June 5, 2008 / 3:09 PM / 11 years ago

UPDATE 1-Bigger U.S. bank failures may be coming - FDIC

(Adds comments on FDIC planning to issue guidance, Basel II)

By John Poirier

WASHINGTON, June 5 (Reuters) - Future U.S. bank failures linked to the downturn in the real estate market may include “institutions of greater size” than in the recent past, Federal Deposit Insurance Corp Chairman Sheila Bair said on Thursday.

An increasing number of banks face high exposure to deteriorating conditions in commercial real estate and construction lending, Bair told a Senate Banking Committee hearing on the state of the banking industry.

“There is also the possibility that future failures could include institutions of greater size than we have seen in the recent past,” Bair said. “Uncertainties in today’s economic environment continue to pose significant challenges for the banking industry, households, and bank regulators.”

So far this year, four small U.S. banks with deposits insured by the FDIC have failed, up from three in 2007. The agency last week boosted its list of troubled banks to 90, which have a combined $26 billion in assets.

The FDIC, which has about $52.8 billion in its deposit insurance fund in the event of bank failures, has launched a review of its risk-assessment rates for larger banks to determine if they reflect current conditions, Bair said.

“The agency plans to examine, among other issues, whether changes in how long-term debt issuer ratings are used to determine premium rates can improve the assessment system’s effectiveness in capturing risks posed by large institutions,” she said.

The FDIC is also focusing on banks’ liquidity risk management and investments in structured credit products.

“The FDIC expects to issue guidance to the institutions we supervise on liquidity risk and issues related to investments in structured credit products,” Bair said. “Market stress over the past year made shortcomings evident in some institutions’ risk management of these areas, and our guidance will address specific areas where risk management efforts should be improved.”

Additionally, the FDIC is preparing guidance for banks that rely on third parties such as loan originators and mortgage brokers. The guidance will include due diligence in selecting a third party, contract structuring, and compensation arrangements to avoid encouraging third parties into steering customers to higher cost products, she said.

The FDIC chief also indicated regulators were open to the idea of allowing the biggest U.S. banks to use a simpler set of capital adequacy rules designed for smaller banks under the so-called Basel II international banking framework. The proposed rules for smaller U.S. banks, known as the “standardized approach,” were submitted to the White House in April for review.

“The standardized approach introduces a more risk sensitive approach for residential mortgages that bases the capital charges on first and second liens on loan to value measures, and also better captures the risks on negative amortization loans,” Bair said.

Previously, the biggest U.S. banks had been expected to use an “advanced approach” requiring complex computer models to understand their credit, operational and market risks.

The Swiss-based Basel committee for international bank supervision, which has been monitoring the deteriorating conditions at big global banks, is also “very close” to updating its practices for liqudity risk management and releasing them for public comment, she said. (Reporting by John Poirier; Editing by Chizu Nomiyama)

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