BOCA RATON, Fla.–A new paper suggests billions of dollars could be saved if Congress revises a law to allow regulators to be more aggressive in reducing losses from insolvent banks.
The paper, published in the July 2017 issue of the Journal of Banking and Finance, calls for the adoption of a new capital ratio that accounts for nonperforming loans and loan-loss reserves.
Dr. Rebel Cole, professor and Kaye Family Endowed Chair of Finance at Florida Atlantic University’s College of Business, and Dr. Lawrence J. White, the Robert Kavesh Professor of Economics at New York University’s Stern School of Business, examined data from the years 2007-2014, during which U.S. bank regulators closed 433 commercial banks and 77 savings institutions. The Federal Deposit Insurance Corporation has estimated that closure costs totaled $77.5 billion, the authors stated.
“We found regulators were not closing banks in a timely fashion based upon the bank’s publicly available reported financial condition,” Cole said.
The authors said the regulators moved too slowly to close financially troubled banks and that earlier closures would have significantly reduced the FDIC’s closure costs. In response, they are proposing using the existing minimum capital-to-asset ratio of 2%, but measuring capital using the “nonperforming asset coverage ratio” (NACR), a capital ratio that employs standardized write-down “haircuts” for a bank’s nonperforming assets.
Cole and White noted that the Financial CHOICE Act legislation recently passed by the House includes a provision calling for the comptroller general of the United States to conduct a study to assess the benefits and feasibility of replacing the current capital ratios with the nonperforming asset coverage ratio outlined in the paper.
Cole and White said their analysis found that the 433 banks closed by regulators during 2007-2014 breached the 2% thresholds, on average, between 12 and 18 months earlier than the actual closure date. Their empirical analysis indicates the savings from closing earlier, based on the benchmarks they propose, could have been as great as 37%, or about $18.5 billion, the study found.
“Our alternative capital ratios could prevent regulators from granting forbearance to insolvent banks, a practice that proved very costly during the past decade,” Cole said.