Summary Analysis of Failed Bank Reviews

This report analyzed failed state member bank reports that the OIG issued between June 29, 2009, and June 30, 2011, to determine the common characteristics, circumstances, and emerging themes related to (1) the cause of the bank failures and (2) Federal Reserve supervision of the failed institutions. Our analysis yielded a series of common observations. We also conducted supplemental research and analysis to understand why certain institutions withstood the financial crisis better than others.

With respect to the cause of the state member bank failures, the majority of the reports cited common themes. In addition to the economic decline that triggered asset quality deterioration and significant losses at each of the failed banks, the common themes included (1) management pursuing robust growth objectives and making strategic choices that proved to be poor decisions; (2) rapid loan portfolio growth exceeding the bank’s risk management capabilities and/or internal controls; (3) asset concentrations tied to commercial real estate (CRE) or construction and land development (CLD) loans, which increased the bank’s vulnerability to changes in the marketplace and compounded the risks inherent in individual loans; and (4) management failing to have sufficient capital to cushion mounting losses. Additionally, the reports revealed certain practices that contributed to specific failures, such as risky funding strategies and incentive compensation programs that inappropriately encouraged risk taking. 

With respect to the supervision of the failed state member banks, many of the reports noted that examiners identified key safety and soundness risks, but did not take sufficient supervisory action in a timely manner to compel the Boards of Directors and management to mitigate those risks. In many instances, examiners eventually concluded that a supervisory action was necessary, but that conclusion came too late to reverse the bank’s deteriorating condition.

In our supplemental research and analysis comparing failed banks to those that withstood the financial crisis, we found that lower CRE and CLD concentration levels, strong capital positions, and minimal dependence on non-core funding were key differentiating characteristics. Our research also revealed a correlation between high CLD concentration levels and the likelihood of failure during the recent financial crisis. 

Based on our mandate to assess the bank failures to determine how losses to the Deposit Insurance Fund might be avoided in the future and our assessment of the emerging themes from the failures we reviewed, we recommended that the Director of Banking Supervision and Regulation (BS&R) 

• supplement current examiner training programs with case studies from the recent failures;
• develop standard examination procedures to evaluate compensation arrangements; and
• provide supplementary guidance on CRE concentrations.

We also suggested that the Director of BS&R

• continue to work with the other federal banking agencies to identify opportunities to enhance Prompt Corrective Action;
• define the appropriate supervisory response for highly concentrated state member banks that continue to pursue aggressive growth strategies; and
• encourage and take appropriate steps to implement a supervisory approach that requires strong and consistent supervisory action during stable economic periods.