Weak banks can – and often do – survive a financial challenge, but only if someone along the line of supervision use restraint to avoid an “unnecessary bank failure,” the vice chairman of the federal bank deposit insurance agency said Monday.
Speaking at the Mercatus Center at George Mason University in Fairfax, Va., Federal Deposit Insurance Corp. (FDIC) Vice Chairman Travis Hill outlined a series of not-so-unlikely events, in his view, that could lead a “poorly rated” bank – for non-financial reasons (because of compliance or operational weaknesses, but no evidence of a deterioration in financial condition)—to face strident requirements cutting off access to sources of credit or capital.
Hill outlined a series of events that could lead a weak, but not necessarily failing, bank to destruction.
“One can imagine a sequence of events like the following: a bank experiences an adverse event, resulting in its FHLB cutting off funding, resulting in its primary regulator downgrading its CAMELS ratings, resulting in the Federal Reserve moving the bank to secondary credit, resulting in the bank’s external auditor concluding the bank lacks the capacity to hold its HTM (hold to maturity) securities to maturity, resulting in the bank’s tangible common equity ratio plummeting, resulting in the external auditor issuing a public going concern opinion, which sparks a loss of confidence in the bank that leads to its abrupt and disorderly failure,” Hill said.
He added that, as a practical matter, such a final outcome is often avoided because “individuals along the line prioritize avoiding an unnecessary bank failure, but we should not assume that will always be the case.”
Hill closed by saying if a bank is insolvent or does not have a viable future, authorities should move swiftly and decisively to put the institution into receivership.
“But weak banks can and often do survive and recover,” he said, “and we should be thoughtful in considering policy choices that may further cripple wounded institutions and reinforce the procyclicality of our current system.”