Challenges and Experiences

1. International Association of Deposit Insurers4th Latin America Regional Committee Meeting Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionChallenges Faced by the FDIC as Deposit Insurer Galo CevallosSenior Internationl Advisor, International AffairsFederal Deposit Insurance Corporation Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

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

3. FDIC: Challenges and ExperienceOverview of Banking and Regulatory System Overview of U.S. Banking System • 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 Large, diverse and complex Well Regulated • Four Federal and 50 State supervisors Financially Sound • ROA: 1.21%; ROE: 11.58%; NIM: 3.20%; Equity/TA: 10.52% • Data as of December 31, 2006 Key Functions of the FDIC • Deposit insurance reform; revised risk-related premium system; US $50.1 billion in deposit insurance fund Deposit Insurance • Primary federal supervisor for 5,220 banks; examined every 12 – 18 months; 7,400 risk management and specialty exams conducted in 2006 Bank Supervision • February 2007 - First bank failure in almost three years; claims modernization project; large bank failure contingency planning Resolutions and Receiverships Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

4. In the aftermath of the US Savings and Loan Crisis – several weaknesses came to light Moral Hazard Resulted in $153 billion cost to the deposit insurer and tax payers. Regulatory Forbearance FDIC: Challenges and ExperienceReducing the Cost of Bank Failures Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

5. FDIC: Challenges and ExperienceReducing the Cost of Bank Failures 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. 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. Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

6. FDIC: Challenges and ExperienceReducing the Cost of Bank Failures Practices that Minimize Losses 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. Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

7. FDIC: Challenges and ExperienceReducing the Cost of Bank Failures Minimizing Cost of Bank Failures The Least-Cost Requirement The least cost testrequires 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. • 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. Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

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

9. FDIC: Challenges and ExperienceDesign Improvements • 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 TwoLaw 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. Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

10. FDIC: Challenges and ExperienceDesign Improvements Improved Fund Managment Insured Deposit Growth Outpaced Fund Growth Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

11. FDIC: Challenges and ExperienceDesign Improvements Improved Fund Managment Fund Ratio Declined Steadily Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

12. FDIC: Challenges and ExperienceDesign Improvements Improved Fund Managment Twin Problems with Funding Design 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. Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

13. Improved Risk Pricing All Banks Should Pay Something FDIC: Challenges and ExperienceDesign Improvements Rates paid by banks once fund was restored Rates paid by all banks while fund was being revitalized Rates paid today by all institutions Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

14. FDIC: Challenges and ExperienceDesign Improvements 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. Improved Risk Pricing All Banks Should Pay Something Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

15. Preserving the Value of Deposit Insurance Protection Protecting Retirees and Keeping Up with Inflation FDIC: Challenges and ExperienceDesign Improvements Retirement accounts are now protected to $250,000. Coverage for all other accounts may be indexed to inflation to preserve the value of protection. Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

16. Risk Assessments An interagency effort Total Banks and Thrifts 8,662 11.9 Trillion Total FDIC-Supervised 5,228 2.2 Trillion Total OCC-Supervised 1,705 6.8 Trillion Total FRB –Supervised 892 1.4 Trillion Total OTS – Supervised 837 1.5 Trillion Division of labor without duplication Examination Sharing Arrangements As insurer, FDIC has access to examination records produced by other federal and state banking agencies • Critical for deposit insurance pricing Examination ratings and capital positions determined by agencies are used to price deposit insurance premiums and gauge adequacy of deposit insurance fund. FDIC: Challenges and ExperienceEnsuring Effective Coordination Interagency Cooperation, Coordination, Communication Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

17. Coordination with State Banking Authorities via Conference of State Bank Supervisors • Interagency • Training and • Policy • Development • Coordination with functional regulators • Shared National Credit Program • Interagency approach to combating money laundering and terrorist financing • Interagency • macro-risk • assessments to identify risks to the deposit insurance fund • FDIC Exam Back-Up authority encourages much collaboration • Central Data Repository: reduces burden and makes regulatory reporting efficient • Formal • and • Informal • Interagency • Information • Sharing • Arrangements • Coordinated supervision of Foreign Banking Organizations • Interagency Country Exposure Review Committee • Large Bank Supervision and Dedicated Examiner Programs FDIC – Experience and Practical Considerations Interagency Cooperation, Coordination, Communication Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007

18. Promoting Uniform Standards: The Important Role ofThe 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 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American RegionSan Salvador, El Salvador - August 2007