Deposit Insurance System

In addition to adding sections 38 and 39 to FDIA to address capital  inadequacy and safety and soundness problems at depository institutions,  FDICIA also required FDIC to establish a system—the deposit insurance  system—to assess the risk of federally insured depository institutions and  charge premiums to finance a deposit insurance fund meant to protect  depositors in the event of future bank and thrift failures. No bank or thrift failed from June 2004 through   January 2007. Regulators Used PCA Appropriately in Cases We Reviewed and Other Enforcement Actions Generally Preceded Declines in These Institutions’ PCA Capital Categories

For the sample of banks and thrifts we reviewed, we found that regulators  generally implemented PCA in accordance with section 38. For example,  when institutions failed to meet minimum capital requirements, regulators  required them to submit capital restoration plans or imposed restrictions  through PCA directives or other enforcement actions. In response, FDIC issued a notice informing the bank of  the restrictions applicable to critically undercapitalized institutions under  section 38. Regulators said that PCA was most effective when it was used to close or  require the sale or merger of institutions as a means of minimizing or  preventing losses to the insurance fund. Regulators Used Other Enforcement Actions to Address Deficiencies in Sampled Institutions Prior to Declines in Their PCA Capital Categories

Although PCA requires regulators to take regulatory action when an  institution fails to meet established minimum capital requirements, capital  is a lagging indicator and thus not necessarily a timely predictor of  problems at banks and thrifts. Regulators Have Made Limited and Targeted Use of the Noncapital Supervisory Actions Available under Sections 38 and 39

Under section 38 regulators have the ability to reclassify an institution’s  capital category and dismiss officers and directors from deteriorating  banks and thrifts. Under section 39, regulators can require institutions to  implement plans to address deficiencies in their compliance with  regulatory safety and soundness standards. Industry officials and academics to whom we spoke and  selected organizations that submitted comment letters to FDIC generally  supported the concept of the new system. The New System Links Risk and Premiums More Closely

To tie institutions’ insurance premiums more directly to the risk each  presents to the insurance fund, FDIC created a system that generally   (1) differentiates between large and small institutions, specifically  between institutions with current credit agency ratings and $10 billion or  more in assets and all other institutions; (2) for institutions without credit  agency ratings, forecasts the likelihood of a decline in financial health  (referred to throughout this report as the general method); (3) for  institutions with credit agency ratings, uses those ratings, plus potentially  other financial market information, to evaluate institutional risk (referred  to throughout this report as the large-institution method); and (4) requires  all institutions to pay premiums based on their individual risk. Appendix I: Objectives, Scope, and Methodology

The objectives of this report were to (1) describe trends in the financial  condition of banks and thrifts and federal regulators’ oversight of these  institutions since the passage of the Federal Deposit Insurance  Corporation Improvement Act of 1991 (FDICIA), (2) evaluate how federal  regulators used the capital or prompt corrective action (PCA) provisions  of FDICIA to resolve capital adequacy issues at the institutions they  regulate, (3) evaluate the extent to which federal regulators use the  noncapital provisions of FDICIA to identify and address weaknesses at the  institutions they regulate, and (4) describe the Federal Deposit Insurance  Corporation’s (FDIC) deposit insurance system and how recent changes to  the system affect the determination of depository institutions’ risk and  insurance premiums. To determine the extent to which federal regulators have used the  noncapital supervisory actions of sections 38 and 39 of FDIA to address  weaknesses at the institutions they regulate, we reviewed regulators’  policies and procedures related to sections 38(f)(2)(F) and 38(g)—the  provisions for dismissal of officers and directors and reclassification of a  capital category, respectively—and section 39, which gives regulators  authority to address safety and soundness deficiencies.
Why GAO Did This Study

The Federal Deposit Insurance Reform Conforming Amendments Act of 2005 required GAO to report on the federal banking regulators' administration of the prompt corrective action (PCA) program under section 38 of the Federal Deposit Insurance Act (FDIA). Congress created section 38 as well as section 39, which required regulators to prescribe safety and soundness standards related to noncapital criteria, to address weaknesses in regulatory oversight during the bank and thrift crisis of the 1980s that contributed to deposit insurance losses. The 2005 act also required GAO to report on changes to the Federal Deposit Insurance Corporation's (FDIC) deposit insurance system. This report (1) examines how regulators have used PCA to resolve capital adequacy issues at depository institutions, (2) assesses the extent to which regulators have used noncapital supervisory actions under sections 38 and 39, and (3) describes how recent changes to FDIC's deposit insurance system affect the determination of institutions' insurance premiums. GAO reviewed regulators' PCA procedures and actions taken on a sample of undercapitalized institutions. GAO also reviewed the final rule on changes to the insurance system and comments from industry and academic experts.

What GAO Found

In recent years, the financial condition of depository institutions generally has been strong, which has resulted in the regulators' infrequent use of PCA provisions to resolve capital adequacy issues of troubled institutions. Partly because they benefited from a strong economy in the last decade, banks and thrifts in undercapitalized and lower capital categories decreased from 1,235 in 1992, the year regulators implemented PCA, to 14 in 2005, and none failed from June 2004 through January 2007. For the banks and thrifts GAO reviewed, regulators generally implemented PCA in accordance with section 38. For example, regulators identified when institutions failed to meet minimum capital requirements, required them to implement capital restoration plans or corrective actions outlined in enforcement orders, and took steps to close or require the sale or merger of those institutions that were unable to recapitalize. Although regulators generally used PCA appropriately, capital is a lagging indicator and thus not necessarily a timely predictor of problems at banks and thrifts. In most cases GAO reviewed, regulators had responded to safety and soundness problems in advance of a bank or thrift's decline in required PCA capital levels. Under section 38 regulators can take noncapital supervisory actions to reclassify an institution's capital category or dismiss officers and directors from deteriorating institutions, and under section 39 regulators can require institutions to implement plans to address deficiencies in their compliance with regulatory safety and soundness standards. Regulators generally have made limited use of these authorities, in part because they have chosen other informal and formal actions to address problems at troubled institutions. According to the regulators, other tools, such as cease-and-desist orders, may provide more flexibility than those available under sections 38 and 39 because they are not tied to an institution's capital level and may allow them to address more complex or multiple deficiencies with one action. Regulators' discretion to choose how and when to address safety and soundness weaknesses is demonstrated by their limited use of section 38 and 39 provisions and more frequent use of other informal and formal actions. Recent changes to FDIC's deposit insurance system tie the premiums a bank or thrift pays into the insurance fund more directly to the estimated risk the institution poses to the fund. In the revised system, FDIC generally (1) differentiates between larger institutions with current credit agency ratings and $10 billion or more in assets and all other, smaller institutions and (2) requires all institutions to pay premiums based on their individual risk. Most bankers, industry groups, and academics GAO interviewed and many of the organizations and individuals that submitted comment letters to FDIC on the new system generally supported making the system more risk based, but also had some concerns about unintended effects. FDIC and the other federal banking regulators intend to monitor the new system for any adverse impacts.