FDIC Final Rule: Interest Rate Restrictions
On May 29, 2009 FDIC released a final rule “Interest Rate Restrictions on Insured Depository Institutions That Are Not Well Capitalized”, changing the way the FDIC administers its statutory restrictions on the deposit interest rates paid by banks that are less than well capitalized. The final rule contains a set of changes that redefine how the “national rate” is calculated, how the prevailing rate in any market is determined, and how exceptions may be handled. The stated purpose of the rule is to clarify interest rate restrictions for both depository institutions and examiners. We will examine the basics and end with our analysis of the rule’s impact.
The substantial changes included in this rule cover almost every aspect of deposit pricing for subject institutions. The Federal Deposit Insurance Act requires the FDIC to prevent banks that are less than well capitalized from soliciting deposits at interest rates that significantly exceed prevailing rates, as potentially an unsafe and unsound practice. According to FDIC Chairman Sheila Barr, “The subjectivity in our current rule is allowing some weak banks to drive up costs for the rest of the industry. Supervisors and banks need a simpler and more objective tool for achieving the statutory goal. This final rule fits the bill.”
The National Rate
The previous rule defined the “national rate” as a percentage (120% to 130%) of the current yield on similar maturity U. S. Treasury obligations. The new rule defines the “national rate”, for deposits of similar size and maturity, as a simple average of rates paid by all insured depository institutions and branches for which data are available. This rate is determined by, and published by, the FDIC.
The FDIC purposely chose not to automatically restrict banks to this “national rate”, but rather offers it as a clear “safe harbor” for both banks and examiners, while providing a means for banks to offer evidence that the prevailing rate in a particular market differs from the national rate. Barring evidence accepted by the FDIC, the presumption exists “that the prevailing rate or effective yield in the relevant market is the national rate.”
Significantly Exceeds
Both in the existing and new rule, the FDIC has provided that a rate of interest “significantly exceeds” another rate if the first rate exceeds the second rate by more than 75basis points.
Market Area
As noted above, the presumption is that the prevailing rate in the relevant market is the national rate. Evidence to rebut this presumption may be submitted to the FDIC. The FDIC’s goal seems to be diluting high deposit cost areas with the more stable national rate.
Other Topics
The final rule continues the basic interpolation methodology for determining yields on deposits with odd maturities. Also, the rule allows for banks to offer evidence that the rates on certain deposit products differ from the rates on other similar products. The FDIC provides an example focused on comparing NOW accounts with MMDAs. Importantly, the FDIC specifies that they will not consider distinctions between like products, such as various types of MMDAs, offered by one institution with other types of MMDAs offered by another institution in the same market. This seems to be taking direct aim at rewards accounts which might promise higher yields based upon special features or requirements.
Effective Date
The final rule will not become effective until January 1, 2010. The FDIC, however, has begun publishing national average rates, and has indicated that they will not object to the immediate use of these rates even though such use will not be mandatory at this time. These rates may be monitored on the FDIC’s web site at the following address.
http://www.fdic.gov/regulations/resources/rates/index.html
Final Thoughts
With this final rule, the FDIC continues down a path of working to restrict weaker institutions from harming stronger ones. When faced with substantial credit losses, insufficiently capitalized institutions have 2 poor choices before them. They may not attempt to implement any desperate strategies to replace lost capital, ultimately resulting in a liquidity crisis and a subsequent quick demise. Alternately, they may attempt to ride out the storm by aggressively bidding up the cost of deposits and die a slow death by credit loss, at least until they are prohibited from doing so, either by closure or market discipline. It is this second strategy which this final rule seeks to moderate. In a period of extremely low rates, it does not seem to us to be unreasonable to prevent these terminal institutions from damaging the net interest margin of their other healthier competitors.
Click here to view FDIC Final Rule as a PDF.