Back in April 2011, Jim Bianco penned a commentary, “Why The Federal Reserve May Have A Hard Time Raising Rates.” He argued that the increase in the FDIC insurance assessment rate for large banks adds to bank funding costs, and thus offsets the impact of Fed ease. Bianco and others infer a roughly 15bp tax or “wedge” on money market assets is created by the FDIC assessment rule. By way of reference, the Fed’s target band for fed funds is 0 to 25bp but has been at low end of this range for months.
David Kotok of Cumberland Advisors subsequently wrote that the FDIC tax is offsetting the 25 bp paid to banks on Fed reserves and is effectively forcing U.S. banks out of the market. (See my paper published by Networks Financial Institute at ISU, “What is a Core Deposit and Why Does It Matter?”, which goes into the changes to the deposit insurance made by the Dodd-Frank legislation.)
Let’s agree with the central contention of the “Bianco-Kotok Hypothesis” (or BKH), namely that the new FDIC assessment is affecting the money markets. But is this change the most compelling explanation for the alarming exodus of banks from the institutional credit markets? Bianco’s research illustrates the collapse of yields in the securities repurchase (or repo) market since April, when the FDIC implemented the new deposit insurance assessment rules. He talks about the task the Fed faces to raise rates given the FDIC assessment:
“If the Federal Reserve attempts to overcome this FDIC fee by raising [interest earned on excess reserves] IOER from 025% to 0.75% or to 1.00%, will the market understand? More than likely such a move would be seen as an extreme tightening.” Indeed, but would we even be talking about the FDIC assessment if Fed funds were trading at 1%?
The new FDIC assessment regime does not raise much more money than the old rule, but the burden is now carried more proportionately by the big banks. This pound of flesh was extracted from Congress by the community bankers to win approval of Dodd-Frank. The other was a future “special assessment” by FDIC on the largest banks to push the insurance fund well above pre-crisis levels. Stay tuned on that count.