Upturn Made Plans for Early Intervention Irrelevant
One year after "prompt corrective action" regulations were written, it's hard to remember what everyone was so worked up about.
Back in September 1992, when regulators sat down to draw up the rules that curb the activities of weak banks, the Federal Deposit Insurance Corp. predicted that the regulations would impact 325 institutions, with $230 billion in assets.
Today, the FDIC says less than 1% of all banks holding about 0.7% of all bank assets fall into any of the three undercapitalized categories created by the rules.
Fearing a taxpayer bailout of the bank insurance fund, Congress would a way to hold down the costs of failed banks for FDIC. To catch bank problems sooner, lawmakers came up with "prompt corrective action" and included it in the FDIC Improvement Act of 1991.
The rules set up five categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Once a bank becomes undercapitalized -- that is, when it's capital falls below 8% risk-based capital and 4% leverage capital -- the regulators move in.
The more capital a bank loses, the more regulatory sanctions it faces. A bank becomes critically undercapitalized when its capital falls below 2%. At this point, the regulators have 90 days to seize the institution.
But record-breaking earnings due to low interest rates have padded banks' capital accounts so much that almost the entire industry is completely unaffected by "prompt corrective action."
"The rising water lifted all those boats that |prompt corrective action' was supposed to sink," says Karen Shaw, president of the Institute for Strategy Development.
Don Inscoe, an associate director in the FDIC's research division, says just 49 banks, with $9.2 billion in assets, are undercapitalized. Another 38 banks, with $15.4 billion in assets, are significantly undercapitalized. Finally, there are six banks, with $400 million in assets, tagged critically undercapitalized.
"When we put this in place the picture looked a lot different," Mr. Inscoe says. "The number of banks that are on the problem bank list is larger than all three undercapitalized categories combined."
Indeed. The FDIC's in-danger-of-failing list has 671 banks, with $377 billion in assets. Though these banks are adequately capitalized, Mr. Inscoe explains that supervisors have other worries about them.Improving FortunesCapital ratings of FDIC-insured banks Number Percent Assets Percent of banks of total (in billions) of totalWell capitalized 11,352 96.7% $3,341.2 89.92%Adequately 286 2.4 348.6 9.38capitalizedUndercapitalized 49 0.4 9.2 0.28Significantlyundercapitalized 38 0.3 15.4 0.41Criticallyundercapitalized 13 0.1 1.5 0.04Source FDIC