Various aspects of the failure of IndyMac will be examined closely in the coming months. In the near term, the failure of IndyMac and continued volatility among other banks provides immediate lessons to the financial services industry.
The prompt corrective action provisions of the Federal Deposit Insurance Act are an important tool enabling regulators to prevent a widespread repeat of the multiple bank failures of the 1980s and 1990s. However, satisfying PCA ratios does not mean a bank has sufficient capital to address customer demands, especially when a bank faces adverse publicity. IndyMac was unable to satisfy customer demands even though it was deemed well capitalized until early July. A well-capitalized bank can be in troubled condition, and it will be more common to see regulatory actions taken against these banks.
IndyMac and several other banks that failed this year held significant amounts of brokered deposits. Well-capitalized banks are under no restrictions on acceptance, renewal, or rollover of brokered deposits. Banks dependent on brokered deposits should expect to see more vigilant regulatory measures designed to restrict or limit brokered deposits. Congressional hearings on brokered deposits have already been held and regulators have sounded warnings that limits may be forthcoming.
For banks with high levels of brokered deposits, regulators will use their PCA powers to make capital downgrades, giving regulators greater control and limiting the ability of liquidity-challenged banks to accept brokered deposits.
IndyMac's failure demonstrates that uninsured depositors face unprecedented, but not unexpected risks. Unlike other periods of multiple bank failures when the FDIC arranged for the assumption of virtually all deposit liabilities, recent bank failures have resulted in uninsured depositors receiving a Receivership Certificate entitling depositors to share any recovered funds.
Another lesson drawn from IndyMac is that immediate information exacerbates the need for liquid assets. Our modern society, replete with 24/7 communication, fosters new challenges to the financial services industry as news reports grant bank customers instant access to information about a bank's financial status. Meanwhile technological advances allow customers to withdraw funds at bank branches or online, creating the opportunity for stealth runs and requiring increased vigilance to bank liquidity. Finally, the federal securities laws impose obligations to promptly disclose all material economic information, thereby requiring publicly held banking organizations that are troubled to push out lots of new bad news.
Having backup lines of credit may not be sufficient. Often these lines can be pulled at any time for any reason. In a time of stress, don't count on a friendly bank assuming your liquidity risks. Banks and their public holding companies are required to provide prompt public disclosures of material information, contributing to the bad-news frenzy. Bankers need to carefully balance nonpublic supervisory correspondence and communications with their disclosure obligations.
What Bankers Must Do Now
Review liquidity plans and have sufficient liquid assets available during periods of enhanced bank publicity, not just about their bank, but adverse publicity about the industry in general. Where applicable, review lines of credit with Federal Home Loan banks, correspondent banks, and Fed funds agreements. Be prepared for the loss of the ability to use brokered deposits. Understand the rules of what is and is not permissible in terms of deposit-gathering.
Monitor both in-line and online traffic to avoid stealth deposit outflows and liquidity challenges during periods of adverse publicity for the financial services sector. Banks with significant uninsured deposits should also plan to enhance liquidity to address potential outflows during periods of adverse publicity.
Plan to increase capital now. The longer a bank waits, the more difficult and expensive it will be to raise capital. Bankers and boards of directors should be considering contingency plans for equity raises, trust-preferred offerings, and asset sales.
Plan for a potential PCA downgrade. Review covenants in contractual commitments that the bank or its holding company may be a party to. Develop contingency plans to address situations that may arise if your bank's capital status drops below well capitalized, such as plans to communicate with lenders about potential default waivers and strategies to communicate with regulators about the consequences of a potential PCA downgrade.
Be proactive with your regulators. There is no downside to being fully open and candid about your condition and potential weaknesses. If your bank is in trouble, the regulators already know its condition. Give regulators every reason to want to work with you proactively to avoid a deteriorating crisis. And if there are things that they can do to help, reach out to them, do not wait for them to come to you.
Also, develop plans to educate your customers on the limits of FDIC insurance and work with customers to structure their accounts to maximize FDIC insurance coverage.
And be prepared to do what is necessary to address customers' concerns — if a traditional run occurs, a media circus may follow. Be aware of customer needs and fears and make accommodations where practical or necessary.