The FDIC and the Banking Industry:
Perspective and Outlook

Introduction
Congress created the FDIC in the Banking Act of 1933 to maintain stability and public confidence in the nation’s banking system. The statute provided a Federal government guarantee of deposits in U.S. depository institutions so that depositors’ funds, within certain limits, would be safe and available to them in the event of a financial institution failure. In addition to its role as insurer, the FDIC is the primary federal regulator of Federally-insured state-chartered banks that are not members of the Federal Reserve System.

The FDIC carries out its mission through three major programs: insurance, supervision, and receivership management.

• The Insurance Program encompasses the activities undertaken by the Corporation to administer the Deposit Insurance Fund (DIF), which is funded through assessments on insured institutions as well as investment income, and to provide depositors with access to their insured funds when an insured institution fails.

• The Supervision Program encompasses the activities undertaken by the Corporation to promote safe and sound operations and compliance with fair lending, consumer protection, and other applicable statutes and regulations by insured institutions for which the FDIC is the primary Federal regulator (in cooperation with state banking agencies). The FDIC also has back-up supervisory responsibility for other insured institutions for which the Board of Governors of the Federal Reserve System (FRB), the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS) are the primary Federal regulators.

• The Receivership Management Program encompasses activities undertaken by the Corporation in its capacity as receiver to resolve failed institutions in the least costly manner to the DIF and to maximize net recoveries to the creditors of receiverships.

Over the next six years, the FDIC will confront numerous issues and challenges in each of these major programs due to changing economic conditions, continuing changes in the nature of the financial services industry, expected changes in financial services regulation, and emerging consumer protection issues that impact the financial services industry. Some of the major issues and challenges are addressed in more detail below.

The Impact of the Economy
The performance of the economy at national and regional levels directly affects the business strategies of individual financial institutions and may affect the industry's overall performance. Lending and funding strategies of insured depository institutions are influenced by interest rates, inflation, unemployment, and changes in the business cycle for sectors such as agriculture, mortgage lending, commercial real estate, and energy.

Since mid-2007, a deep and prolonged housing market downturn in many areas of the U.S. has coincided with significant disruptions to credit markets to create a much more challenging operating environment for FDIC-insured institutions. The industry has experienced sharply higher credit losses in mortgage and construction lending and large write downs in other mortgage related assets. Institutions that were highly dependent on market-based sources of funding have had to adjust their business models. The historic scale and scope of these credit market disruptions implies that their effects will continue to be felt for some time to come.

In this more restrictive credit environment, U.S. economic activity slowed markedly in late 2007 and early 2008. Residential construction continued to weaken as nonprime mortgage credit became less available, and growth in consumer and business spending also slowed. Economic activity in the industrial Midwest continued to lag the nation, while regional economies in and around Florida and California showed significant adverse effects from the housing market distress. The U.S. economy as a whole lost payroll jobs in each of the first six months of 2008, and inflationary pressures rose as oil prices spiked to record highs. This poor U.S. economic performance has led policymakers to implement both monetary and fiscal stimulus measures that have helped prevent real economic activity from shrinking outright.

The economic and credit market stresses of the past year have shown that some depository institutions took on riskier activities during this decade in response to competitive pressures within the industry and with non-bank lenders. Many institutions that were actively involved in subprime and nontraditional mortgage lending, or the financing of residential construction projects, have already experienced significant losses in recent quarters, and some have failed. Institutions that have significant concentrations of certain other loan products, such as credit card loans or commercial real estate loans, also could find themselves more vulnerable to losses in the event of a more serious economic downturn. Many institutions, especially larger institutions, have also become more reliant on various forms of non-interest income, such as trading income and gains on asset sales, which can be more volatile than traditional revenue sources.

The combination of a downturn in U.S. economic performance, ongoing disruptions in credit markets and large increases in bank and thrift credit losses make for a cautious outlook for the financial performance of FDIC-insured institutions through 2009. These market disruptions could, in the longer term, work to the advantage of banks’ ability to access deposits since they are heavily regulated compared to non-bank service providers. However, it appears unlikely that the record industry earnings of recent years will soon be matched, and higher levels of both problem institutions and failed institutions can be expected. These uncertainties will ultimately be resolved over time with the recognition of losses, an improvement in credit practices, and the re-pricing of risk in the financial markets. In the meantime, there remains a potential for additional financial market disruptions which could result in further adverse consequences for FDIC-insured institutions. This situation highlights the need for both the Corporation and other regulators to identify and manage the risks posed by new and existing financial products.

Challenges Facing the FDIC
In addition to the challenges posed by the economy, the FDIC also expects to face challenges from other sources, including:

• Industry consolidation and the increasing concentration of industry assets in a small number of large, complex institutions for which the Corporation is not, for the most part, the primary Federal supervisor. Primary and back-up supervision of large complex financial institutions will require increasingly specialized examination staff capable of understanding complex financial instruments and assessing their risk. The potential for the failure of large complex financial institutions could require highly specialized resolution strategies.

• Increasing globalization and interdependence, which heighten the potential for financial and economic instability to transcend geographic boundaries.

• Implementation of the Basel Committee on Bank Supervision’s new international capital standards.

• The FDIC’s expanded and strengthened international leadership role as the result of its more active participation in the International Association of Deposit Insurers.

• A critical need for reform measures to provide more uniform and equal consumer and prudential standards between depository institutions and other financial institutions. However, as Congress considers reforms in the existing Federal financial regulatory structure, any changes must preserve key elements of the current regulatory structure that have made the FDIC a model for other countries. These include the FDIC’s status as an independent agency with its own governance structure and source of funding; its authority to address identified risks in the banking system through establishment of a risk-based premium system and its special examination authority for all insured institutions; and its role as a primary regulator for state-chartered institutions under a dual banking system. The FDIC will be prepared to take on new responsibilities, as necessary, that build on its strong record of accomplishments over the past 75 years.

• Continued progress on “culture change” initiatives, including development of an enhanced performance-based compensation system, will impact our ability to attract and retain a highly-skilled, engaged workforce.

The FDIC also expects to continue its tradition of strong consumer protection over the next six years, by:

• Maintaining a rigorous and responsive consumer protection supervisory program that both complements and informs the Corporation’s risk management supervision program regarding emerging risks.

• Advocating broader economic inclusion within the nation’s banking system through small-dollar loan programs, access to mortgage credit for low- and moderate-income borrowers, and products that promote wealth accumulation and other services responsive to the needs of underserved populations.

• Promoting consumer education on topics such as insurance coverage, identify theft, and privacy, as well as expanding the FDIC’s award winning Money Smart curriculum.