UPDATE 2-FDIC sees lower bank failure cost, cancels fee bump

* FDIC seeing lower losses than expected from failures

* Says foregoing Jan. 1, 2011, fee increase for banks

* Proposes new assessment, dividend rules for future (Adds details on proposals, comments from Bair, Chessen)

By Karey Wutkowski

WASHINGTON, Oct 19 (Reuters) - U.S. bank regulators revised down the estimated cost of bank failures and proposed rules for how to restore the depleted insurance fund that backs bank deposits.

The Federal Deposit Insurance Corp said on Tuesday it is now estimating that bank failures will cost the Deposit Insurance Fund $52 billion from 2010 through 2014, compared with a prior estimate of $60 billion.

It attributed the downward revision to lower losses than it had expected in 2010.

Because of that lowered cost estimate and because the Dodd-Frank reform legislation laid out new rules for the insurance fund, the FDIC voted to forego a 3-basis-point increase in bank fees that had been scheduled to go into effect on Jan. 1, 2011.

That translates into about $2.5 billion savings for the bank industry, said Jim Chessen, chief economist at the American Bankers Association.

Chessen said that the fee reprieve is especially helpful while the economy is still weak and said it frees up money that banks can use to lend.

The Deposit Insurance Fund, financed by banks that pay into the fund, guarantees individual accounts up to $250,000. It is used to cover the cost of bank failures, which have surged during the financial crisis and are expected to peak this quarter.

So far this year, 132 banks have failed, compared with 140 last year and 25 in 2008.

During this recent financial crisis, the fund turned negative when the cost of bank failures outpaced the fees banks were paying into the fund.

To shore up the FDIC's resources, the agency late last year asked banks to prepay three years of assessments, to give the FDIC plenty of cash on hand, but the banks did not have to recognize the cost on their own books until payments would have regularly been due.

By the same token, the fund is not able to recognize the cash infusion, and remains at a negative balance.

As of the end of the second quarter this year, the insurance fund had a negative balance of $15.2 billion.

NEW FEE APPROACH

The FDIC also proposed new rules for bank fees in the future that will be used to replenish the insurance fund.

The agency laid out a new approach in which it would not pay out dividends to banks once the insurance fund reaches a target. Instead, the FDIC proposed that it charge lower fees once the insurance fund reaches certain targets.

The FDIC said the new approach will make fees more predictable and will preserve a cushion in the fund.

"Our action now will establish standards for sound fund management for a long time to come and better position the FDIC to resist future calls to reduce assessment rates or pay large dividends at the expense of prudent fund management," FDIC Chairman Sheila Bair said.

The agency also proposed setting a much higher long-term target for the minimum level of the fund.

The new goal is a 2 percent reserve ratio. The insurance fund's reserve ratio measures its balance versus the amount of insured deposits. Previously, the target was 1.25 percent.

Chessen from the ABA said he hopes the FDIC looks at that 2 percent figure as a target, so that banks do not have to continue paying large fees to grow it beyond that amount.

"The FDIC now has an unlimited ability to grow the fund as large as they want," he said. "I think that's going to be the real debate in the future, is how big of a fund do you really need to protect against these kind of cyclical bank failures."

The FDIC proposal will be out for public comment for 30 days.

The agency plans to tackle other insurance fund reforms later this year, including switching the basis of banks' fee levels to assets from domestic deposits.

The switch will shift the fee burden to large banks, because they often have a more diverse asset pool. Small banks' assets are largely composed of customer deposits. (Reporting by Karey Wutkowski, editing by Maureen Bavdek and Matthew Lewis)