Comparison of Small Bank Failures and FDIC Losses in the 1986–92 and 2007–13 Banking Crises
Abstract: Failure rates of small commercial banks during the banking crisis of the late 1980s were about 7.6%, which is significantly higher than the 5.7% failure rate during the recent crisis. The higher rate is surprising because small banks had significantly increased their commercial real estate (CRE) lending by the second crisis, which is riskier than other types of lending, and economic shocks were more severe in the recent crisis. We compare failure rates in the two periods using a statistical model that allows us to decompose the effect of changes in bank characteristics and economic shocks on failure rates. We find that the severe economic shocks of the recent crisis had a larger impact on high bank failure rates than bank characteristics. Increases in risk from CRE lending were offset by higher capital levels and other changes in bank characteristics. The failure rate would have been much lower in the later crisis if banks were subject to the less severe economic shocks of the earlier crisis. To the extent that higher capital levels were due to Basel I and the prompt corrective action (PCA) provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991, we find that these reforms were beneficial. We also compare Federal Deposit Insurance Corporation (FDIC) losses on failed banks between the two periods. Here, despite the PCA reforms, losses on failed banks were higher in the recent crisis than in the earlier one. These differences are not accounted for by changes in CRE concentrations or the relative size of economic shocks. On this dimension, the reforms of the early 1990s did not seem to help. Finally, we find that a discretionary accounting variable, interest accrued but not yet received, is predictive of both failure and higher FDIC losses in both crises.
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Provider: Federal Reserve Bank of Cleveland
Part of Series: Working Papers (Old Series)
Publication Date: 2017-11-13
Pages: 55 pages