With trillions of "cash" investments hanging in the balance, a battle has begun in Congress over extending unlimited FDIC insurance in noninterest bearing transaction accounts, with the Investment Company Institute (ICI) declaring opposition and the Independent Community Bankers of America (ICBA) arguing for an extension. Yesterday, the ICI commented in a section on "Unlimited Insurance for Noninterest-Bearing Transaction Accounts" in its "Written Testimony for House Hearing: The Impact of Dodd-Frank on Customers, Credit, and Job Creators." General Counsel and Executive Vice President of Legg Mason & Co. Thomas Lemke said, "In the Dodd-Frank Act, Congress granted circumscribed authority for the FDIC to provide unlimited deposit insurance only to specified accounts and only for a two-year period. Congress should reject calls to extend this program beyond its statutory expiration date, because the program has the potential to dislocate markets and increase systemic risk in times of market stress by creating an unlimited taxpayer-supported backstop for noninterest-bearing transaction accounts."
ICI's comments explain, "Section 343 of the Dodd-Frank Act requires the FDIC to provide unlimited insurance for "noninterest-bearing transaction accounts" for two years starting December 31, 2010. This provision is intended to give depositors of insured depository institutions, most notably corporations and other institutional investors, additional assurance that their balances in noninterest-bearing transaction accounts will be safe as the financial crisis wanes. As with any program that insures customer funds, however, the insurance coverage authorized by Section 343 poses potential costs to taxpayers and raises the risk of dislocations elsewhere in the financial system. Presumably in recognition of these potential costs and risks, Congress granted circumscribed authority, requiring the FDIC to provide unlimited insurance for only specified accounts, and for only a two-year period."
They continue, "We understand that some are calling for Congress to extend this unlimited insurance program beyond its statutory expiration date. ICI strongly opposes any such extension. We view the program as having the potential to dislocate markets and increase systemic risk in times of market stress by creating an unlimited taxpayer-supported backstop for these transaction accounts. To understand ICI's concerns, it is helpful first to understand the economic role of deposit insurance and how deposit insurance can influence the actions of banks and depositors, as well as investors in the broader markets. Banks have limited ability to liquidate assets quickly to meet large, unexpected withdrawals. Deposit insurance reduces the probability of bank runs by eliminating the potential advantage enjoyed by those depositors who are first to withdraw their money from a bank. Greater stability of bank deposits provides greater stability in the credit creation process and the overall economy."
ICI adds, "Despite its demonstrated benefits, however, deposit insurance also entails risks for the financial system. For example, insurance reduces the incentives for insured depositors to monitor the creditworthiness of banks, which in turn creates a moral hazard that can encourage banks to take additional risks, knowing that depositors will not withdraw their deposits if the bank's financial condition deteriorates. In addition, deposit insurance can cause other systemic risks for financial markets by increasing the propensity for investors to sell off assets -- such as stocks, bonds, mutual fund shares, and other securities -- and move the proceeds into insured deposits. As the FDIC has previously observed, this behavior can produce or exacerbate broader market dislocations during periods of financial stress."
Finally, the Insitute's comment says, "Indeed, recent experience suggests that such activity would worsen any future financial crisis and reduce credit available to businesses, state and local governments, and other borrowers. Depository institutions would be unlikely, and in many cases unable, to buy the assets investors were selling. Instead of risking a recurrence, every effort should be made to avoid such a series of events. Historically, the risks posed by deposit insurance programs have been mitigated by capping the amount of a depositor's account that is insured (currently $250,000). In the case of the insurance authorized by Section 343 of the Dodd-Frank Act, the statutory limits on the types of accounts covered and the December 31, 2012 termination date should serve to reduce the possible negative effects of the program. With the stability of the U.S. financial system at stake, the importance of these limits cannot be overemphasized. Congress therefore should resist any efforts to vitiate them."
The Independent Community Bankers of America recently wrote to Senators Reid and McConnell, "The undersigned bankers' banks, which serve more than 5,000 community banks nationwide, urge Congress to extend the FDIC's transaction account guarantee ("TAG") insurance well before its scheduled expiration at year-end 2012. We are deeply concerned about the impact on community bank liquidity and business lending should FDIC TAG insurance be allowed to lapse at year-end. In the current economic environment, an abrupt contraction in liquidity would pose an unacceptable risk to credit availability and the economic recovery. We ask that the Congress extend the FDIC TAG program at the earliest possible opportunity. Banks fully pay for this FDIC insurance coverage through their insurance premiums and no taxpayer money is used."
The ICBA letter continues, "TAG provides full insurance coverage for non-interest bearing transaction accounts used by businesses of all sizes, municipalities, hospitals and other non-profit entities for payroll and other recurring expenses. TAG was enacted during the financial and economic crisis to protect depositors and to prevent a sudden withdrawal of deposits that would dislocate the banking system. According to the latest FDIC figures, some $200 billion is deposited in community bank TAG accounts where it supports local loans to small businesses and consumers. The average community bank under $10 billion in assets has $23 million in TAG-insured deposits. A lapse in TAG would very likely shift these deposits out of community banks in favor of the largest banks. In fact, bank regulators are already instructing community banks to prepare written "contingency funding plans" to show how they would replace deposits in the event that TAG lapses. The FDIC apparently also believes that these funds will leave our community banks."