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Federal deposit insurance reform beefs up coverage: Retirement savings accounts stand to benefit most

March 13, 2006

Federal deposit insurance reforms signed into law by President Bush last month boost coverage of some retirement accounts and will raise coverage for other bank accounts beginning in 2010.

The legislation, debated by lawmakers for the past six years, is significant because it offers the first increase in deposit insurance coverage in more than 25 years, and just the seventh rise since 1935.

Federal deposit insurance currently covers as much as $100,000 per depositor. Starting no later than November, depositors will receive as much as $250,000 in insurance coverage for retirement accounts. The law also allows the coverage limits for other types of deposit accounts to increase every five years starting in 2010, depending on inflation.

For workers saving for retirement, using bank accounts to stash large sums of money may become a more attractive option, said Kenneth Carow, chairman of the undergraduate program at Indiana University's Kelley School of Business in Indianapolis.

"This move makes a lot of sense," he said. "People need to be saving more than $100,000. This will allow them to consolidate their accounts and have confidence that the accounts will be guaranteed by the FDIC's government insurance."

Federal lawmakers created the FDIC, or Federal Deposit Insurance Corp., in 1933 in response to the panics of the early 1930s, when 9,000 banks-30 percent of the nation's total-went under.

In the rare event that a bank fails, the FDIC writes checks to every depositor up to the coverage limits. When deposits exceed those limits, any amount over the threshold can be lost.

The new $250,000 limit on retirement accounts is a reasonable adjustment, Carow said, considering $100,000 in 1980, when adjusted to inflation, would equal $303,000 today.

The American Bankers Association and the Independent Community Bankers of America both backed the legislation. The Washington, D.C.-based ABA is pushing the FDIC to establish the new rules affecting retirement accounts by April 15-the deadline to file taxes.

"People think about IRAs and additional contributions to retirement accounts right up to April 15," said James Chessen, the ABA's chief economist. "The FDIC has the ability to get that increase in place by April 15, if it chooses to do so."

The FDIC in 2010 and in five-year increments thereafter will analyze inflation rates for other deposits to determine whether coverage should increase. The first bump in coverage would take effect in 2011. Increases in coverage for retirement accounts would be indexed to the same inflation rate.

The new law will benefit banks by letting them compete more for retirement fund dollars. Money from deposits, in turn, drives lending.

"The increase in insurance coverage will help us market to, and attract, a growing number of retirement accounts," said David Lindsey, executive vice president of First Indiana Bank's consumer banking division. "It's not uncommon to see retirement accounts have a quarter-of-a-million dollars in them, or more."

The delay in bumping coverage for deposits besides retirement accounts is the result of a compromise among lawmakers who disagreed whether an increase should begin immediately.

Former Federal Reserve Chairman Alan Greenspan and U.S. Treasury Secretary John Snow opposed an earlier version of the legislation that would have immediately raised coverage to $130,000.

Much of the hesitancy to bump the amount can be traced to the savings and loans scandals of the mid-1980s, said David Barr, spokesman for the FDIC.

The increase in coverage from $40,000 to $100,000 in 1980 represented the largest jump since the FDIC's inception. But a dramatic rise in interest rates in the late 1970s and early 1980s triggered the collapse of the thrift deposit insurance program.

Savings and loans take short-term deposits and make long-term mortgage loans. Rising interest rates increased the cost of servicing deposits and cut revenue from outstanding mortgage loans. Losses from the interest-rate squeeze wiped out the industry's net worth and cost taxpayers more than $150 billion.

The law merges the FDIC's insurance funds for banks and thrifts-the Bank Insurance Fund and the Savings Association Insurance Fund-giving the agency more flexibility with the reserves kept in the fund.

Banks pay $1.25 for every $100 of insured deposits, Barr said. Ninety-four percent have not paid into the insurance fund since 1996, because the industry is in such solid financial standing. Banks will receive credits totaling $4.7 billion to offset premiums they paid that led to the fund's overcapitalization.

Thrifts, however, were in danger of having to pay into their fund. By merging the two, they avoid the expense.

The FDIC reported Feb. 28 that earnings from banks and thrifts set a fifth consecutive record in 2005, with help from higher net interest income and growth in noninterest income at the larger companies.

FDIC-insured banks and thrifts reported revenue of $134.2 billion last year, beating the record of $122.4 billion set in 2004.

The FDIC also reported that it set a record for the longest number of days in which it did not provide help to a failed or failing institution. The last failure occurred in June 2004.
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"Lending is picking up and interest rates [on deposits] remain relatively low," Barr said. "Consumers may not like it, but it's great for banks."
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