New FDIC limits could hurt some banks

Bumping up deposit caps may be a psychological boost for consumers. But it could make it even tougher for some struggling banks.

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By David Ellis, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- Now that the Senate has passed a new version of the controversial bailout bill, consumers and businesses worried about what may happen to their bank deposits if more banks go under could breathe a little easier.

Embedded within the amended legislation was a provision to raise the limits on the amount of money that the Federal Deposit Insurance Corp. insures for bank accounts to $250,000 from $100,000.

Federal bank regulators, who first floated the idea to Congress late Tuesday, said that bumping up the insurance limits would help improve liquidity at banks across the country. It may also provide a much-needed dose of confidence for consumers who may be worried about the health of their bank.

"For most people it would make little factual difference, but it might still be comforting," said Mark J. Flannery, a professor of finance at the University of Florida's Warrington College of Business Administration.

In the last month alone, both consumers and investors have watched some of the biggest names in banking collapse under the weight of the credit crisis and market fear.

Last week, Washington Mutual folded after depositors began pulling their money out of the bank. The Seattle-based savings and loan was subsequently purchased by JPMorgan Chase (JPM, Fortune 500) for $1.9 billion after being seized by the FDIC.

And following rampant speculation about the fate of Wachovia (WB, Fortune 500), regulators were forced to step in to help broker a sale of the firm's banking assets to Citigroup (C, Fortune 500), which was announced Monday.

Devil in the details

If the bill passes in the House, the increase in deposit insurance limits will just be a temporary fix, which would expire in December 2009.

In addition, Congress approved new limits in 2005 that would peg deposit caps to inflation. But those changes are not due to go into effect until 2011.

What the banking industry is watching closely however, is whether or not they will be forced to pay higher premiums to support the fund the FDIC has to insure deposits.

The Senate's bill prevents the FDIC from charging banks more money to specifically cover the increase in the deposit limit. Instead, the FDIC will be able to borrow directly from the Treasury to meet any funding needs tied to the higher limits.

But banks have already been bracing for a hike in premiums following the number and magnitude of bank collapses the industry has experienced so far this year. WaMu was the 13th bank to fail this year.

That failure won't cost the FDIC anything because of the quick sale to JPMorgan Chase.

But the FDIC's takeover of the California-based mortgage lender IndyMac, which was seized in July, could be expensive. The FDIC has yet to finalize a sale for IndyMac.

A spokesman for the FDIC said the agency's board of directors is expected to approve an increase in premiums when they meet next Tuesday. The increase could help cover the approximately $4.5 trillion in deposits the agency currently insures.

Fears have surfaced in the industry that the increase in premiums will be larger than banks were hoping for. And this could further dry up their cushion of capital at a time when it is so precious.

"Banks pay [the FDIC premiums] right off their bottom line, so that would have an impact on their earnings," said Camden Fine, president and CEO of the Independent Community Bankers of America, which represents over 5,000 local and community banks.

Helps small banks more than big banks

There have also been some concerns about just how much the FDIC will need to cover more bank failures. In a story last week, Bloomberg News reported that the FDIC might have to raise $150 billion.

But the FDIC issued a sharp rebuke to that story. In a letter to Bloomberg News that was made public by the FDIC, a spokesperson for the agency wrote that "the insurance fund is in a strong financial position to weather a significant upsurge in bank failures."

The FDIC added that the proposed higher premiums on "poorly managed" banks should encourage these banks to take less risk.

Nonetheless, experts said that raising deposit caps for consumers won't correct many of the loan troubles that banks overall face as the housing market continues to falter.

Nor would it stop the wholesale depositors, like money market funds who go in search of the best returns at banks around the country, from pulling their money out of an institution when trouble looms.

Still, that's not to say that raising the limits won't help the industry. Arguably, small and community-level institutions stand to benefit the most.

Whereas regulators have stepped in to help orchestrate a rescue or an orderly collapse of large financial institutions such as WaMu or Wachovia to prevent broader fallout, that hasn't been the case with some of the smaller banks that failed.

That puts customers of community banks whose deposits surpass current limits squarely at risk, said Ray Soifer, chairman of Soifer Consulting, who formerly covered the commercial banking industry for Brown Brothers Harriman.

"The effect would be beneficial for deposits and banks that wind up being too small to benefit from a Wachovia-type takeover," said Soifer. To top of page

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