Hey Sheila, Ditch the Interest Rate Cap

Al Capone once said, “Vote early and vote often.”

I urge BankInnovation.net members to do the same (well, not the “vote often” part) and tell the Federal Deposit Insurance Corp. not to adopt a new interest-rate cap and other restrictions on under-capitalized banks. In fact, the FDIC should strike the current version of section 337.6 of the FDIC’s regulations (12 C.F.R. § 337.6) altogether. File it under: “Dumb Banking Rules.”

At a board meeting on Tuesday, the FDIC proposed new deposit interest-rate caps for under-capitalized banks. Should the rules go into effect, such banks would not be allowed to pay more than 75 basis above an FDIC-set “National Rate” on deposits acquired through a broker.

This rule change is being proposed because Treasury rates, against which the previous cap was pegged, are so low that a troubled bank would effectively be unable to pay any deposit interest today, which was not the intent of the original statute. Instead, the FDIC would publish weekly “National Rates” every week against which the cap would be set.

My problem is not with the new formula — it is with the cap altogether. Before I explain why, we need to look at the reason for this cap. The FDIC explains the need as follows:

We note that the purpose of the interest rate restrictions is to prevent institutions that are less than well-capitalized from evading the prohibition against the acceptance of brokered deposits by offering high rates (with or without the assistance of a broker), and more generally to prevent such institutions from inappropriately exploiting the guarantee provided by federal deposit insurance.

So, it seems to me that the FDIC doesn’t want a bank in trouble to heap on new deposits, because that could end up costing the FDIC (and taxpayers) more in insurance claims should the institution fail. I get that. The only problem is that we are talking about a bank teetering on failure. The FDIC should not limit the teetering bank’s ability to raise deposits by capping the rate it can pay a deposit broker. That just hampers the bank’s ability to rescue itself from the brink.

Rather, the FDIC should cap the volume of deposits a flailing bank can put on its books. If a bank is, say, 20% under-capitalized, the FDIC should limit the bank’s new deposits to 20% above its current amount. This will prevent the bank from heaping on deposits recklessly, but still give it a chance to return to a state of “well-capitalized.” After all, does not the FDIC want the bank to become well-capitalized and not fail? If above-market-rate deposit interest rates save a bank from failure, all taxpayers should rejoice. That includes the folks working at the FDIC.

A caveat: I agree that at some interest rate, a troubled bank is simply digging a deeper hole for itself. What that exact rate is I am not sure, but surely it is not 75 basis points over the national average. The FDIC should let the free market, and not its regulatory code, save banks.

Click here for more information on the proposed interest-rate-cap rule.