Have you ever wondered about the financial health of your bank? The Federal Deposit Insurance Corporation (FDIC) maintains a confidential list of banks deemed to be in distress, an intriguing aspect of the banking system that many may not be aware of.
This secret list identifies banks at risk of financial failure. The FDIC keeps this information under wraps to prevent panic among customers, as the last thing they want is for depositors to withdraw their funds, potentially triggering widespread bank runs.
By maintaining confidentiality, the FDIC aims to provide assistance to these troubled banks, working to restore their stability and avert failures.
For a bank to be classified as “problematic” and be included on this list, it must receive a CAMELS rating of 4 or 5 from FDIC examiners. This acronym encompasses key aspects of a bank’s health, which include Capital, Assets, Management, Earnings, Liquidity, and Sensitivity.
The CAMELS scoring system ranges from 1 (the best) to 5 (the worst).
On May 29, the FDIC published its Quarterly Banking Profile for the first quarter of 2024. Notably, it revealed that 11 additional banks were added to the problem bank list during this quarter, raising the total from 52 to 63.
Your bank could possibly be one of these troubled institutions, which collectively hold around $82.1 billion in assets—a $15.8 billion increase since the end of 2023.
Simultaneously, unrealized losses on available-for-sale and held-to-maturity securities surged by $39 billion to reach $517 billion during Q1 2024. This marks the ninth consecutive quarter of unusually high unrealized losses, a trend that has occurred since the Federal Reserve began raising interest rates in Q1 2022.
Soaring unrealized losses pose a significant challenge. We will delve deeper into this issue shortly, but first, let’s explore some historical context.
Bank Failures
If the FDIC fails to assist a bank listed as a problem institution, that bank will be moved to another list maintained by the FDIC, which is available to the public. This publicly accessible list enumerates all U.S. bank failures dating back to October 1, 2000.
As of this writing, that list includes 569 bank failures, translating to an average of about 24 failures each year. Some years have seen more significant losses while others have been relatively stable.
For instance, there were no bank failures between October 24, 2020, and March 11, 2023—roughly 28 months. In stark contrast, 2010 experienced 157 bank failures, amounting to a failure every 2.3 days throughout the year.
Currently, only one bank failure has been reported in 2024: Republic First Bank, which closed its doors on April 26.
In 2023, just five banks failed, including Silicon Valley Bank, Signature Bank, First Republic Bank, Heartland Tri-State Bank, and Citizens Bank. The noteworthy aspect of the 2023 failures isn’t merely the number but the scale involved.
The most significant bank collapse in U.S. history was Washington Mutual Bank, which failed on September 25, 2008, with $307 billion in assets. Following that, First Republic, Silicon Valley Bank, and Signature Bank encountered similar fates in 2023, with assets of $212 billion, $209 billion, and $110 billion, respectively.
Confidence Games
If a bank makes it onto the FDIC’s public list, it signifies a lost cause. The bank has already failed. In theory, if your deposits are under $250,000 at a failed bank, they are protected by the FDIC. But how secure is this assurance, really?
In its latest Quarterly Banking Profile, the FDIC disclosed that its Deposit Insurance Fund (DIF) holds a balance of $125.3 billion, equating to a reserve ratio of just 1.17% of total insured deposits. Alarmingly, this reserve ratio does not meet the FDIC’s own legal requirements.
The FDIC initiated a DIF Restoration Plan on September 15, 2020, aimed at returning the reserve ratio to the legal minimum of 1.35% by September 30, 2028. However, a lot can change in the years ahead, and the minimum reserve of 1.35% is itself questionable in terms of adequacy.
In our assessment, reserves of merely 1.17% (or even 1.35%) vis-à-vis potential obligations do not constitute genuine insurance; instead, they amount to a fragile trust designed to maintain customer confidence and discourage deposit withdrawals during crises.
In a severe panic scenario, it is conceivable that FDIC reserves would be depleted within a day. Additionally, in cases where most depositors maintain balances exceeding $250,000, as seen with SVB and Signature Bank, the FDIC’s so-called “insurance” proves insufficient. Yet, maintaining confidence is still paramount.
Crisis in the Making
This prevailing confidence extends from the FDIC to the Federal Reserve. In a fiat currency system, the quantity of credit generated can be limitless; however, the critical issue lies in its quality.
As the Federal Reserve continually provides excess credit to support the banking sector, the actual value of that credit risks decline. The precise breaking point, however, remains unknown.
A primary factor driving the $517 billion in unrealized losses mentioned earlier is the decline in value of residential mortgage-backed securities stemming from rising mortgage rates. Commercial real estate loans also face significant risks. According to the FDIC:
“Weak demand for office space is softening property values, and higher interest rates are affecting the credit quality and refinancing ability of office and other types of CRE loans. As a result, the noncurrent rate for non-owner occupied CRE loans is now at its highest level since the fourth quarter of 2013.”
The relationship between real estate values and credit health is crucial to the banking ecosystem. When the debt owed on properties surpasses their market value, lenders face challenges in recovering losses should borrowers default, a scenario the FDIC has highlighted as increasingly common.
As more banks become insolvent with liabilities exceeding their assets, the FDIC may struggle to insure all customer deposits at risk.
Remember, the advent of quantitative easing in the U.S. back in November 2008 involved purchasing mortgage-backed securities to stabilize a banking system overwhelmed by non-performing loans.
When QE1 was launched, the Fed’s balance sheet stood at about $800 billion. Today, it has ballooned to roughly $7.3 trillion.
The current accumulation of non-performing residential and commercial loans signals a looming crisis. What will unfold with a surge in bank failures?
Will the Federal Reserve allow depositors to be completely wiped out, potentially triggering a systemic collapse of the financial system? Or will they ramp up the printing presses to absorb all these bad loans?
Recent patterns suggest they will choose the latter, further eroding the quality of the dollar.
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MN Gordon
for Economic Prism
