Score one for the small banks

Rep. Barney Frank is among legislators backing new policies to help community banks.

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NEW YORK (Fortune) -- Big banks aren't the only ones with powerful lobbyists that know how to pull strings in Washington.

A possible change in how banks pay for the federal deposit insurance fund shows that policymakers haven't forgotten about the 8,000 or so smaller financial institutions that dot the nation.

Indeed, it appears that for the first time, regulators are poised to make institutions deemed too big to fail start paying for that privilege.

The Federal Deposit Insurance Corp.'s board may vote Friday on a proposal that would change how much banks pay for deposit insurance, according to published reports. Under the proposed changes, the FDIC would assess insurance premiums based on a bank's assets, rather than on its domestic deposits, as is the case now.

The change would save millions of dollars for small banks, which depend on deposits to fund their lending. More important, it would mean big and small banks "are paying based on the risks they pose to the insurance fund," said James MacPhee, CEO of Michigan's Kalamazoo County State Bank.

The small bankers' lobbying group, the Independent Community Bankers Association, has been calling for such a shift for some time, arguing that too-big-to-fail institutions such as Citigroup (C, Fortune 500) aren't paying for the risk they pose to the stability of the system.

"The current deposit insurance premium assessment system places a disproportionate burden on community bank liquidity," the group said last December in a memo to President Obama's transition team.

The ICBA pointed out that some big banks have foreign deposits or other funding sources they can tap for lending in the U.S. - but that don't count against them in current insurance calculations.

If the FDIC decides to start calculating assessments based on broader asset bases, that could be a blow for big multinational banks like JPMorgan Chase (JPM, Fortune 500) and Bank of America (BAC, Fortune 500). BofA declined to comment, and JPMorgan didn't respond to a request for comment.

The proposal comes as regulators juggle the competing demands of big and small banks, and as the industry struggles with surging loan losses and a depleted deposit insurance fund.

The FDIC's board is scheduled to meet Friday afternoon as part of a meeting that will decide how much banks will have to pay this year to support the fund. The agency didn't respond to a request for comment.

The fund's balance dropped 64% last year to $19 billion, as 25 banks failed, including the costly collapse of California mortgage lender IndyMac. This year, with unemployment soaring and real estate prices in free fall, 33 more banks have failed.

But banks got good news on the assessment front Tuesday. Congress passed a bill that would more than triple the size of the FDIC's credit line with Treasury.

FDIC chief Sheila Bair has said passage of that legislation would allow the agency to cut the size of a special assessment it proposed in February in response to the steep decline of the deposit insurance fund balance.

At the time, the FDIC proposed socking banks with a one-time fee equivalent to 20 cents on every $100 of deposits. But banks rebelled, with smaller institutions saying the industry was being tarred by association with the big banks that got tens of billions of dollars in taxpayer funds last fall in the Troubled Asset Relief Program.

"We have been the common sense lenders, we have paid FDIC premiums for our deposits, and we have used solid underwriting practices," MacPhee wrote in a March 2 email to Bair that was posted on the FDIC's Web site. "For us to be asked to continue to pay for the sins of the TBTF banks is outrageous, and we request that you cancel this increased premium."

MacPhee said Wednesday that if the FDIC imposed the 20-basis-point premium as initially planned, it would wipe out half his bank's earnings for the year. Many smaller banks also faced the possibility of being further punished as they drew in new deposits from consumers seeking the security of a well-run bank.

The smallest banks aren't the only ones upset about the impact of higher FDIC fees. Iberiabank (IBKC), a Lafayette, La., lender that operates 150 branches and earlier this year was the first bank to repay its TARP borrowings, spelled out just how painful the increased fees would be during its first-quarter earnings conference call last month.

"As a point of reference, each one basis point increase in our assessment costs us about $400,000 on a pretax basis," Iberiabank vice president John Davis said. "While we may consider this a painful stomach virus, for some financial institutions it may potentially be a terminal illness."

Of course, the bigger banks will benefit from lower one-time assessments. JPMorgan Chase said this month in its first-quarter report with regulators that the one-time fee could set it back as much as $1.5 billion. That number stands to be lower once the special assessment is pared back.

Still, with bailout rage percolating, the small banks' argument seems to have hit home with policymakers who want to show their priority is supporting lending on Main Street.

"There's a pattern here of the larger institutions' failure imposing costs on the smaller," House Financial Services Chairman Barney Frank, D-Mass., said Tuesday. "It's our job to prevent that from happening."