Capital Concerns

Most consumers understand that FDIC stands for “Federal Deposit Insurance Corporation.” Consumers appreciate knowing that deposits they place in a bank or thrift are insured up to $250,000. Unfortunately few consumers realize that all of the money paid into this insurance company comes from the banks and thrifts whose customers’ deposits are insured. In fact the entire operation of the FDIC is paid by those insured banks and thrifts. Not a single penny of taxpayer money goes into this fund or the operation of the FDIC.

Granted, during the savings and loan crisis of the late 1980s and early ’90s, the FDIC used the full faith and backing of the federal government to borrow money to pay for those losses, but the debt and interest was paid by the surviving banks and thrifts.

Banks and thrift managers today, however, often wonder if FDIC does not stand for “Forever Demanding Increased Capital.” Banks and thrifts, on average, have maintained about 8 percent capital. Lately that capital average has risen closer to 12 percent. On the surface, an increased capital level sounds ideal to most consumers. The more capital the bank has, the less likely it is to fail during an economic decline.

However there is a flip side to increased capital that most consumers do not understand. Capital is leveraged with customer deposits and used primarily to make loans. At 8 percent capital, a bank can make $12 worth of loans for every $1 of capital; however, at 12 percent capital, the bank can only make $8 of loans for every $1 of capital.

With today’s weak loan demand and high deposit levels, there is not much concern whether capital is at 8 percent or 12 percent. When the economy begins to improve, though, if regulators do not decrease their capital expectations, many loans that could help the economy in its recovery will not be made. Deposits will decrease and will be diverted into the stock market. At the very time that increased lending will be most needed, banks and thrifts will not be able to fund as many loans, due to the lack of deposits used to leverage capital into loans.

Let’s hope that regulators back off of this quest for more capital as the economy picks up. If not, I fear it will be a short recovery.

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