Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August Galo Cevallos Senior Internationl Advisor, International Affairs Federal Deposit Insurance Corporation International Association of Deposit Insurers 4 th Latin America Regional Committee Meeting Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region Challenges Faced by the FDIC as Deposit Insurer

2 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Challenges and Experiences Program Outline FDIC – 75 Years of Challenges and Experience Overview of US Banking and Regulatory Systems Key Challenges to FDIC as Deposit Insurer  Reducing the cost of failed banks  Improving the design of the deposit insurance system  I nsuring effective interagency coordination

3 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Overview of U.S. Banking System Key Functions of the FDIC Large, diverse and complex Well Regulated Financially Sound 8,861 insured institutions; US $11.8 Trillion in assets; US $4.2 Trillion in insured deposits; Median bank size US $140 million; largest bank – US $1.2 Trillion in assets Four Federal and 50 State supervisors ROA: 1.21%; ROE: 11.58%; NIM: 3.20%; Equity/TA: 10.52% Data as of December 31, 2006 Deposit Insurance Bank Supervision Resolutions and Receiverships Deposit insurance reform; revised risk-related premium system; US $50.1 billion in deposit insurance fund Primary federal supervisor for 5,220 banks; examined every 12 – 18 months; 7,400 risk management and specialty exams conducted in 2006 February First bank failure in almost three years; claims modernization project; large bank failure contingency planning FDIC: Challenges and Experience Overview of Banking and Regulatory System

4 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 FDIC: Challenges and Experience Reducing the Cost of Bank Failures In the aftermath of the US Savings and Loan Crisis – several weaknesses came to light Moral Hazard Resulted in $153 billion cost to the deposit insurer and tax payers. Regulatory Forbearance

5 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Addressing Moral Hazard and Regulatory Forbearance Prompt Corrective Action (PCA) is intended to minimize the cost of resolving bank failures and limit regulatory forbearance by requiring more timely closure of failing institutions and earlier intervention in problem banks. FDIC: Challenges and Experience Reducing the Cost of Bank Failures The Least-Cost approach compels the FDIC to use the least costly method to the deposit insurance fund when resolving a failing institution. Prior to 1991, the FDIC was not required to determine the least costly resolution and could pursue any resolution alternative, as long as it cost less than liquidating the institution.

6 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Prompt Corrective Action (PCA) PCA requires supervisory intervention at an early stage as indicated by a bank’s capital position. Supervisory actions escalate in proportion to the bank’s capital level. Some of these actions are mandatory, while others are discretionary. A key point is that supervisors are required to intervene while the bank has positive regulatory capital and is believed to have positive economic capital, which lessens the cost to the insurer. Practices that Minimize Losses FDIC: Challenges and Experience Reducing the Cost of Bank Failures

7 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Resolution method chosen must represent the least cost to the FDIC of all possible alternatives. FDIC must document its selection, which will be evaluated by the inspector general. An exception to the least-cost requirement may be made for systemically important banks. Minimizing Cost of Bank Failures The Least-Cost Requirement The least cost test requires the FDIC to perform cost-benefit analyses on all possible resolution alternatives, based on the best available information at the time, when deciding how to resolve a failed financial institution. Immediate Impact of Least Cost Requirement 1991 Pre FDICIA 1993 Post FDICIA Percent of closed banks where uninsured depositor lost money 17%88% FDIC: Challenges and Experience Reducing the Cost of Bank Failures

8 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 FDIC: Challenges and Experience Design Improvements A Commitment to Continuous Redesign A sign of an effective deposit insurance system is that it is continuously changing to account for its experiences and to keep up with a changing environment. The Federal Deposit Insurance Corporation Reform Act (February 2007) Principal Reform Features Included: Improved management of the fund Improved risk pricing Preserving the value of deposit insurance protection

9 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Problem OneLaw restricts the FDIC from charging premiums to most banks that are well capitalized and highly rated by bank supervisors as long as the Deposit Insurance Fund’s Designated Reserve Ratio is above 1.25 percent of insured deposits. **** 95 percent of banks do not pay for deposit insurance (9/30/2007); 1,100 newly established banks never made contributions to the deposit insurance fund (2005) Improved Fund Managment Twin Problems with Funding Design Problem TwoLaw requires the FDIC to assess premiums across-the-board at a rate of at least 23 basis points when the Designated Reserve Ratio falls below 1.25 percent; likely resulting in the industry paying high premiums when both banks and the economy can least afford it. FDIC: Challenges and Experience Design Improvements

10 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Improved Fund Managment Insured Deposit Growth Outpaced Fund Growth FDIC: Challenges and Experience Design Improvements

11 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Improved Fund Managment Fund Ratio Declined Steadily FDIC: Challenges and Experience Design Improvements

12 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Simple Yet Elegant Solution Congress gave the FDIC’s Board of Directors the authority to set the Designated Reserve Ratio between 1.15 and 1.50 percent. The FDIC is authorized to charge all institutions a risk-based premium regardless of the level of the designated reserve ratio. Improved Fund Managment Twin Problems with Funding Design FDIC: Challenges and Experience Design Improvements

13 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Improved Risk Pricing All Banks Should Pay Something FDIC: Challenges and Experience Design Improvements Assessment Rates Capital Group Supervisory Subgroup ABC Well Adequate Under Assessment Rates Capital Group Supervisory Subgroup ABC Well0317 Adequate31024 Under Assessment Rates - Today Capital Group Supervisory Subgroup ABC Well Adequate10 Under2843 Rates paid by all banks while fund was being revitalized Rates paid by banks once fund was restored Rates paid today by all institutions

14 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Improved Risk Pricing All Banks Should Pay Something FDIC: Challenges and Experience Design Improvements Assessment Rates - Today Capital Group Supervisory Subgroup ABC Well5 -7 (I) 28 (III) Adequate10 (II) Under28 (III)43 (IV) The Final Rule All banks pay premiums. To further refine banks in Group I, performance metrics and CAMELS component ratings will be considered. Consolidates nine risk categories into four categories to better align them with their respective historical failure and loss experience. Capital ratios and supervisory ratings continue to drive the risk matrix. FDIC Board of Directors may adjust rates +/-3 basis points with relative ease. Market risk indicators considered when determining rate paid by large banks.

15 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Retirement accounts are now protected to $250,000. Coverage for all other accounts may be indexed to inflation to preserve the value of protection. Preserving the Value of Deposit Insurance Protection Protecting Retirees and Keeping Up with Inflation FDIC: Challenges and Experience Design Improvements

16 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Risk Assessments An interagency effort Division of labor without duplication Examination Sharing Arrangements Critical for deposit insurance pricing Total Banks and Thrifts8, Trillion Total FDIC-Supervised5, Trillion Total OCC-Supervised1, Trillion Total FRB –Supervised Trillion Total OTS – Supervised Trillion As insurer, FDIC has access to examination records produced by other federal and state banking agencies Examination ratings and capital positions determined by agencies are used to price deposit insurance premiums and gauge adequacy of deposit insurance fund. Interagency Cooperation, Coordination, Communication FDIC: Challenges and Experience Ensuring Effective Coordination

17 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Interagency Cooperation, Coordination, Communication FDIC – Experience and Practical Considerations Interagency Training and Policy Development Formal and Informal Interagency Information Sharing Arrangements Interagency macro-risk assessments to identify risks to the deposit insurance fund Large Bank Supervisio n and Dedicated Examiner Programs Coordination with functional regulators Coordinated supervision of Foreign Banking Organizations Shared National Credit Program Interagenc y Country Exposure Review Committee Coordination with State Banking Authorities via Conference of State Bank Supervisors Central Data Repository: reduces burden and makes regulatory reporting efficient FDIC Exam Back-Up authority encourages much collaboration Interagency approach to combating money laundering and terrorist financing

18 Challenges and Recent Experiences of the Deposit Insurance Systems in the Latin American Region San Salvador, El Salvador - August 2007 Promoting Uniform Standards: The Important Role of The Federal Financial Institutions Examination Council The Federal Financial Institutions Examination Council (FFIEC) comprises Federal and State banking agencies, and credit union regulators. It promotes uniform principles, standards, and reporting:  The Financial Institution Rating System (CAMELS)  Definitions for classifying assets  Financial reports (Call Reports)  Examiner training