The financial insecurities of commercial banks - Essay Example

Introduction The article discusses the main issue as the financial insecurities of commercial banks, depending on their characteristics, and how they respond to such financial fears. The important question answered in this article is whether the implementation of prompt corrective action (PCA), managed to curb the FDIC losses on failed banks. The article focuses on comparing the FDIC losses over failed banks and the failures of commercial banks, over the periods 1985 to 2006, a period within which the bank characteristics fully developed, before each financial crisis. The author compares the FDIC losses on failed banks between two critical periods (Balla, Prescott and Walter 2). First, between 2007 to 2013, and the periods between 1985 to 2006. The background of this issue is that 998 banks experienced failures between the year 1986 and 1992. Commercial banks in the United States experienced a severe financial crisis from the mid of 1980 to early 1990’s and actually at the end of the year 1985. The federal deposit insurance corporation receivership was undertaken, and 6.0% failed bank deposit and 5.4% bank assets of the non-de Novo banks failed during this period and underwent the receivership process. There was need therefore for reforms to be done in the banking sector during this period. For one, the regulatory capital requirements for Basel 1 were to be increased, and strict conditions given to bank supervisors to take certain actions against banks whose capital requirements dropped below a certain standard or threshold (Balla, Prescott and Walter 3). Secondly, the prompt corrective action (PCA) was included in the provisions of the 1991 Federal Deposit Insurance Corporation Improvement Act. The background of the issue is the assumption that the FDIC losses, the incurred taxpayers loss from failed banks and thrifts, were increased by use of forbearance due to the inclusion of the PCA provisions in the FDIC of 1991. The financial crisis was still high on commercial banks, despite these reforms (Balla, Prescott and Walter 4). The solution from other articles A different article gives solution on how to curb the federal deposit insurance corporation losses on failed commercial banks. According to him, the FDIC losses can be reduced if the Federal Deposit Insurance Corporation Act of 1991 would be amended to allow FDIC authorities calculate the insured and uninsured depositors amounts for each deposited with several accounts in the same bank. The process of calculation will be done on a daily basis at the end of any banking day. This would be done by banks with at least two million deposit accounts. He suggests that within a large bank, this process will help a lot to allow insured depositors right to use their deposits within one business day of failure. Uninsured depositors are advised to share in the insolvency bank losses at the end of the banking period. He suggests that this solution will apply to almost 37 banks as at the year 2014. The FDCI has tried to make the prompt corrective action initiative more determinable to secure the FDCI losses on the failing banks. The FDIC has used the test known as “least cost resolution” to protect uninsured depositors against any loss from their deposit accounts even in the failing banks. This article suggests that the entire franchise bank deposit insurance and the uninsured deposits be sold to one or more banks if this test would be successful to protect the uninsured depositors. This test aims at reducing the FDIC loss in a failed bank, by completely protecting the uninsured depositors against any financial loss (Schaeck 170). The failed deposits of a bank and the related customer relations can be sold as a one way of reducing the FDIC loss at a time of closing the bank. This lowers the deposit insurance premiums for successful banks. The tradition proposed to protect uninsured depositors at a time the bank undergoes liquidation also helps calm the stability crisis in financial markets. For example, approximately 30% of the uninsured deposits from failed banks suffered a loss that threatened the financial security of the commercial banks in the United States and the financial markets leading to the FDIC losses (Schaeck 174). The other solution is that the enactment of the FDIC of 1991, which introduced the FDIC annual examination that is a test the FDIC did to charge the 1993 risk-based assessments, by classifying the banks into a 9-group category. Each of these category groups is determined its successful contribution to curbing the FDIC losses on failing banks by estimating the amount of bank capital and level of supervision given by supervisors during the liquidation times of the bank. If a bank is in category A, it pays the lowest premium while those in category C pays the highest premiums (Bennett, Mark and Timothy 30). FDIC sets limits to all banks to avoid taking greater risks to attract customers with big accounts. However, FDIC losses have tried to be solved using the method of “assumption deposit method”, where FDIC finds a buyer of the failing bank or merges the failing bank with a stronger bank. In this manner, FDIC is relieved from compensating depositors as well as opening the failing bank to the local economy under new management. If the merging process becomes impossible, the FDIC uses the payoff method, to compensate the depositors of their losses up to a maximum amount (Bennett, Mark and Timothy 31). Solution from the author The author suggests that the Capital and bank size lowers and reduces the failure probability in the banking sector, and the losses. Security holdings lower losses and failure probabilities in the later period. Core deposits also assist curb the FDIC losses and the payoff method of deposits, where the insured depositors are made whole by selling of the bank assets to the FDIC and the corporation compensates any shortfall. The introduction of PCA provisions in the FDIC of 1991 provided clear restrictions that failing banks were to comply with if its capital falls below a certain level. The author suggests that the FDIC should keep a failing bank under receivership or conservatorship within 90 days if the capital of the bank is low. The FDIC can also keep the bank in the private sector or liquidate. A failing bank can be sold at whole though at a negative price to another financially stable bank through a purchase and an acquisition agreement. If liquidated, the insured depositors are paid off, and receivership manages the bank assets in the best way to be able to compensate the bank claimants and the FDIC. All of the failing bank assets and liabilities should be assumed by the company that purchases it, and if any assets are left during this receivership process, are supposed to be sold over time. The FDIC share agreements recommend that the loss on some assets left to be shared after some assets are given under control of the acquiring bank (Balla, Prescott andWalter 7). Agreements and disagreements Agreeing with the author’s argument about putting a failing company into receivership is quite evident. The fact that a failing bank is financially constrained even to settle its debts and those of claimants makes it necessary to transfer such a company’s liabilities and claims to another strong company. The process of purchase and acquisition of a failing bank makes the “buying bank” that is stronger in this case to assume all the bank assets and liabilities of the failing bank in whole. This is one way by which the FDCI losses can be reduced because the failing company claimants and the uninsured depositors are protected and compensated. The other issue agreed upon is that of loss sharing agreements made during the purchase and acquisition process. The FDIC should share loss especially on assets that exceed some threshold and not under the control of the acquiring bank so that the FDCI perceives to protect the uninsured depositors of the failing bank against much loss. In agreement also that the FDCI should liquidate a failing bank in which it’s disposed of or either sell it to a private sector reorganizations. The reason behind this is that both these two methods of disposing of a failing bank are determined by the same factors, however, much the difference in the expense incurred to perform either process. This is because in these two methods of disposition, the value of assets, the interest of claimants, the level of FDCI loss, and many liabilities are a concern (Balla, Prescott &Walter 14). Disagreeing on the point that the construction and the land development lending ( CLD) increase the probability of failure. It is evident that the commercial and industrial lending also has the same effect. This is because the best profitable business function of a bank is lending and the bank has the overall mandate to lend deposited money to various people and even institutions. A bank cannot survive without lending money because it is from the interests accrued that the banking process is termed business. The two lending processes should help a bank from failing and be able to settle its liabilities, since loans are assets of the bank. In addition, only the insured depositors should be made whole when the assets of the failing company are sold during liquidation and any loss be covered by FDIC (Balla, Prescott &Walter 10). Proposal for improvement The FDIC of 1991 needs to be repealed to protect the interests of both the insured and uninsured depositors, and not only pay off the insured depositors in full during the liquidation process. The reason why this Act should be repealed is because most provisions covered to protect security firms and commercial banks are already contained in the banking act of 1933, called the Glass-steagall act. Just like the banking Act sections 20 and 21, the FDIC 1991 Act is the greatest contributor to the 2000 financial crisis in the banking industry. For example the PCA provisions contained in the FDIC act, have not been successfully implemented to curb the FDIC losses, which instead are on the increase. The Act should have provisions covering the FDIC loss sharing agreement to cover protection of the uninsured depositors against loss. This also helps to secure the local financial markets from loss. Amendment provisions to the lending process of the bank should be included and not considered a method of failure contribution to the FDIC loss. Lending is one effective way a bank business is made profitable (Balla, Prescott &Walter 15). Conclusion The PCA regulate supervisors of banks to calm the storm of bank failure and insolvency, by intervening in the bank activities and liquidate a bank before its financial crisis becomes worse. The commercial bank failure, results once no reasonable steps are taken by the FDIC and supervisors to control such an institution once threats of low capital runs appear (Balla, Prescott &Walter 20). Works cited Balla Eliana, Prescott Edward Simpson, &Walter John R. Did the Financial Reforms of the Early 1990s Fail? A Comparison of Bank Failures and FDIC Losses in the 1986-92 and 2007- 13 Periods. Federal Reserve Bank of Richmond working paper, (2015):15-05 Schaeck, Klaus. Bank Liability Structure, FDIC Loss, and Time to Failure: A Quantile Regression Approach. Journal of Financial Services Research. 33.3 (2008): 163-179. Bennett, Rosalind L., Mark D. Vaughan, and Timothy J. Yeager. "Should the FDIC worry about the FHLB? The impact of Federal Home Loan Bank advances on the Bank Insurance Fund." (2005). Read More