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Speeches & Testimony
Remarks by FDIC Chairman Sheila C. Bair to the Florida Bankers Association, Sarasota, FL
September 4, 2008
I'd like to start with an overview of the industry's performance, and then talk about emerging liquidity problems that we're seeing across the industry, and the need for a rainy day backup plan to raise cash quickly.
2nd quarter bank earnings
As you've probably heard by now, industry results in the second quarter were pretty dismal.
The industry earned just $5 billion in the second quarter, which is well below the $30 billion-plus record earnings that we had been seeing over the past few years.
By any yardstick, it was another very rough quarter.
But the results were not surprising as the industry coped with financial market disruptions, the housing slump, worsening economic conditions, and the overall downturn in the credit cycle.
The main reasons for the drop off are the same that we've been seeing since the second half of last year:
The most significant negative factor overall in the second quarter was increased expenses for credit losses.
We flagged all these trends last quarter, and urged banks and thrifts to beef up reserves enough to cover any potential credit losses.
And in the second quarter, you devoted almost one-third of your operating revenue to building up reserves.
Getting the house in order
Something that you've all heard me say, but that bears repeating: it's absolutely critical that you get your balance sheets in order.
You simply must accept that the credit downturn is far from over. It's a tough slog but there's no easy way out.
Banks in danger rising
The number of "problem" institutions continues to rise as well.
While we don't see a return to the record high earnings of previous years anytime soon, most institutions remain fundamentally sound.
Banks have taken steps to encourage capital formation.
Even so, retained earnings keep declining, because of a more rapid drop-off in net income.
Nevertheless, these are appropriate steps to deal with a challenging operating environment. And we welcome these efforts to shore up balance sheets.
Need for smart liquidity risk management
Asset quality problems are putting more pressure on the funding side of the balance sheet.
Ten banks have failed so far this year, and more will fail and others will go on the "problem" list.
Having enough cash, securities and other marketable assets on-hand is absolutely vital.
The same can be said for the ability to maintain stable funding from core deposits and other funding sources.
But liquidity can be an elusive thing.
Liquidity squeeze: early warning signs
Liquidity can be plentiful when times are good, but scarce when it's really needed.
Liquidity problems can often hit an institution fast and hard, which is why it's so important to have ample liquidity on hand and readily available.
Some of the early signs that can alert us to liquidity problems include:
You should know that at FDIC, we are revisiting our off-site monitoring to better detect these problems to help on-the-ground examiners identify and resolve them promptly.
FDIC liquidity letter
We highlighted our concerns about liquidity management last week in a letter to top executives at banks that the FDIC supervises.
The guidance in the letter is not new. But it clarifies our expectations framed in today's terms.
Bankers must understand the stability and volatility of the funding sources they use.
If a bank relies on volatile, and credit-sensitive liquidity strategies and other complex strategies like securitization and secondary market sales, management should step-up liquidity risk measuring, and monitoring.
To put this in perspective, consider the banks that failed so far this year.
Banks should have comprehensive contingency funding plans, which will include pro forma cash flow statements.
Backup plans and pro forma cash flow statements should address multiple stress scenarios, factoring in the various "what-ifs" that might influence funding options.
A good contingency funding plan will:
Pro forma cash flow statements are a key part of the contingency plan. They show where funding gaps and mismatches exist between assets and liabilities.
Restrictions on brokered & high-rate deposits
The FDIC letter also reminds bankers that there are certain deposit restrictions on brokered and high-cost deposits.
Many banks that relied on volatile funding may now be facing new funding challenges if their capital levels drop and they fall into one of the lower capital categories we use for "prompt and corrective action."
Why does this matter?
Currently, there are several dozen institutions nationwide that are borderline "well-capitalized" and whose brokered deposits as a percentage of assets exceeds 25 percent.
These are the types of trends that concern us, and that will be the subject of much closer scrutiny by our examiners.
We have the power to grant a waiver for a bank that falls to "adequately-capitalized."
The restrictions on high-cost deposits, in the current rate environment, can significantly limit a bank's ability to renew brokered deposits even if they DO get a waiver.
These restrictions are very significant considerations for many bankers these days.
And they're another factor that examiners will evaluate as part of banks' contingency planning, and liquidity risk management.
Now, I'd like to speak briefly about the deposit insurance fund.
First, and foremost, the fund has all the resources and the tools we need to meet our commitment to insured depositors.
We're confident that our industry funded reserves will be more than adequate to cover any losses caused by more bank failures.
But the public should understand that we have multiple tools at our disposal to maintain our insurance guarantee.
Recent bank failures pushed the insurance fund's reserve ratio below the 1.15 percent statutory minimum.
We had anticipated that this might occur.
In early June, I warned Congress that a significant increase in insurance losses could push the fund below the minimum.
With the reserve ratio now below 1.15 percent, we're required to develop a restoration plan to increase the reserve ratio to no less than 1.15 percent within five years.
We've been working on a plan over the past couple of months that the FDIC's board will consider in early October.
DIF funding sources
Despite the recent draw-down to cover losses, the insurance fund is in a strong financial position to weather a significant increase in bank failures.
Another point is that the fund is a 100 percent industry-backed.
Because we have the power to raise premiums to cover our losses, in effect, the capital of the entire banking industry is available to support the fund.
We also have a line of credit at the Treasury. This would enable us to borrow, if needed, up to $30 billion to cover additional losses. But we don't expect to have to use this line.
For short term liquidity needs, we also have a separate credit line at the Treasury.
We will certainly see more banks fail.
But given the stress analyses (including high-loss scenarios) that we've been doing for over a year we're confident that our industry funded resources available to the insurance fund are more than enough to cover projected losses.
But ultimately, insured deposits are guaranteed by the full faith and credit of the United States government.
Conclusion: still a silver lining?
When I was here last December, I said I saw a silver-lining to all the problems we've been having.
I'm an optimist by nature. And I still believe we could see a renaissance in Main Street banking in the years ahead after we get through the current mess.
Thank you very much.
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