The Federal Deposit Insurance Corporation is trying to do its part to respond to the crisis. It has proposed to change how it charges large financial institutions for depository insurance. The FDIC wants additional measures of risk to dictate its assessments on institutions over $10 billion in size. That sounds sensible. But why limit the change to big banks?
Small Banks Can Take On Big Risk Too
Here's what the press release says will change:
Under the proposal, risk categories and long-term debt ratings would no longer be used. The FDIC would continue to use the supervisory ratings as a factor in measuring risk. The FDIC would replace the financial ratios currently used with a scorecard consisting of well-defined financial measures that are more forward looking and better suited for large institutions. The proposal also includes questions about how to incorporate other risk measures, like the quality of underwriting or risk management practices, in the future.
These changes make a lot of sense. Debt rating was an aspect of finance found to be deeply flawed during the financial crisis, both for bonds and firms. Regulator risk categories had some problems too. A broader set of variables used to evaluate riskiness would force more aggressive firms to pay more for their insurance. Think of it like auto insurance: aggressive drivers often end up paying higher premiums than cautious drivers. Since there are many ways by which a firm can engage in risky behavior, there should be a number of variables taken into account, as the FDIC indicates.