VIEWPOINT : End Favored Treatment for Mega-Banks : Small Institutions Subsidize Deposit Insurance Fund for Big Rivals

Until the rescue of Chicago’s Continental Illinois Bank in spring 1984, there was a myth abroad in the land that all bank failures could and should be treated the same.

Why not? After all, the law providing up to $100,000 in insurance protection to each depositor makes no distinction between banks based on size.

Now we know better. The truth is that big banks are treated differently from small ones. The tiny handful of mega-banks engaged in international endeavors enjoy particularly favored treatment.

Under current law, they pay insurance premiums only on their domestic deposits. Yet experience has shown that all their deposits, both foreign and domestic, as well as all their other assets, enjoy de facto 100% insurance.

Adding insult to injury, the smaller banks are in effect subsidizing the larger brothers, their most feared competitors.

Every time a bank fails, the cost to the Federal Deposit Insurance Corp. is paid by all participants in its insurance fund, and when a mega-bank is rescued, the hit to the fund can be very large.

The law provides for a standard premium of 1/12 of 1% on all domestic deposits. For more than 30 years before the 1980s, about half the premiums were refunded, a most welcome check that all bankers looked forward to receiving from the FDIC each year.

Then, with costly bank failures increasing, only a token refund was possible for 1984.

And in 1985, for the first time since the refund mechanism was established in 1950, there was no refund at all. A loss carryforward of $1.1 billion from 1985 virtually ensures that there will be no refund again for 1986.

With big banks continuing to fail in record numbers, I would hesitate to guess when refunds will be resumed.

The demise of the refund does not imply any substantial weakening of the FDIC fund itself.

The interest earned on its portfolio is exempt from the refund calculation, so despite the heavy outlays during the year, the fund grew to a record level of $17.9 billion at year-end 1985.

Fund Grew Steadily

The fund, which stood at just $3.7 billion when I first joined the FDIC board in 1968, has grown steadily each year without interruption and will continue to grow, despite signs that portend more and larger bank failures.

The extent of the small bank subsidy of the mega-banks came into clear focus for the first time with the rescue of Continental.

With domestic deposits of slightly more than $3 billion, Continental had paid only $6.5 million in insurance premiums in 1983 to protect those deposits.

Yet, when faced with an international banking panic certain to ensue with the failure of Continental, the FDIC protected the entire $69 billion structure of Continental--its foreign deposits as well as domestic, its uninsured deposits as well as the insured, its holding company, and all its non-book as well as book liabilities.

When the $1.3-billion reserve for losses on Continental was established as of year-end 1985, the insurance refund for all of the nation’s 15,000 banks was wiped out. By comparison, the reserve for all 120 failures in 1985 totaled just $500 million, about one-third of the single bank total for Continental.

In contrast, scores of small banks can fail with minimal cost to the FDIC fund. By comparison, the small banks have relatively few deposits and relatively few assets to dispose of, and the loss to the fund is relatively insignificant.

Clearly, since mega-banks are not going to be allowed to fail, they should be charged insurance on all their deposits, not just the domestic ones.

In 1984, the 10 banks engaged most heavily in foreign transactions had just as many foreign deposits as domestic ones; thus they paid just half of the insurance premium that, in fairness, they should have been assessed.

The disparity is not limited to the big-small bank comparisons. Even the giants are not treated equally. In 1984, Citibank, the largest in the nation, paid only $18.5 million in FDIC premiums; Bank of America, slightly smaller, paid $40 million. The reason: Citibank was much more heavily involved with foreign deposits.

It would take a simple sentence in the pending banking legislation to correct these gross inequities. Just change the language to say that FDIC premiums are to be paid on “all deposits,” not “domestic deposits” as the current law reads.

If this were done, the premium rate for all banks could be reduced. The big banks would pay more; the small banks less; the FDIC income would remain the same.

The chance for such a reform being enacted this year is remote, but it could very well come in the future. The big banks have the muscle to stop it now, but they could not resist a groundswell from around the nation calling for equity.

Members Preoccupied

Congress has not focused on the issue and its members will be preoccupied in coming weeks, primarily with getting reelected, but also on addressing the Gramm-Rudman tangle, sanctions on South Africa, the entire appropriation process, the budget resolution, extension of the debt limit, the failed farm policies, and other issues that will leave no time for real banking law overhaul.

But the problem must be addressed. Continental was not an aberration. The FDIC earlier had declared Detroit’s Bank of Commonwealth and Philadelphia’s First Pennsylvania Bank as essential and rescued them.

Sales were arranged to keep open New York’s Franklin National Bank and San Diego’s U.S. National Bank, albeit with new owners.

Big banks are not allowed to close their doors. Some device is always found to protect all their depositors and creditors.

These rescue decisions are made by the FDIC board. If two of the three board members agree on a course of action, that’s it.

As a practical matter, the decisions are collegial--the Federal Reserve and the Treasury Department are consulted and in many instances--but not always--their input is decisive.

Record Pace for Failures

The process of saving big banks continues unabated in 1986. So far this year we have had 100 bank failures, a rate that seems destined to top the all-time record of 120 in 1985. And the 1986 failures have been unusually expensive.

In July, the FDIC had to pay a $73.3-million fee just to get someone to take over the failed $1.5-billion First National Bank & Trust Co. of Oklahoma City. The ultimate loss on this transaction could approach $600 million as the FDIC disposes of the bank’s questionable assets.

A few weeks later, the FDIC board approved in principle the investment of $130 million in Oklahoma City-based Bank of Oklahoma to keep it operating.

Other losses in the Energy Belt have been increasingly costly, and the failure pattern is spreading across the land. The FDIC problem bank list exceeds 1,300, and is growing.

With large sections of the nation’s economy in a shambles, bank failures are destined to continue. Since it is clear that no big bank is to be allowed to fail outright, it is time to charge them appropriately for the insurance protection they already enjoy.