Should Bank Liability Structure Influence Deposit Insurance Pricing?

Abstract

In this paper, I discuss the influence of the banking industry's liability structure on the FDIC's risk exposure, the relationship between this exposure and the assessment base, and various ways that the FDIC could incorporate the effects of bank liability structure into its price for deposit insurance. For most of the industry, I find that the FDIC's risk exposure increases when banks move from domestic deposits to other funding sources because decreases in assessment income associated with a smaller assessment base are not offset by reductions in the FDIC's exposure to loss. However, this may not be the case for banks that rely heavily on unsecured credits due to the benefits of market discipline. I outline three ways to incorporate bank liability structure into the FDIC's pricing policy for deposit insurance: 1) change the assessment base; 2) adjust the pricing matrix; and 3) price directly for risk. I conclude that no such changes should be made in isolation. In particular, issues related to bank size must also be addressed because any change associated with liability structure would effectively shift the assessment burden towards larger banks. The FDIC's historical loss experience indicates that, in terms of cost per dollar of expected FDIC losses, large banks already pay considerably more for deposit insurance than small banks. Even though certain characteristics of very large banks may justify higher prices, the size of the current price differential across bank size, combined with the correlation between asset size and liability structure, means that a simple adjustment to the FDIC's pricing policy for bank liability structure would be unwise. Instead, a holistic approach is warranted, considering numerous factors simultaneously.