Future Challenges: Talking with the FDIC

Recently, I had the privilege of meeting with the chairman and top staff of the FDIC to talk about my views on some of the challenges ahead for the agency and the banking industry. It was a real pleasure for this former chairman to see his old friends at the agency, which is currently under the excellent chairmanship of Donna Tanoue.

My focus was on the challenges that face our country’s network of community banksu00e2u20ac”the element that is essential in maintaining our effective, decentralized financing system in this country. It has been my view that this systemu00e2u20ac”so different from those found in the rest of the worldu00e2u20ac”is one of the reasons the United States leads other countries in new business and productivity.

Here are the highlights of our freewheeling conversation about banks in the new millennium.

Margins. Statistics show that community banks’ margins and returns are decreasing at a time when larger banks are moving in the opposite direction. Some experts believe that slide will continueu00e2u20ac”reflecting the increased efficiency of large banks as they continue to merge and grow. Others believe the trend merely reflects the fact that community banks have not moved as rapidly as the “big boys” to fee-based income. In any event, the dwindling of margins and returns is not a development to make community bankers overly confident about the future.

The Internet. The speed of change in the business caused by Internet banking is a real threat to some community banks. Funding will go to the low-cost producers wherever they are located. Thus, deposit gathering on the Net is already redefining the concept of a “community” bank.

Deposit insurance. These changes also reemphasize the importance of deposit insurance to small banks. With adequate deposit insurance, small banks can benefit from the new technology: without it, community banks can’t compete effectively in a national market.

To prove my point: A couple of years ago, I suggested that because of this vital link between the amount of deposit insurance and small banks ongoing viability, the $100,000 protection ceiling should be increased. For this to actually happen, the government would have to recognize, as I do, that the deposit insurance system should be maintained not only to protect depositors, but also to help community banks survive in this new technological environment. Of course, the moral hazard of granting such an increase is a factor that would have to be weighed against the economics and social benefit to the system. Interestingly, if we pay off the national debt (an unlikely event, but one our president is predicting), then the insured bank deposits will be the only fully guaranteed U.S. debt in existence. Perhaps this too-rosy forecast will result in banks being inundated with fundsu00e2u20ac”but I wouldn’t count on it.

Funding. If the deposit insurance ceiling isn’t increased, small banks likely will look to increase their funding through the Federal Home Loan Bank system. H.R.10, the proposed bank modernization legislation, provides for a considerable increase in this areau00e2u20ac”probably the single best feature of the legislation for community banks. Here again, though, this type of funding raises even more difficult questions about the moral hazard of providing a clear government subsidy.

Technology. On the asset side, another subject of concern we discussed was credit-scoring technology. Particularly with Internet banking, its use increases the speed with which credit decisions are made today. And while all banks can use credit scoring, the question is, are larger banks better able to develop this technology to meets their specific credit needs more than smaller banks? Looked at in another way, will community banks be able to afford the technology and systems they need to remain competitive, when most small loans today are approved in a matter of hours, not days? Smaller banks’ capabilities here will also affect their ability to securitize loansu00e2u20ac”an area where, once again, large institutions clearly have the advantage.

During my conversation with Chairman Tanoue and her colleagues, we raised many other subjects of interest as we tried to peer into the future and foresee the challenges to the banking system, its regulators, and the FDIC insurance funds. Perhaps I’ll address those topics in another issue. In the meantime, as is true for all forecasters: He who lives by the crystal ball eventually will eat ground glass.”