The Risk Professional: US - collapsing banks are too small to notice, not too big to fail

When Shore Bank of Chicago was forced out of business last week and its deposits and assets reversed into a new entity called "Urban Partnership Bank" there was one aspect of the failure that stood out: this was one of very few banks to fail this year which had deposits and "assets" exceeding USD1,000 million.

Its biggest problem was that its deposits were USD1,540 million while its "assets" were USD2,160 million. And falling.

The new bank has entered into a "loss-share" agreement with FDIC, the regulator which supervises failed banks. Already the value of "assets" has been discounted to take account of falling home and other property prices - hence the shortfall against deposits. The "loss-share" agreement allows for the new bank and FDIC to share losses, should they arise, on USD1,410 million of the "assets" purchased.

FDIC has placed an estimate on how much its losses in the stop loss scheme (and other underwriting of losses when a bank fails). That limit is USD367.7 million.

If we assume that three-quarters of that figure will be in relation to continued asset devaluation, that means that the new bank and FDIC think that the current portfolio may fall in value by as much as USD550 million (approx).*

The loss-share scheme is "projected to maximise returns on the assets covered by keeping them in the private sector," says FDIC. What that means is that FDIC doesn't consider it appropriate to manage those assets - in short, it wants a clean break with the dead bank in such a way that FDIC does not become, by default, a "bad bank" and it does so by offering the incoming incumbent a grant of 50% of any shortfall that bad and doubtful debt creates in the incoming bank's balance sheet.

However, incoming banks do not show their half of the risk as a contingent liability in their balance sheets because there is no accounting mechanism for so doing. They merely appear, if they appear at all, as a note to the accounts.

The continuing rate of failures of small banks bodes ill for the US banking sector - and shows that big government is, again, focussed on big money. The banking crisis is not over: the totals at risk in the small bank sector dwarf those of Bear Sterns and Lehman Brothers. The trouble is that each individual bank is, simply, too small to notice instead of being too big to fail.

*Formula: USD367.7 rounded up to 368.

368x75% x 2 is approx 550.