U.S. regulators brace for jump in bank failures

WASHINGTON (Reuters) - The rate of U.S. bank failures is expected to increase more than four-fold this year as federal regulators get fresh resources to handle insolvent banks, and as the Obama administration takes a more aggressive approach toward some banks’ dismal prospects.

Bank analysts and industry insiders say a continued deterioration in credit conditions will be the driving force behind a big upswing in the number of failures, but policy decisions will also push the numbers up.

“I think people were surprised there weren’t more last year, and I think that has to do more with the capabilities of the (Federal Deposit Insurance Corp) than the quality of the banks,” said Richard Eckman, chairman of law firm Pepper Hamilton’s financial services practice group.

The FDIC seized 25 banks last year. In just the first seven weeks of 2009, 14 banks failed and the FDIC is on pace to close more than 100 in 2009.

The agency is on a hiring spree and wants to triple its line of credit with the Treasury Department, better equipping it to close weak banks and find buyers for their assets.

“The FDIC has clearly stated that we expect an increase in our resolution activity as we work through this economic cycle,” said FDIC spokesman Andrew Gray. “The prudent planning efforts by the FDIC over the last year and a half reflect this -- including additional hiring, contractor engagements and budget increases.”


The FDIC has also been freed from the shackles of a previous administration that may have delayed bank closures to increase confidence in the financial industry last year, said Ken Thomas, a bank consultant and economist based in Miami.

“There were many more banks that could have been closed,” Thomas said. “What we’ve seen is a total ramping up in failures, a total new policy.”

FDIC Chairwoman Sheila Bair testifies before the House Financial Services Committee about housing foreclosures on Capitol Hill, September 17, 2008. REUTERS/Larry Downing

The FDIC and a bank’s primary regulator have some latitude on when exactly to close an insolvent bank’s doors. Declaring a bank failure sooner rather than later often minimizes taxpayer costs.

The small U.S. banks that failed in recent weeks could easily have been closed last June or September, said Thomas, who expects more than 100 bank failures in 2009.

Other predictions are more pessimistic. RBC Capital Markets said recently more than 1,000 U.S. banks -- or one in eight lenders -- may fail in the next three to five years.

FDIC’s Gray said a bank’s chartering authority generally makes the decision whether to close a financial institution, based on the condition of the bank and statutory requirements. U.S. banks can be chartered under a state banking regulator, or by the Office of Comptroller of the Currency, the Office of Thrift Supervision, or the Federal Reserve.

“The FDIC coordinates with bank regulators to project and plan for failures months ahead of time,” Gray said. “There are times when a failure occurs as expected and times when they occur either earlier or later due to unexpected events.”

The FDIC is clearly bracing for a flood of failures, and has revised upward the expected cost to its deposit insurance fund over the next three years.


On Thursday, the agency will release data on the state of the banking industry in the final quarter of 2008, including an update on the number of problem banks on its watchlist and how much money it is setting aside to handle future failures.

The number of problem banks -- banks that are under close scrutiny and often have weak capital cushions -- spiked in the third quarter to 171 from 117 at the end of the prior quarter. That marked the highest number since 1995 when federal regulators were wrapping up the savings and loan crisis.

Thomas said he expects the number of problem banks rose to about 200 at the end of the fourth quarter.

The FDIC will also release an updated figure on how much cash it has left in the Deposit Insurance Fund, an industry-funded reserve to back the deposits at FDIC-member banks, and how much it has provisioned for future failures.

The fund fell 23.5 percent in the third quarter to $34.6 billion. That amount included about $12 billion provisioned for failures it expected in the fourth quarter of 2008.

The FDIC said in December that it expected the fund to drop to about $29 billion at the end of the fourth quarter. The exact figure will be released on Thursday.

The FDIC is under pressure to protect the insurance fund as it grapples with a crisis that could easily exceed the savings and loan collapse when 1,386 lenders failed from 1988 to 1990, said Ronald Glancz, chairman of law firm Venable’s financial services group and a former FDIC official.

Glancz sees up to 200 bank failures in 2009 as conditions deteriorate and private capital stays on the sidelines. “This is a much more serious crisis than the S&L crisis because it affects the entire financial market,” he said.

The FDIC has been creative by extending liquidity programs and negotiating rescue deals or acquisitions for the largest banks on the brink of failure, Glancz said.

But the agency needs to also explore ideas like open bank assistance in which the FDIC could give incentives for private investors to jump into struggling banks. That would help prevent the damaging effects of bank failures, which can have a depressing ripple effect, similar to home foreclosures.

“A bank failure can really cause a crisis in the community,” Glancz said.

Reporting by Karey Wutkowski; Editing by Tim Dobbyn