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Closing Failing Banks Sooner Could Save Billions of Dollars

The paper, published in the July 2017 issue of the Journal of Banking & Finance, calls for the adoption of a new capital ratio that accounts for nonperforming loans and loan-loss reserves.

The paper, published in the July 2017 issue of the Journal of Banking & Finance, calls for the adoption of a new capital ratio that accounts for nonperforming loans and loan-loss reserves.


By james hellegaard | 6/19/2017

Billions of dollars could be saved if Congress revises a law to allow regulators to be more aggressive in reducing losses from insolvent banks, according to a recent study co-authored by a faculty member from .

The paper, published in the July 2017 issue of the , calls for the adoption of a new capital ratio that accounts for nonperforming loans and loan-loss reserves.聽

, Ph.D., professor and Kaye Family Endowed Chair of Finance at 爱妃传媒鈥檚 College of Business, and , Ph.D., the Robert Kavesh Professor of Economics at New York University鈥檚 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 (FDIC), the deposit insurer for these institutions, has estimated that closure costs totaled $77.5 billion.

鈥淲e found regulators were not closing banks in a timely fashion based upon the bank鈥檚 publicly available reported financial condition,鈥 Cole said.

Cole and White argue that regulators acted too slowly to close financially troubled banks and that earlier closures would have significantly reduced the FDIC鈥檚 closure costs. They propose using the existing minimum capital-to-asset ratio of 2 percent, but measuring capital using the 鈥渘onperforming asset coverage ratio鈥 (NACR), a capital ratio that employs standardized write-down 鈥渉aircuts鈥 for a bank鈥檚 nonperforming assets.

The legislation recently passed by the U.S. House of Representatives as a replacement for the Dodd-Frank Act 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 found that that the 433 banks closed by regulators during 2007-2014 breached the 2 percent 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 percent, or about $18.5 billion.

鈥淥ur alternative capital ratios could prevent regulators from granting forbearance to insolvent banks, a practice that proved very costly during the past decade,鈥 Cole said.

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