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FRBSF
WEEKLY LETTER
April 11, 1986
Recent Bank Failures
The number of bank failures in the U.s. has
increased steadily over the past several years. It
reached 120 in 1985 - far more than in any
other year since the Great Depression. In addition, the Federal Deposit Insurance Corporation
continues to rate more than 1100 banks as
"problem" banks based on its assessment of
their capital, assets, management, earnings, and
liquidity (CAMEL rating). These figures seem to
indicate that the rise in bank failures that began
in 1982 has not yet run its course. This Letter
examines recent trends in bank failures, their
causes, and ways in which failures are resolved
by bank regulators.
Recent experiences
Until 1981, bank failures in the post-World War
II era averaged about six per year and, except for
the occasional failure of a very large bank (e.g.,
Franklin National in 1974), were not a source of
great concern to most observers. Since 1982,
however, the number of bank failures has grown
rapidly, rising from 10 in 1981 to the postDepression record level of 120 in 1985 (see
chart).
The assets of banks that failed in 1985 amounted
to $9.1 billion, or nearly three times the $3.3
billion 1984 level (a figure that excludes the
Continental Illinois rescue). More than half of
the 1985 total was due to the failure of a single
New York savings bank (Bowery Savings Bank,
assets of $5.3 billion). Except for the assets of
this organization and one other sizable savings
bank (also in New York), the total volume of
assets in failed banks in 1985 was nearly identical to that in 1,984. In all, the assets of failed
banks in 1985 represented less than one-half of
one percent of total U.S. bank assets.
Banks that failed in 1985 generally were smaller
than those that failed in 1984. The smaller average size offailed banks in 1985 mainly reflected
the greater concentration of bank failures within
farmbelt states, where banks tend to be relatively
small. For the year, the average size failed bank
held $28 million in assets (ignoring the two large
savings bank failures), as compared to $41 million in assets in 1984. The largest commercial
bank to fail in 1985 held assets of $214 million,
while the smallest held assets of $2.7 million.
All but six of the 120 banks that failed in 1985
had assets of less than $100 million.
Economic factors in recent failures
Empirical research offers somewhat limited
insight into the broader causes of bank failures
by linking them to such economic variables as
the unemployment rate, real interest rates, and
the level of corporate debt burden. An analysis
of recent failures, however, suggests that more
specific economic factors have played an important role.
Certainly, with sharp recessions in 1980 and
1982, commercial bank loan quality has suffered. For a number of banks, the problems have
persisted well into the recovery because asset
quality has been slow to improve in many lending areas. Specifically, an overall improvement
has been hampered by a shift from a high-inflation to a low-inflation environment, a relatively
strong dollar, persistently high real interest rates,
reduced export demand for commodities, and
declining farmland and energy prices. Thus,
many banks remain saddled with poor quality
agricultural, energy, and real estate loans.
Geographic distribution
The geographic distribution of failed banks supports this view. From 1982 through 1985, there
were 289 bank failures in the U.S. Seventy percent (201) of these failures occurred in ten states
whose economic fortunes are closely linked to
the farming and energy industries. These states
include Kansas, Iowa, Nebraska, Illinois, Missouri, Oregon, Oklahoma, and Texas. Two other
states - California and Tennessee - also experienced numerous bank failures during this
period. Failures in Tennessee during the
1982-85 period (31) were largely the result of a
major fraud and insider abuse scandal involving
numerous commonly owned banks. Bank
failures in California (20) were the result of a
diversity of factors including agricultural and
real estate lending problems. Foreign loans do
not appear to have contributed significantly to
bank failures in any state during the 1982-85
FRBSF
period. Furthermore, it is important to note that
twenty-seven states experienced only one or no
bank failures during the 1982-85 period.
The problems of farm banks - those with more
than 25 percent of their loans in agricultural
credits - have become most acute in recent
years. In 1985, farm bank failures accounted for
slightly more than half (62 of 120) of all bank
failures. This compares to one-third in 1984 and
less than one-fourth in 1983 and 1982.
Nebraska (13), Iowa (10), and Kansas (9) led the
way in farm bank failures in 1985. Eight other
states also recorded a total of thirty farm bank
failures in 1985. Depressed farm land prices and
commodity prices are expected to persist in
1986 and will likely cause additional farm bank
failures.
A substantial number (16) of non-farm bank
failures also occurred in Texas and Oklahoma
last year. Many of these fai lures, as well as several failures in Wyoming, can be attributed to
energy-related loans exposure. The recent
plunge in oil prices will only exacerbate such
problems.
A scattering of bank failures occurred among
other states during 1985. California recorded
seven bank failures, while New York had four
and Florida two. The cause of insolvencies in
these states is more difficult to pinpoint. The
presence of important real estate markets within
these states suggests that problems in this lending area may have been responsible for some
failures.
Effects of deregulation
In addition to farm, energy, and real estate lending problems, some economists believe that
financial deregulation and innovation are contributing to bank failures in the 1980s. Deregulation of deposit interest rates has been
accompanied by increased competition from
new sources - banking and nonbanking alike.
This heightened level of competition has meant
that banks now operate in a harsher and less forgiving environment in which poor management,
fraud, and insider abuse (a contributing factor in
as many as three-fifths of all failures since 1980)
exact greater penalties than before.
Deposit deregulation and expanded lending and
investment powers have been argued to contribute to instability in banking by fostering
increased risk-taking by banks. Many argue that
the assumption of additional risk is encouraged
by what is generally perceived to be a deposit
insurance subsidy that partially insulates banks
from the costs of assuming higher levels of risk.
Deregulation, they argue, gives banks greater
scope to act on the incentives to take risks.
Some economists, however, take exception to
the view that deregulation is at the core of the
current spate of bank failures. They contend that
the failures are due simply to deteriorated conditions in the agriculture and energy sectors.
Handling failed banks
When a bank fails, the FDIC - a governmentrun corporation that insures depositors up to
$100,000 against loss - can exercise several
options in its role of protecting depositors. Its
settlement practices are what some observers
believe have encouraged banks - especially
large banks - to incur excessive risks in recent
years.
When a bank fails, the FDIC usually employs
either a deposit payoff or a purchase and
assumption ("P&A"). In a deposit payoff, the
FDIC pays depositors the value of their accounts
(up to $100,000), and sells the failed bank's
assets to payoff creditors, including the insurance fund and uninsured depositors. Creditors
suffer a loss if the proceeds of the asset sale do
not cover creditor claims.
In a P&A, the failed bank is sold to another
financial institution that is willing to assume
most of the bank's liabilities (including all
deposits). In return, the acquiring institution
receives the failed bank's good assets (performing loans, securities, physical plant) plus cash
from the FDIC for the amount by which the
assumed liabilities exceed the purchased assets
minus the premium paid by the acquiring bank.
Because of the manner in which the FDIC has
handled P&As for bank failures, few uninsured
depositors at large institutions have suffered
losses. Critics of the FDIC argue that the FDIC's
settlement practices and the government's
FDIC-Insured Bank Failures
Number
120
110
100
90
80
70
co.uld create destabilizing effects by forcing the
private sector to speculate on the health of individual banks. The continual prospect of runs
precipitated by rumors of troubled banks could
jeopardize the entire banking system. In
response, many banks would probably become
~~ch more conservative in their lending polICies and restrict the availability of credit to all
but the most creditworthy customers.
60
50
40
30
20
10
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1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1985
pledge never to permit a large bank to fail have
created de facto deposit insurance for all
deposits at large banks, including those that are
legally uninsured.
They argue that in the past this has bestowed a
deposit-gathering advantage on the largest banks
and reduced the crucial role of "market discipline" in restraining risk-taking. Because past
guarantees made smaller failed banks more
likely to be liquidated at a loss to the uninsured
depositor, they may have encouraged large
depositors to place funds only in the largest
banks.
Without deposit insurance, market discipline
would dictate that riskier banks pay more for
their funds to compensate depositors for taking
greater risks. With de facto insurance for all
deposits, poorly managed banks or those with
low quality assets can raise funds almost as
cheaply as much stronger institutions because
depositors have little to fear about losing their
funds and therefore will not demand as high a
risk premium.
Supporters of current settlement practices point
to the dangers of moving toward greater market
discipline. The present system of formal and
informal guarantees, they argue, has worked
well to create a sound and stable banking system. Any shift to increased market discipline
Proponents of this view argue in favor of continued reliance on the P&A or, alternatively, a
government takeover of large failed banks - an
option that, in effect, was exercised in the 1984
Continental Illinois episode. Such takeovers
result in losses to shareholders but protect
depositors and allow the troubled bank to
remain in operafion under the regulators' control. Takeovers also give formal recognition to
the fact that federal guarantees become the
largest asset of the failed bank and that federal
guarantors comprise the bank's largest claim
holder.
Summary
Last year was a record year for bank failures
with many of them involving relatively small
institutions concentrated in a small number of
farmbelt and energy-producing states. Banks in
those states have been adversely affected by a
n.umber of factors including two recessions, persistently high real interest rates, a strong dollar,
and declining prices for commodities, farm land,
and energy.
A similarly large number of bank failures is
expected during 1986 with the failures again to
be heavily concentrated within the farmbelt
region. Increased failures also could occur
among energy banks - particularly in view of
the recent and sizable drop in oil prices.
However, because the failures will result from
specific economic developments whose impacts
v.ary by region and bank portfolio, they do not
Signal any fundamental weakness in the banking
system.
Anthony W. Cyrnak
Opini?ns expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Fr~nCl.sco, or of the Board of Governors of the Federal Reserve System.
EdItOrial co,:"ments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtamed from the Public Information Department, Federal Reserve Bank of San Francisco P.O Box 7702 San Francisco
94120. Phone (415) 974-2246.
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and liabilities
Large Commercial Banks
Loans, Leases and Investments 1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
Leases
U. S. Treasu ry and Agency Secu ritie~
Other Securities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances 4
Total Non-Transaction Balances 6
Money Market Deposit
Accounts-Total
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS
Two Week Averages
;;::o;..f::.D::::ai::..ly~F:..:i!:l:gu:.:r..::.e::..s
Reserve Position, All Reporting Banks
Excess Reserves (+ )jDeficiency (-)
Borrowings
Net free reserves (+ )jNet borrowed( -)
1
2
3
4
S
6
7
Amount
Outstanding
Change
from
3/19/86
202,180
183,622
53,110
66,469
38,981
5,648
10,577
7,980
200,099
47,553
32,317
15,326
137,220
3/12/86
531
872
305
198
565
2
- 263
79
- 615
142
- 222
57
- 417
45,950
-
9
37,545
25,915
-
278
287
Change from 3/20/85
Dollar
12,618
11,649
66
3,915
5,957
327
69
1,036
6,798
3,593
3,885
2,111
1,095
6.6
6.7
0.1
6.2
18.0
6.1
- 0.6
14.9
3.5
8.1
13.6
15.9
0.8
2,089
4.7
-
1,413
8363
-
3.6
47.6
Period ended
Period ended
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22
30
8
71
191
119
Includes loss reserves, unearned income, excludes interbank loans
Excludes trading account securities
Excludes U.S. government and depository institution deposits and cash items
ATS, NOW, Super NOW and savings accounts with telephone transfers
Includes borrowing via FRB, TT&L notes, Fed Funds, RPs and other sources
Includes items not shown separately
Annual ized percent change
@FedFRASER