Treasury defends FDICIA bank reform.

When the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 was passed, many bankers denounced it as the epitome of regulatory burden, according to Richard Scott Carnell, assistant secretary of the treasury for financial institutions. However, Carnell told attendees at a conference on bank reform at the Brookings Institution, in Washington, D.C., that depository institutions have in fact prospered since FDICIA's enactment.

Commercial banks' return on assets had more than doubled since 1991, he said, and the return on equity rose to 14.4% in 1996 from 7.94% in 1991. He also said the percentage of commercial banks reporting net losses plummeted by two-thirds, while aggregate commercial bank net income rose to set new records from 1992 to 1995. "Not only has bank profitability increased but also failures and problem cases have fallen to a tiny fraction of prior levels."

The assistant secretary said the banking industry's prosperity also was due to favorable interest rates and the economic recovery of the last four years. The act was part of a process that began with the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 and included the tightening of bank supervision in 1989, 1990 and 1991. Nonetheless, Carnell said FDICIA differed from previous banking legislation because it consciously sought to change the incentives of the banks' owners, managers and regulators. "Specifically," said Carnell, "it sought to align those incentives more closely with the interests of the federal deposit insurance funds and the taxpayers." The pre-FDICIA environment encouraged "perverse incentives for owners and managers to take excessive risks and for regulators to forbear and overextend the federal safety net," he said. "FDICIA reforms helped create a better set of incentives, reduced the potential for moral hazard and helped regulators be more faithful agents of the taxpayers."

Carnell said he was confident the regulations under FDICIA would not pose risks the next time the financial system came under stress. He said the law took into account that future regulators would continue to strive for a balance between the costs and benefits of safety-and-soundness regulation. However, he said it was important the benefits of the law's key reforms were not squandered by a sense of complacency that could "leave depository institutions needlessly vulnerable to future stress."