Markets Brace for Possible U.S. Bank Failures

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Haunted by the ghost of savings and loan failures past, U.S. financial markets are bracing for what some say will be a flurry of bank closings when more stringent capital standards take effect later this month.

Under the new risk-based capital framework, U.S. banks are required to maintain total capital equal to at least 8% of risk-adjusted assets. Beginning Dec. 19, federal regulators will be obliged to close banks with less than 2% capital.

Ideas that the cost of closing bankrupt institutions will exceed industry reserves have kept U.S. financial markets on edge since October. "Bad news for the banking industry is bad news for the stock market," says Jeffrey Given, an economist at Chicago-based Robert Genetski & Associates Inc.

Given adds a wave of bank failures would be expected to send stock prices reeling. The bond market also would weaken, but losses there might be tempered "by a small flight to quality," he says.

Banking on the brink

The "December Surprise" furor responds, in part, to a recent study by Roger Vaughan and Edward Hill entitled "Banking on the Brink." The economists claim the Federal Deposit Insurance Corp. (FDIC) faces potential losses of $95.5 billion in December and a sizeable taxpayer bailout is unavoidable.

Acting FDIC Chairman Andrew Hove has estimated 120 to 125 U.S. financial institutions with about $76 billion in assets will close their doors in 1993. But he says he does not know how many of the projected failures would be a result of the tougher capital requirements.

Hove insists Vaughan and Hill's "pessimistic scenarios" are inflated by more than $25 billion "in advertent double-counting and the failure to allow for existing reserves for future liquidation losses." In sum, he says the study demonstrates "sloppy computational methods, a lack of understanding of bank financial reports and an unfamiliarity with such concepts as default and loss rates."

Federal Reserve Board Governor John LaWare dismisses the bank failure forecast as "alarmingly high" and warns public confidence in the banking system should not be undermined by "misleading research conclusions."

"Reports of huge future losses make sensational headlines, but the economy would need to decline dramatically from current levels to produce losses that approach estimates seen recently in the media," LaWare told Congress. …