366 Banks, S&Ls Could Be Shut By Policy Shift

Proposed legislation that would require regulators to close sick institutions faster - a practice known as early intervention - has the potential to affect 366 banks and thrifts with nearly $200 billion in combined assets.

According to data compiled for the American Banker by ADP BISG Data Services, New York, 133 banks with $39 billion in assets and 233 thrifts with another $157 billion in assets have less than the 2% equity capital. Regulators would have to close these banks within 30 days, according to a measure now before Congress.

Regulators would be forced to severely restrict the activities of another 1,066 banks and thrifts with $1.3 trillion in assets because they don't meet minimum capital standards, according to yearend data.

Key lawmakers are convinced that swifter action by regulators would reduce the cost of bank closings and decrease the likelihood of a future deposit insurance fund bailout. Senate Banking Committee Chairman Donald W. Riegle Jr., D-Mich., is one of the plan's most fervent proponents. Thus, it is nearly certain that early intervention will be a feature of any broad banking legislation adopted this year.

Delay Aggravates Losses

The flagging Federal Deposit Insurance Corp., whose reserve fund has shrunk 55% since 1987, has added urgency to the proposal.

Studies have shown that insurance fund losses escalate dramatically when federal regulators delay closing failed banks. Left open, the troubled institutions continue to rack up operating losses. Big depositors yank their uninsured funds, creating liquidity problems, and the franchise loses value as management sells off its best assets to raise cash.

The Sick Are Lingering Longer

There is little doubt that regulators are letting sick institutions stay open longer and, in the process, get much deeper in the red before they are finally seized. A recent study prepared for Congress found that in 1989 regulators let the worst-rated banks languish an average of two years and four months before closing them - up from an average of 15 months in 1980.

The FDIC's average cost of closing banks has increased sevenfold to 22% of assets from 3% in the early 1970s, according to the FDIC.

Regulators agree that the current system can be improved.

"I think we can save a lot of money - billions of dollars - if we can find ways to do things sooner," said Harrison Young, the FDIC's director of resolutions.

But Mr. Young noted that regulators lack the authority they need. Under current law the FDIC can yank a troubled bank's deposit insurance coverage, but it can do little more as long as the institution has capital.

"Regulators are in the position of a kindergarten teacher with a baseball bat," he said. "You can get the kids' attention, but you're very reluctant to use that baseball bat."

Reluctant? Or unwilling?

"They let institutions operate at a loss for years and years," said John D. Hawke, a former Fed general counsel and a partner with Arnold & Porter in Washington. "It's the bureaucracy. They don't deal with things until a crisis arises."

Hope for Recovery

Regulators counter that the decision to intervene early is not one they take lightly. They claim that many sick banks can be nursed back to health, and that once a bank is seized its franchise value declines 10% to 15% in the eyes of potential investors.

Federal Reserve Board Chairman Alan Greenspan said recently that "many institutions suffering a capital setback can be expected to recover."

Mr. Greenspan did not quantify his statement, but Fed staffers note that 20 of the country's largest 50 banks have battled back from capital deficiency and that almost 50% of the banks with ratings of 4 under the Camel system a year ago are at Camel 3 or better today. (Camel is the five-point regulatory rating formula based on a bank's capital, asset quality, management, earnings, and liquidity.)

Volcker Agrees

Paul Volcker, former Fed chairman, made a similar argument in congressional testimony recently.

"When you get to the point that you have a bad loan on the books, you are going to have to have time to work it out," he said. "My sense is that there are certain types of problems that time will heal."

But critics say the regulators have already given weak banks too much forbearance. They point to the saving bank industry, where the number of institutions on the FDIC's problem list doubled last year to 34. Overall, FDIC-insured savings banks lost a record $2.4 billion in 1990, more than three times their 1989 loss.

The legislation now before Congress would deny regulators the discretion they now have to grant forbearance to undercapitalized institutions.

First, dividend payments would be banned, then asset growth would be capped and subordinated debt payments halted. Once capital fell below a "critical level," defined as 1.5% in the House bill and 2% in the Senate bill, regulators would be required to seize the bank.

The regulators are fighting this part of the reform bill, insisting that such specific rules rob them of the flexibility they need to be effective. But the provision has gained plenty of support.

"A more forceful system of earlier intervention by bank regulators to prevent bank insolvencies is long overdue," Robert E. Litan, a scholar at the Brookings Institution, testified recently.

According to Mr. Litan's research, 40% to 61% of all banks with equity capital of less than 1.5% of assets are likely to fail. With capital at 3% to 6%, 38% of the banks fail. But for banks with more than 6% equity, only 1% to 2% fail, he said.

Oversight of Regulators

The Senate bill being sponsored by Sen. Riegle would require an investigation of the regulators by the agency's inspector general when a failure imposes a big loss on the insurance fund. This provision would become fully effective on Jan. 1, 1993.

"It is certainly time to make the regulatory authorities more accountable for their actions," James R. Barth, a former regulator who is now a professor at Auburn University, testified before Congress.

Frederick D. Wolf, a partner with Price Waterhouse in Washington, said regulators move fast enough once they discover trouble at a bank. The problem, according to Mr. Wolf, is that regulators take too long to realize a bank is sinking.

By the time they recognized the true plight of Bank of New England, he said, "there wasn't anything they could do. It was doomed. That bank was insolvent.

"You can put in mandatory requirements," he added. "But all of that presumes that you know which institutions have problems."

Judgment Calls

Some industry executives would rather live with regulatory discretion than by strict laws.

"Early intervention is OK, but it should be a judgment by the regulators," said Theodore H. Roberts, a former Federal Reserve Bank president who is chief executive of Talman Home Federal Savings and Loan Association, Chicago. "Congress tends to take a simplistic look at things.

"If 2% [capital] is good, why not 5%? Where in the world would that thing go?"

Karen D. Shaw, president of the Institute for Strategy Development, also questioned the wisdom of forcing government takeovers when a bank's capital falls below a certain level.

"I think we are compensating for a failure of will with an excess of law, which is cathartic but counterproductive," she said. "They lacked the will to do anything about what they saw. You can't really fix that by statute."

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