2. Insured Deposits
Since June of 1990, annual growth rate for BIF-insured deposits has been as high as 6.3 percent and as low as an annual shrinkage of 1.8 percent (Figure 1). After declining June of 1992 through June of 1994, insured deposits grew between 1.5 percent and 3.3 percent annually from June of 1995 to June of 1999. Insured deposits grew by 5.1 percent, 6.3 percent, and 4.6 percent for the twelve months ending June 30, 2000, June 30, 2001, and June 30, 2002, respectively. Such growth slowed to a rate of 2.0 percent for the twelve months ending June 30, 2003. Staff projects that insured deposits will grow at a rate of 3.5 percent for the twelve months ending June 30, 2004. The projected growth rate, which is below the five-year average growth rate of 4.2 percent, is consistent with the recent slowdown in insured deposit growth.

     Figure 1

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It takes approximately $20 billion in insured deposit growth to create a 1 basis point decline in the BIF reserve ratio, all other things held constant. Based upon the June 30, 2003, fund balance, it would take about $81.3 billion in insured deposit growth (3.2 percent) to reduce the reserve ratio to the DRR at June 30, 2004, all else being equal. Our preliminary estimate indicates that deposit growth over the next year will be greater than this figure. However, the net worth of the BIF is likely to grow and the ultimate level of the reserve ratio will depend on how fast the net worth of the fund grows relative to the growth of BIF-insured deposits.

Staff developed a statistical model that projects insured deposit growth based upon previous growth in insured deposits and previous and current growth in total deposits. After analyzing the results of this model, the best judgment of the staff is that BIF-insured deposits are likely to experience a growth rate in the range of +0.2 percent to +6.7 percent between June 2003 and June 2004. This range represents the statistical margin of error in the estimate provided by the model³. The staff believes the most likely scenario is that insured deposits will grow at the midpoint of this range (3.5 percent), which will bring the total for BIF insured deposits to $2.6 trillion. The model estimates future growth rates in insured deposits through historical growth rates in insured and total deposits and, as such, does not explicitly incorporate economic shocks into the model. However, some events that could force insured deposits into the high range of our forecast are a depressed stock market with high volatility as well as monetary expansion. Some events that could force insured deposits into the low range of our forecast are an upturn in the stock market and in the U.S. economy as a whole.

3. BIF Reserve Ratio
Based on the projected BIF balance and the growth of the insured deposit base, the best estimate of the BIF reserve ratio at June 30, 2004, is 1.27 percent (Table 4, next page). The best estimate assumes a baseline of a moderate reversal of loss provisions, stable or slightly increasing interest rates, and an insured deposit growth rate of 3.5 percent.

The staff projects the lower bound and upper bound of the likely range to be 1.16 percent and 1.35 percent, respectively (Table 4, next page). The lower bound, which reflects a 13 bp decrease from the June 30, 2003, ratio, assumes a strong increase in the insured deposit base (6.7 percent growth) and a higher interest rate scenario, resulting in a downward adjustment to the fund balance due to a reduction in the aggregate amount of unrealized gains on AFS securities (Table 3). The lower bound also incorporates the high loss estimate for insurance losses from possible near-term failures as projected by staff. The estimate reflects the staff's view of a reasonably possible adverse scenario. It is not intended to represent a "worst case" scenario.

The upper bound produces a 6 bp increase in the reserve ratio at June 30, 2004. This estimate assumes slower growth (0.2 percent) in the BIF-insured deposit base, the low loss estimate for the provision for losses, and lower interest rates, resulting in an upward adjustment to the aggregate amount of unrealized gains on AFS securities.

As indicated above, staff's best estimate of the reserve ratio for June 30, 2004 is slightly higher than the DRR, represents a 2 bp decline from the June 30, 2003 ratio and a 5 bp decline from the preliminary September 30, 2003 ratio. Although this appears inconsistent with recent history, where the ratio has increased for four straight quarters, staff believes several factors indicate that a decline in the reserve ratio between now and June 30, 2004 is most likely:

• Nearly one-half ($682 million) of comprehensive income in the first nine months of 2003 is represented by a reversal of the provisions for insurance losses due to reductions in estimated losses on prior failures and due to significant reductions in the contingent loss reserve. Although staff remains cautiously optimistic about the condition of the banking industry, it is not reasonable to expect such substantial reversal to the loss provisions to continue through next June.
• Interest rates have remained at very low levels throughout 2003, but staff believes rates are unlikely to decline further during the upcoming nine months. The BIF's unrealized gains on available-for-sale securities will be reduced even in a stable interest rate environment, because such unrealized gains disappear as securities move closer to their maturity dates. In a rising rate environment, reductions in unrealized gains would accelerate.
• BIF insured deposit growth was low through the first three quarters of 2003. Although staff does not believe that insured deposit growth will approach growth rates seen from 2000 through 2002, staff believes that growth closer to the five-year average rate is not unreasonable.

As a result of these factors, staff believes that a decline in the BIF reserve ratio is both reasonable and likely. However, given that the BIF reserve ratio is currently greater than 1.25 percent and that staff's best estimate of the ratio for June 30, 2004 is above 1.25, staff believes that it is reasonable to maintain the existing BIF rate schedule. Even if the BIF reserve ratio declines below the statutory DRR of 1.25 percent, the Board would have two semiannual assessment periods to bring the ratio back to the target.

Risk-Based Assessment System
Staff recommends retaining the current spread of 27 bp between the assessments paid by the best- and worst-rated institutions as well as the rate spreads between adjacent cells in the assessment rate matrix. The proposed assessment rate schedule appears in Table 5. The Board previously determined that the current rate spreads provide appropriate incentives for weaker institutions to improve their condition and for all institutions to avoid excessive risk-taking, consistent with the goals of risk-based assessments and existing statutory provisions. The current rate spreads also generally are consistent with the historical variation in bank failure rates across cells of the assessment rate matrix.

Table 5 Proposed Assessment Rate Schedule First Semiannual Assessment Period of 2005 BIF-Insured Institutions

Capital Group	A	B	C
1 Well	0 bp	3 bp	17 bp
2 Adequate	3 bp	10 bp	24 bp
3 Under	10 bp	24 bp	27 bp

In setting assessment rates to achieve and maintain the reserve ratio at the target DRR, the Board is required to consider the effects of assessments on members' earnings and capital. The estimated annual revenue from the existing rate schedule is $82 million, which is $5 million more than the annual amount that was projected six months ago. In recommending that the Board maintain this schedule, the staff has considered the impact on bank earnings and capital and found no unwarranted adverse effects.

The Assessment Base Distribution and Matrix Migration

Table 6 summarizes the current distribution of institutions across the assessment matrix.

Table 6 BIF Assessment Base Distribution (1) Assessable Deposits as of June 30, 2004 Supervisory Subgroup and Capital Groups in Effect July 1, 2004

Capital Group		A		B		C
1. Well	Number	7,413	91.70%	472	5.80%	87	1.10%
	Base ($billion)	3,927	96.20%	119	2.90%	20	0.50%
2. Adequate	Number	82	1.00%	9	0.10%	14	0.20%
	Base ($billion)	10	0.30%	1	0.00%	3	0.10%
3. Under	Number	0	0.00%	2	0.00%	1	0.00%
	Base ($billion)	0	0.00%	0	0.00%	0	0.00%
Estimated annual assessment revenue    $82 million Assessment Base                                     $4,081 billion Average annual assessment rate (bp)       0.20 basis points Notes: (1)     “Number” reflects the number of BIF members, including BIF-Oakar institutions; “Base” reflects all BIF-assessable deposits.

With 98.5 percent of the number of institutions and 99.4 percent of the assessment base in the three lowest assessment risk classifications of "1A," "1B," and "2A," as of July 1, 2003, the current distribution in the rate matrix reflects little fundamental difference from the previous semiannual assessment period. The current distribution reflects slight shrinkage in the best-rated premium category. Since the previous assessment period, 164 institutions migrated into the "1A" risk classification (Table 7), and 174 institutions migrated out of the "1A" risk classification. Only 667 institutions are classified outside of the best risk classification.

Table 7 BIF Migration To and From Assessment Risk Classification 1A

Institutions entering 1A	Number	Base ($billion)
Due to capital group reclassification only	75	11.9
Due to supervisory subgroup reclassification only	89	10.1
Due to both	0	0
Total	164	22

Institutions entering 1A	Number	Base ($billion)
Due to capital group reclassification only	49	6.1
Due to supervisory subgroup reclassification only	119	64.8
Due to both	6	1.5
Total	174	72.4
Notes: The table reflects BIF-insured institutions that moved in and out of assessment risk classification 1A from the first semiannual assessment period of 2003 to the second semiannual assessment period of 2003 The numbers only include institutions that were rated in both periods The table does not reflect other assessment risk classification migrations that are not either to or from “1A”

Overall, the supervisory subgroup component of the risk classification was upgraded since the previous period for 120 institutions with an assessment base of $12.9 billion and was downgraded for 149 institutions with an assessment base of $68.9 billion.

Other Issues
Refunds for second semiannual period of 2003. Since BIF-insured institutions classified as "1A" currently pay no assessments to the BIF under the proposed rate schedule they are ineligible to receive any refund for the First semiannual period of 2003.

FICO Assessment. The Funds Act separates the Financing Corporation (FICO) assessment from the FDIC assessment, so that the amount assessed on individual institutions by the FICO is in addition to the amount paid according to the BIF rate schedule. All institutions are assessed the same rate by FICO, as provided for in the Funds Act, and the FICO rate is updated quarterly. The FICO rate for the first quarterly payment in first semiannual assessment period of 2004 will be determined using September 30, 2003 Call Report and Thrift Financial Report data.

Staff Contacts
For information about deposit insurance assessments, please contact Christopher Newbury, Chief, Fund Analysis Section, Division of Insurance and Research, at (202) 898-3504, or Joe DiNuzzo, Counsel, Legal Division (202) 898-7349. For FICO assessment information, please contact Richard Jones, Chief, Deposit Insurance Pricing Section, Division of Insurance and Research, at (202) 898-6592.

Footnotes
¹ Although the current effective rate schedule is 0 to 27 basis points, the base rate schedule, established in 1995, is still 4 to 31 basis points. The FDIC may alter the existing rate structure and may change the base BIF rates by rulemaking with notice and comment. Without a notice-and-comment rulemaking, the Board has authority to increase or decrease the effective rate schedule uniformly up to a maximum of 5 basis points, as deemed necessary to maintain the target DRR.

² The Board reviews and weighs the following factors when establishing an assessment schedule: a) the probability and likely amount of loss to the fund posed by individual institutions; b) case resolution expenditures and income; c) expected operating expenses; d) the revenue needs of the fund; e) the effect of assessments on the earnings and capital of fund members; and f) any other factors that the Board may deem appropriate. These factors directly affect the reserve ratio prospectively and thus are considered as elements of the requirement to set rates to maintain the reserve ratio at the target DRR.

³ The model is a regression model where the current growth rate in insured deposits is estimated as a linear function of the previous growth rate in insured deposits as well as the current and previous growth rates of total (insured and uninsured) deposits. The range (+0.2%, +6.7%) corresponds to a 95% confidence level. In other words, we can be sure with 95% confidence that the actual growth rate in insured deposits, from June 2003 to June 2004, will lie within this range. The growth rate predicted by the model (thus, the most likely rate) is the midpoint of this range (3.5% annual growth).

Appendix - Interest Rate Assumptions
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