WASHINGTON — The slowdown in failures has led the Federal Deposit Insurance Corp. to pull back on its budgeting.
On the same day it proposed new capital requirements for all institutions, the FDIC's board of directors approved a 2011 agency budget of $3.96 billion, a 0.7% drop from the previous year.
Though that is only a slight decline, agency officials described the move as an important step.
It represents a "transition point for the agency," said FDIC Vice Chairman Martin Gruenberg.
The spending proposal came as the board took steps to implement the "Collins Amendment," a Dodd-Frank Act provision crafted by Sen. Susan Collins, R-Maine, that establishes an industrywide capital floor as well as new market risk capital standards unveiled last year by the international Basel Committee on Banking Supervision.
The board also finalized a new target ratio of agency reserves to insured deposits — known as the designated reserve ratio — of 2%. The new ratio is well above the previous DRR of 1.25%, but will only serve as a long-term goal that would not be reached before 2027.
But the biggest surprise perhaps from the meeting was the proposed decrease — however small — in the budget. The FDIC had not seen any decline in expenditures since 2006, while spending has expanded tremendously over the past few years to handle the wave of failures.
Still, it was a minor decrease. Agency officials said high numbers of staff were needed to deal with supervisory issues, including a long problem-bank list currently at 860 institutions as well as implementing FDIC reforms resulting from Dodd-Frank.
But it was clear the agency sees positive signs ahead, at least for now. "The budget contemplates that there will be a lower number of failures" in 2011, while being "mindful of course that we have sufficient resources here to maintain readiness in case that's incorrect," Thomas Peddicord, a deputy director in the FDIC's division of finance, told the board.
He said while the number of problem banks is high, that number too is expected to decline.
"That trend appears to be leveling off and I think we would expect that in 2011 that we will reach the peak in terms of problem institutions," he said.
Overall, the FDIC proposed a net increase of 2.5% in staffing compared with 2010 spending — and 6.9% over the proposed budget last year — to a total of 9,252 in authorized personnel. The budget envisions a net drop of 133 positions for the division of resolutions and receiverships, largely because the agency is eliminating 215 resolution positions that had already gone vacant.
However, the agency was adding a net 314 positions for supervision.
"Clearly, the number of bank failures and closings has slowed down, and as it has slowed down we have actually left some of our positions vacant in DRR and legal, and we don't have any reason to believe that this isn't the peak of the number of failures," Peddicord said.
The budget drop was understated because spending has increased so dramatically since 2007, when expenditures were about $1.12 billion. Last year, the proposed budget rose 55% from 2009, to just under $4 billion.
But John Bowman, a board member and the acting director of the Office of Thrift Supervision, questioned whether the budget drop was justified in light of continued unemployment and asset-quality problems.
"The question is: Are we being a little premature?" said Bowman.
Officials responded that the budget projections are still cautious. "I'm actually optimistic that the actual budget will end up being somewhat lower than this, but we want to be prepared," said FDIC Chairman Sheila Bair.
The meeting was also notable for the agency's actions on capital requirements. Bair lauded the Collins provision, which she actively pushed for during the regulatory reform debate, saying it would "do more to strengthen the capital in the U.S. banking industry than any other section of Dodd-Frank."
The proposal will ensure that capital requirements applied to thousands of banks across the country would serve as a floor for the largest U.S. financial companies, she said.
"Large financial institutions need the capital strength to stand on their own without government assistance," Bair said. "The Collins Amendment appropriately ensures that large institutions operate with at least as much capital in proportionate terms as is required of thousands of Main Street banks nationwide."
The proposal would replace transition floors set in the advanced approaches rule under Basel II with permanent risk-based capital floors that are equal to the capital requirements computed using the agencies' general risk-based capital rules, according to the FDIC.
"The premise of the advanced approach was that the largest banks because of their sophisticated internal risk models and superior diversification simply did not need as much capital in relative terms as smaller banks," Bair said. "The crisis demonstrated the fallacy of this thinking."
While the board unanimously backed the measure, some expressed concerns about the burdens and costs of the requirement as well as others related to capital covered under Dodd-Frank, especially during periods of financial stress. "It is vital that capital requirements be as commensurate with risk as possible," Bowman said. "Hopefully with this proposal we move in that direction."
Additionally, the board agreed to release a second proposal that would amend the FDIC's risk-based capital rules for banks with significant exposure to market risk. The rule would require banks with significant trading activities to continue to use internal models and standard tranches to calculate minimum regulatory market risk requirements, helping to significantly raise these capital requirements. Additionally, it would revise the definition of covered positions in order to help reduce regulatory arbitrage between the market risk and capital risk frameworks, and more.
John Walsh, the acting comptroller of the currency, endorsed the proposal, saying it is an "important next step in addressing weakness in the current market risk framework as evidence of the large losses on trading book activities during the early stages of the financial crisis."
Observers said the proposal's impact could be large.
"Although blindingly technical, the U.S. proposal to rewrite the market risk rules will define U.S. financial markets," Karen Shaw Petrou, the managing partner at Federal Financial Analytics Inc. "Now that the biggest trading institutions are subject to bank capital requirements, a lot more equity will need to back whatever trading the 'Volcker Rule' still lets them do."