIC to assess premiums across-the-board at a rate of at least 23 basis points when the Designated Reserve Ratio falls below 1.25 percent; likely resulting in the industry paying high premiums when both banks and the economy can least afford it.

FDIC: Challenges and Experience Design Improvements

Page 10: Challenges and Experiences

10 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Improved Fund Managment

Insured Deposit Growth Outpaced Fund Growth

FDIC: Challenges and Experience

Design Improvements

3.3%

DIF Fund Balance2.3%

3.3%

2.3%

3.2%

0.1%

5.9%6.1% 6.2%

5.1% 5.1%

3.6%

0.8%

3.2%2.9%3.2%2.9%

3.9%

2.0%2.0%

6.9%

7.5%7.4%7.6%

6.4%

5.4%4.9%

4.3%

2.7%2.9%2.8%

5.4%5.1%5.0%

DIF Insured Deposits

-2%

0%

2%

4%

6%

8%

10%

6/02 12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06

Quarter

5.6%

8.5%

September 30, 2006

Per

cen

t C

han

ge

Page 11: Challenges and Experiences

11 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

1.21%

1.23%

1.26%

1.25%

1.34%

1.29%

1.30%

1.32%

1.23%

1.22%

1.29%

1.33%1.33%

1.31%

1.31%

1.32%

1.28%

1.20%

1.23%

1.26%

1.29%

1.32%

1.35%

12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06

Quarter

Reserv

e R

ati

o

December 31, 2006

Improved Fund Managment

Fund Ratio Declined Steadily

FDIC: Challenges and Experience

Design Improvements

Page 12: Challenges and Experiences

12 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Simple Yet Elegant Solution

Congress gave the FDIC’s Board of Directors the authority to set the Designated Reserve Ratio between 1.15 and 1.50 percent.

The FDIC is authorized to charge all institutions a risk-based premium regardless of the level of the designated reserve ratio.

Improved Fund Managment

Twin Problems with

Funding Design

FDIC: Challenges and Experience

Design Improvements

Page 13: Challenges and Experiences

13 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Improved Risk Pricing

All Banks Should

Pay Something

FDIC: Challenges and Experience Design Improvements

Assessment Rates - 1993

Capital Group

Supervisory Subgroup

A B C

Well 23 26 29

Adequate 26 29 30

Under 29 30 31 Assessment Rates - 2001

Capital Group

Supervisory Subgroup

A B C

Well 0 3 17

Adequate 3 10 24

Under 10 24 27

Assessment Rates - Today

Capital Group

Supervisory Subgroup

A B C

Well 5 -7

28Adequate 10

Under 28 43

Rates paid by all banks while fund was being revitalized

Rates paid by banks once fund was restored

Rates paid today by all institutions

Page 14: Challenges and Experiences

14 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Improved Risk Pricing

All Banks Should

Pay Something

FDIC: Challenges and Experience Design Improvements

Assessment Rates - Today

Capital GroupSupervisory Subgroup

A B C

Well 5 -7 (I)

28 (III)Adequate 10 (II)

Under 28 (III) 43 (IV)

The Final Rule

All banks pay premiums.

To further refine banks in Group I, performance metrics and CAMELS component ratings will be considered.

Consolidates nine risk categories into four categories to better align them with their respective historical failure and loss experience.

Capital ratios and supervisory ratings continue to drive the risk matrix.

FDIC Board of Directors may adjust rates +/-3 basis points with relative ease.

Market risk indicators considered when determining rate paid by large banks.

Page 15: Challenges and Experiences

15 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Retirement accounts are now protected to $250,000.

Coverage for all other accounts may be indexed to inflation to preserve the value of protection.

Preserving the Value of Deposit Insurance Protection

Protecting Retirees and

Keeping Up with Inflation

FDIC: Challenges and Experience Design Improvements

Page 16: Challenges and Experiences

16 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Risk Assessments An interagency effort

Division of labor without duplication

Examination Sharing Arrangements

Critical for deposit insurance pricing

Total Banks and Thrifts 8,662 11.9 Trillion

Total FDIC-Supervised 5,228 2.2 TrillionTotal OCC-Supervised 1,705 6.8 TrillionTotal FRB –Supervised 892 1.4 TrillionTotal OTS – Supervised 837 1.5 Trillion

As insurer, FDIC has access to examination records produced by other federal and state banking agencies

Examination ratings and capital positions determined by agencies are used to price deposit insurance premiums and gauge adequacy of deposit insurance fund.

Interagency Cooperation, Coordination, Communication

FDIC: Challenges and Experience Ensuring Effective Coordination

Page 17: Challenges and Experiences

17 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Interagency Cooperation, Coordination, Communication

FDIC – Experience and Practical Considerations

Interagency Training and

Policy Development

Formal and

InformalInteragency Information

SharingArrangements

Interagency macro-risk

assessments to identify risks to the

deposit insurance

fund

Large Bank

Supervision and

Dedicated

Examiner Programs

Coordination with

functional

regulators

Coordinated

supervision of Foreign Banking

Organizations

Shared National Credit

Program

Interagency

Country Exposure Review

Committee

Coordination with State

Banking Authorities

via Conference

of State Bank

Supervisors

Central Data

Repository: reduces

burden and makes

regulatory reporting efficient

FDIC Exam Back-Up authority

encourages much

collaboration

Interagency approach to combating

money laundering

and terrorist financing

Page 18: Challenges and Experiences

18 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region

San Salvador, El Salvador - August 2007

Promoting Uniform Standards: The Important Role of

The Federal Financial Institutions Examination Council

The Federal Financial Institutions Examination Council (FFIEC) comprises Federal and State banking agencies, and credit union regulators. It promotes uniform principles, standards, and reporting:

The Financial Institution Rating System (CAMELS) Definitions for classifying assets Financial reports (Call Reports) Examiner training