An opportune time for deposit insurance reform

In recent months, two proposals for reform of the federal insurance program protecting bank deposits have been advanced. One, advocated by Dick Kovacevich of Norwest Corp., is essentially a self insurance plan, while the other, developed by Tom Hoenig of the Federal Reserve Bank of Kansas City, would narrow the safety net by precluding protection of deposits at large, globally active banks significantly engaged in nontraditional activities. These proposals, along with the coinsurance scheme developed at this bank, offer a range of promising alternatives for restricting deposit insurance coverage and improving market discipline of banks.

Given the profitability and stability of the banking industry in recent years, this may seem an unlikely time for consideration of major reform of deposit insurance. But it is precisely these conditions that set the stage for reform, for it is in this favorable environment that dispassionate analysis of the advantages and disadvantages of various proposals can be assessed. After all, it would be ill-advised to consider, much less introduce, a new, and presumably narrower, deposit insurance plan in an environment of weak banks and fragile financial conditions.

Deposit insurance reform is a particularly timely, even urgent, public policy issue in view of regulatory and legislative proposals under serious consideration. The Comptroller is proposing to expand the range of activities in which banks may engage, the Federal Reserve is proposing to permit subsidiaries of holding companies to increase their commitment to the investment banking business, and some in Congress are thinking of even more sweeping reforms of the financial services industry. Other things equal, these proposals would surely extend the scope of the government safety net provided by deposit insurance and its concomitant taxpayer exposure. Further evidence of the timeliness of this important public policy issue was provided by Federal Reserve Board Chairman Greenspan's remarks at the annual convention of the American Bankers Association in October, where he reiterated his concern about the lack of market signals in banking that usually accompany excessive risk-taking.

Each of the three proposals mentioned previously relies on a somewhat different rationale to justify reform. Kovacevich is principally concerned about the regulation imposed on banks as a consequence of federal deposit insurance and other aspects of the safety net, arguing that such regulation is excessively costly to the banking industry and its customers. Hoenig, on the other hand, questions the ability of bank examiners to keep up with innovation in financial instruments and practices, suggesting that banks engaged in nontraditional activities in a major way pose an unacceptably large threat to the safety net. And finally, the Minneapolis Fed proposal, authored by John Boyd and Art Rolnick, emphasizes coinsurance to address the moral hazard problem and enhance market discipline of banks. Despite their differences, all lead to the conclusion that reform of deposit insurance is good public policy.

I think that this is an opportune time to see if a consensus about deposit insurance reform can be reached, at least within the banking community. To this end, I intend to form an advisory committee of Ninth District bankers to discuss, over the course of the next year, reform of deposit insurance.