As the nation's biggest financial institutions benefit from Uncle Sam's financial stability programs, many of the smaller banks may have to shut their doors over the next few years.
To date, 37 banks have failed in 2009. Another 305 are on the Federal Deposit Insurance Corp.'s so-called problem list. Historically, approximately 13 percent of the institutions on that list fail. While the government doesn't publicly predict how many banks might fail, one private company estimates that 500 to 1,000 additional banks may collapse if the economy further destabilizes.
The government's much publicized stress tests tried to determine if the 19 largest financial institutions have adequate resources to withstand the next two years under a couple of different, worsening economic scenarios, one considerably more dire than the other.
Stress tests for small banksThe government didn't apply the test to the more than 8,000 smaller banks, but Sandler O'Neill, an investment banking and financial advisory firm, did. It estimated that as many as 500 smaller banks might not be able to raise the capital needed to get through a prolonged, more strenuous downturn.
Robert Albertson, chief strategist at Sandler O'Neill, then ran additional loss ratio scenarios and came up with possibly 1,000 banks failing.
"It's a theoretical machine exercise using numbers on a page with commonly accepted data," says Albertson. "Is that a reasonable estimate of possible failures in the system? My answer is that it may be. It may also be on the high side because what we're doing in this exercise is apply a Great Depression loss cycle on every bank in the country. But my personal thought is it's certainly 500 and probably more.
"If you say between 500 and 1,000, I don't think you'll get a lot of argument from the industry that it's an extreme number, nor would you get an argument in general that it shouldn't happen. It certainly has the effect of removing weaker financial institutions or consolidating them with others to make for a more efficient banking system, but it's a bad thing in that it disrupts communities and smaller banks, which are key to our communities; plus it costs money to close them."
The FDIC's Deposit Insurance Fund, or DIF, is the piggy bank the agency dips into if necessary to pay insured deposits and other expenses when an insured bank fails. So far this year, the cost to the DIF has been $10.5 billion. The latest balance given by the FDIC is that the fund had $13 billion as of March 31, 2009. The agency estimates that failures through 2013 will cost $70 billion; $28 billion has been set aside to cover potential failures over the next 12 months.
The fund is required to have a reserve ratio of $1.15. That means the fund should have $1.15 on hand for every $1 of insured deposits. The current reserve ratio is $0.27. The FDIC, as required, has formalized a plan to bring the reserve up to the required amount within seven years. Agency officials say costs to the DIF are expected to be front-loaded into this year and next and that the number of failures should start to diminish in 2011.