Inspector General Says Fed Failed to Curb Bad Lending Practices that Led to Bank Closures

A new report from the US Inspector General says that the Fed failed to adequately supervise two banks in California and Florida that eventually failed.

From the Bloomberg article:

"Riverside Bank of the Gulf Coast in Cape Coral, Florida, “warranted more immediate supervisory attention” by the Atlanta district bank, Fed Inspector General Elizabeth Coleman said in a report to the central bank’s board. In overseeing County Bank in Merced, California, the San Francisco Fed should have taken a “more aggressive supervisory” approach, Coleman said in another report, also dated Sept. 9.

The findings follow criticism by lawmakers including Senate Banking Committee Chairman Christopher Dodd, who say the Fed failed to curtail flawed underwriting and other lending abuses that contributed to the collapse of the housing market. Another report by the Fed’s inspector general in June faulted the Atlanta Fed’s oversight of First Georgia Community Bank."

Notice that most of the abuses occurred on the lending side of the business. Banks generally fail because bad loans precipitate a loss of confidence in the bank. This leads to a run. To try and counter a run, banks raise their deposit rates.

In most cases, the Fed steps in before this cycle plays out and closes the bank.

The report also addressed deposits:

“Consistent with the report’s recommendation, the Division will remind the districts to provide timely written notification of brokered deposit restrictions to financial institutions deemed less than well capitalized."

Brokered deposits allow banks to raise deposits through brokers. The deposits generally come with higher rates. There has been some discussion of lumping high-yield Internet accounts into the brokered deposits category. That means that if a bank is deemed to be impaired, it would be unable to offer high rate savings and cd accounts. Something similar to this played out with Ally Bank several months ago.

As more banks fail, expect the FDIC and other regulatory bodies to force banks to tighten up both lending and deposit requirements.