Among the troubled sectors of the American economy, banks have taken center stage.
As Treasury Secretary Timothy Geithner noted last month, one of the keys to avoiding a deeper recession is the making more credit available at lower interest rates. Banks, however, are shying away from providing credit, because of pressures on their balance sheets from assets whose market prices are uncertain or depressed. These toxic assets exist because banks were taking too many risks, but now banks are overcompensating by taking too few.
To make more capital available for lending, banks must be able to remove some of the toxic assets from their balance sheets. The most straightforward method of doing this, selling the assets, presents more difficulties than it solves. If these assets are sold at their depressed prices, banks will be forced to recognize the loss on their balance sheets, further denigrating their capital levels.
Recognizing this problem, the Financial Accounting Standards Board recently ratified proposals that will let banks avoid having their assets classified as "impaired," as long as they intend to hold on to the asset and state that it is more likely than not that they will. By keeping assets from being designated as impaired, the new rules will make it easier for banks to keep their capital above regulatory minimums.
However, the rules may also encourage banks to retain these toxic assets on their balance sheets, instead of finding ways to remove them, and keeping them could prove counterproductive to a recapitalization.
Even if they do try to sell their toxic assets, many banks are small enough that it would be difficult for them to attract a sufficient number of purchasers to establish a "best price" for these assets. And finding a purchaser still leaves the problem of the impact on the bank's capital. As a result, many banks are trapped in a situation where they cannot readily sell their depressed assets, and even if they could, the sale could do more harm than good to their balance sheets.
An answer to this Catch-22 is not a new idea, but a revival of a familiar one: bankers' banks.
First used in Minnesota in the 1970s, these state or federally chartered institutions lend money and provide services to other banks, rather than to the general public. The investor banks pool their resources to create funding, and they obtain resources that allow them to compete effectively with larger national or multinational banks.
Because they are limited to serving banks, bankers' banks are exempt from normal capital reserve requirements.
United Bankers' Bank, the first bankers' bank, has expanded since 1975 to serve 250 investor banks in seven states with almost $8 billion of combined assets. Currently, the largest bankers' bank is TIB-the Independent BankersBank in Irving, Texas, which is owned by 475 community banks and manages over $20 billion of assets.
Under federal regulations, bankers' banks have a great deal of flexibility. For example, they can do business with specifically designated nondepository institutions, and working with other institutions can be approved on a case-by-case basis by the Federal Reserve Board.
More importantly, the Office of the Comptroller of the Currency is authorized to waive any legal, regulatory, or organizational requirement that may impede the bank's ability to provide the desired services to its market.
This provides bankers' banks with an opportunity to relieve some of the pressure that toxic assets have put on bank balance sheets. Community banks could use these assets to make an investment in bankers' banks, transferring them in exchange for an ownership interest.
With an OCC waiver of regulatory accounting rules, the banks would not need to devalue the assets to a market price, but they would still be removed from the banks' balance sheets.
On the other side, the bankers' bank would be able to resolve, sell or securitize the troubled assets without worrying about falling below the capital reserve requirement, because it is exempt from that restriction.
The Federal Deposit Insurance Corp. recently asked for specific comments on how small banks might fare in its Legacy Loans Program — part of the Public-Private Investment Program — recognizing a potential imbalance among needy banks. The bankers' bank approach may help adjust any such imbalance.
Because of the potential variety of troubled assets that a bankers' bank could receive from investor banks, the bankers' bank would have a diverse portfolio that could better withstand the pressure of troubled assets.
Moreover, the bankers' bank could form a virtually tailor-made portfolio of assets it would acquire and handle. The recovered value of these troubled assets, minus the fees to cover expenses, would be returned to the investor banks.
By pooling investor banks' assets, the bankers' bank can more readily attract the attention of purchasers and funding sources. In addition, the bankers' banks would provide for more effective and economical management of the disposition or resolution of these assets, facilitate contracting for third-party experts and stimulate competition for the community banks with their larger, more powerful neighbors.
Because of the flexibility provided to the OCC, any current regulations that would stand in the way of this mechanism can be waived or adapted to fit the situation.
In addition, because bankers' banks do not provide services to the general public, they are not capital-intensive enterprises and are of little risk to the banking system in general or the Deposit Insurance Fund in particular.