PrefBlog

Sheila Bair of the FDIC made a speech today indicating willingness to move towards better risk assessment of banks:

So who should pay for an “anybody can fail” doctrine? Certainly not the taxpayer. As a tax-paying citizen, I don’t favor encouraging foolish behavior. Nor should those costs be borne by the Deposit Insurance Fund, which should continue to be used only for the costs of protecting depositors when banks fail.

A new resolution authority could include assessments on larger firms to fund a reserve that would be tapped to absorb losses for a failure. I believe it’s only fair that the industry that benefits should pay … just as banks pay for deposit insurance.

The assessments could be based on the differential in the cost of capital between smaller institutions — which clearly can fail and thus have higher costs — and their larger competitors. Moreover, we should not base this strictly on size, which might not be perfectly aligned with risk. For example, a large mutual fund that invests in the S&P 500 is not systemic. Risk-based surcharges should be imposed on higher risk behavior. This might include certain derivatives, market making or proprietary trading, and rapid growth. We now have such a risk-based system for the insurance premiums we charge for deposit insurance, and it’s working very well.

My problem with the ideas as stated is that they are not integrated with other elements of bank regulation – which, to be fair, she probably does not want to be seen as encroaching upon. I certainly supported graduated risk premia – we have such a thing in Canada, but it’s a joke: just about everybody qualifies for the lowest premium level. And I support the idea that bank capital requirements should include elements such as a surcharge for size – say, for instance, risk-weighted-assets in excess of $250-billion attract a 10% surcharge – and better differentiation between investment banking (which should penalize buy-and-hold behaviour) and regular banking (which should penalize trading).

However, the FDIC still charges premia based on all deposits, not just insured deposits, which is simply craziness – it reduces the incentive for banks to pay premium rates for non-insured deposits and leaves the FDIC with something of an obligation to make good on the uninsured deposits of a failed bank. Premium reform needs to start there.

These are the germs of good ideas, but to some extent are encroaching on the role of the Fed as US banking regulator. If reform efforts are not to degenerate into intra-regulator cat-fights, Ms. Bair will have to be very careful!

Another good solid day for prefs, with FixedResets slightly outperforming PerpetualDiscounts.

This entry was posted on Monday, April 27th, 2009 at 7:29 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.