On February 7, 2011, the Federal Deposit Insurance Corporation (FDIC) issued a final rule regarding the risk-based deposit insurance assessment system that better reflects the risks to the Deposit Insurance Fund (DIF). Under the final rule, the FDIC redefines the assessment base as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). In addition, the final rule adopts a separate risk-based assessment system for large insured depository institutions (institutions with greater than $10 billion in assets). The final rule applies to all insured depository institutions and is effective on April 1, 2011.

In the aggregate, the FDIC expects to raise the same amount of revenue under the new assessment system as the current assessment system, however, it will increase the share of assessments paid by large institutions. Based on initial calculations, the overall assessments paid by large institutions will increase from 70 percent to approximately 79 percent of the aggregate assessment. As a result, most institutions will pay a lesser amount in assessments than what they currently pay.

Assessment Base and Assessment Rate Adjustments

Under Dodd-Frank the assessment base of an institution is determined by calculating the average consolidated total assets minus the average tangible equity. Prior to the effective date, the FDIC will continue to calculate the assessment base from adjusted domestic deposits and incorporate three adjustments into its risk-based pricing system. As a result of the changes to the assessment base, the FDIC will charge assessments on secured liabilities. In addition, the final rule adds the depository institution debt adjustment (DIDA) for long-term debt held by an insured depository institution where the debt is issued by another insured depository institution. All of the adjustments will be scaled to the new assessment base.

The FDIC preserved the incentive to issue long-term unsecured debt and the brokered deposit adjustment. According to the preamble, greater amounts of long-term unsecured debt can reduce the FDIC’s loss in the event of a failure. However, the cap on the adjustment for unsecured debt changed from the current 5 basis points to the lesser of 5 basis points or 50 percent of the institution’s initial base assessment rate. Although the final rule retained the brokered deposit adjustment, an institution that is well-capitalized and has a composite CAMELS rating of 1 or 2 is exempt from the surcharge. The brokered deposit adjustment is capped at 10 basis points.

The DIDA is meant to offset the benefit received by institutions that issue long-term unsecured liabilities when those liabilities are held by other institutions. The final rule increases the assessment rate of an institution that holds this debt because when the debt is held by another institution the overall risk to the DIF is not reduced by much. The DIDA should discourage institutions from holding excessive amounts of another insured depository institutions’ debt.

Dividends and Assessment Rates

The final rule suspends the FDIC from declaring dividends when the reserve ratio of the DIF exceeds 1.5 percent, and instead adopts progressively lower assessment rates for when the reserve ratio exceeds 1.5, 2, and 2.5 percent. The lower assessment rates will serve the same function as dividends by preventing the DIF from growing unnecessarily, but it also provides a more stable and predictable assessment rate schedule for institutions.

Currently, all institutions are assessed based primarily on their risk category, which is based on the institution’s ratings, capital levels, supervisory evaluations, and certain other factors. The applicable initial base assessment rates range from 12 to 45 basis points, and total base assessment rates can range from 7 to 77.5 basis points after adjustments.

Due to the expanded assessment base the new assessment rates are actually lower than the current rates. The new initial base assessment rates will range from 5 to 35 basis points, and total base assessment rates will range from 2.5 to 45 basis points after adjustments. The same range of assessment rates will apply to large and highly complex institutions, however, those institutions will not be assigned by risk categories. The FDIC believes that the changes to the assessment rates will not change the overall amount of assessment revenue that it would have otherwise collected under the Restoration Plan.[1] The new rates will affect the earnings and capital of individual institutions, with the majority of institutions paying assessments at least 5 percent lower than those currently.

The FDIC has the authority to adopt actual rates higher or lower than the total base assessment rates but it cannot increase or decrease the assessment rate schedule from one quarter to the next by more than 2 basis points and the cumulative increases and decreases cannot be more than 2 basis points higher or lower than the total base assessment rates.

Subsequently, when the reserve fund ratio meets or exceeds 1.15, 2, and 2.5 percent the initial and total base assessment rates will be adjusted downward. The initial base assessment rates will range from 3 to 30, 2 to 28, and 1 to 25 basis points, respectively. The total base assessment rates will range from 1.5 to 40, 1 to 38, and 0.5 to 35 basis points, respectively. The new assessment system adequately addresses the need to reduce the pro-cyclicality of the current system. Under the final rule, the FDIC will charge moderate assessments throughout the economic and credit cycles which enables it to maintain a larger reserve fund. Steady, predictable assessments will decrease the need to assess higher rates during times of economic downturn. The reserve ratio is unlikely to reach these levels for many years, but when it does the effect will be positive for all institutions.

The FDIC has updated its assessment calculators to help banks estimate insurance assessment rates and premiums for future quarters under the new assessment system - Future Assessment Calculator.

Assessment System for Large Insured Depository Institutions

The final rule incorporates many of the changes proposed by the FDIC as revisions to the assessment system for large institutions in April 2010; FDIC Proposes Revisions to Risk-Based Assessment System for Large Insured Depository Institutions and Adjustments to Assessment Range for All Insured Institutions. The assessment system for large institutions has been amended to better capture the risk at the time the institution assumes the risk, to differentiate risk during periods of good economic conditions and during periods of stress and downturns, and to better take into account the losses the FDIC may incur if a large institution fails. The FDIC has eliminated risk categories and the use of long-term debt issuer ratings for determining assessments for large institutions. Instead, assessment rates will be calculated using a scorecard, which includes CAMELS examination ratings and certain forward looking financial measures used to assess risk. One scorecard applies to large institutions and the other to highly complex institutions (institutions with greater than $50 billion in assets that are owned by a parent holding company with more than $500 billion in assets or a processing bank or trust company).

The scorecards use quantitative measures to predict the long-term performance of a large institution. Each scorecard produces two scores, a performance score and loss severity score that are combined and converted to an initial base assessment rate. The performance score measures a large institution’s financial performance and its ability to withstand stress. The performance score is based on the weighted average of: (i) the weighted average CAMELS rating score; (ii) the ability to withstand asset related stress score (e.g. weighted average of Tier 1 leverage ratio, concentration measure, the ratio of core earnings to average quarter-end total assets, and credit quality measure); and (iii) the ability to withstand funding-related stress score (e.g. core deposits to total liabilities ratio and a balance sheet liquidity ratio).

The loss severity score is a measure that estimates the relative magnitude of potential losses to the DIF in the event of a failure. The loss severity measure applies a standardized set of assumptions, based on recent failures, regarding liability runoffs and the recovery value asset categories to calculate possible losses to the DIF. All performance and loss severity scores will be calculated between 0 and 100.

Highly complex institutions have a slightly different scorecard. Those institutions are evaluated based on the same measures and components as large institutions, however, the performance score component regarding the ability to withstand funding-related stress contains an additional measure of average short-term funding to average total assets ratio. This measure is added because heavy reliance on short-term funding significantly increases a highly complex institution’s vulnerability to unexpected adverse developments in the funding market as seen in recent failures of large, complex institutions.

The FDIC has the discretion to adjust the total score, the sum of the performance and loss severity scores, of a large institution or highly complex institution by 15 points up or down based on significant risk factors not captured in the scorecards. Adjustments to the total score will have a greater effect on the assessment rate of those institutions with a higher total score since the assessment rate rises at an increasing rate as the total score rises. The FDIC will not apply adjustments until objective guidelines are proposed and commented on later this year. Notification will be made before an upward adjustment to an institution’s assessment rate takes effect, allowing the institution an opportunity to respond to the FDIC’s actions. The final rule does not affect the procedures and timetable for appealing assessment rates. Accordingly, an insured depository institution may challenge the FDIC assessment rate in writing within 90 days of the date the assessment rate being challenged appears on the institution’s quarterly invoice, along with sufficient documentation to support the change sought by the institution. An institution will be notified in writing of the FDIC’s determination, and whether further appeal to the Assessment Appeals Committee will be required.