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Board Report:  March 31, 2011

Review of the Failure of Independent Bankers' Bank


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Independent Bankers' Bank (IBB) opened in 1986 as a state-chartered member bank of the Federal Reserve System. IBB was supervised by the Federal Reserve Bank of Chicago (FRB Chicago), under delegated authority from the Federal Reserve Board, and by the Illinois Department of Financial  and Professional Regulation (State). On December 18, 2009, the State closed IBB, under its emergency authority, due to concerns about IBB's ability to continue processing payments on behalf of respondent banks and appointed the FDIC as receiver. According to the FDIC IG, IBB's failure will result in an estimated $20.8 million loss to the Deposit Insurance Fund (DIF), or 2.7 percent of the bank's $773.7 million in total assets. While the loss is not material, we conducted an in-depth review after determining that IBB's failure presented an unusual circumstance because it was a bankers' bank and was unable to continue processing payments on behalf of its respondent banks.

IBB failed because its Board of Directors and management did not effectively control the risks associated with the bank's business strategy. IBB kept service fees low to attract respondent banks and relied on interest income from its investment portfolio to supplement income. The bank acquired collateralized debt obligations (CDOs), primarily backed by trust preferred securities and private label mortgage-backed securities, to obtain higher yields, and developed a concentrated, high-risk investment portfolio. In addition, the bank depended on non-core funding sources to support asset growth and provide liquidity. A sharp decline in economic conditions, coupled with increasing turmoil in the CDO market, led to rapid devaluation in IBB's investment portfolio and forced the bank to recognize significant losses. These losses eliminated earnings, depleted capital, and severely strained liquidity.

With respect to supervision, FRB Chicago complied with the examination frequency guidelines for the timeframe we reviewed, 2004 through 2009, and conducted regular off-site monitoring. Our analysis of FRB Chicago's supervision of IBB revealed that FRB Chicago had multiple opportunities to take earlier and more forceful supervisory action. Earlier action may have been warranted to address (1) IBB's risky business strategy, (2) the Board of Directors' insufficient management of the bank's investment portfolio risk, (3) early indications of economic decline, and (4) IBB's excessive reliance on non-core funding sources. While we believe that FRB Chicago had opportunities for earlier and more forceful supervisory action, it is not possible for us to predict the effectiveness or impact of any corrective measures that might have been taken by the bank. Therefore, we cannot evaluate the degree to which an earlier or alternative supervisory response would have affected IBB's financial deterioration or the ultimate cost to the DIF.

We believe that IBB's failure highlighted several lessons learned that can be applied when supervising banks with similar characteristics. In our opinion, examiners should obtain a comprehensive understanding of the risks embedded in investment portfolios and any external factors that may heighten these risks. Specifically, examiners should gain thorough knowledge of investment product characteristics and risk attributes and be cognizant of market conditions or significant events that may adversely affect the value of an institution's investments. 

We also believe that IBB's failure underscored the unique nature of a bankers' bank and the critical functions that a bankers' bank provides to its respondent banks. Therefore, examiners should (1) closely monitor the condition of a bankers' bank to facilitate immediate response to adverse changes; and (2) evaluate risk exposure stemming from concentrations in loans, investments, and funding sources.