Small-gauge lenders running out of steam

As more US banks come off the rails the Obama administration is pushing for sweeping reforms, while many community lenders are heading for the buffers.

WASHINGTON - APRIL 13: (L-R) James Vanasek former risk officer, Washington Mutual Bank in Scottsdale, Arizona, Ronald Cathcart, former risk officer, Washington Mutual Bank in Seattle, Washington, and Randy Melby former general auditor, Washington Mutual Bank in Miami, Florida, raise their right hands as they are sworn in during a Senate Homeland Security and Governmental Affairs Committee hearing on Capitol Hill, on April 13, 2010 in Washington, DC. The committee is hearing testimony on the financial crisis on Wall Street and the role of high risk loans.   Mark Wilson/Getty Images/AFP== FOR NEWSPAPERS, INTERNET, TELCOS & TELEVISION USE ONLY == *** Local Caption ***  293529-01-10.jpg *** Local Caption ***  293529-01-10.jpg

Banks in the US are disappearing at a rate of more than one every two days this year. This rate of attrition is the same as the frequency of railway accidents in India. So does this mean banking in the US is in as poor a state as the subcontinent's famously creaky mass transit infrastructure? Granted, it is not exactly a fair comparison, not one that most US bankers would welcome, but it does highlight the fact there are fundamental flaws in the banking system that are causing these bank malfunctions.

The US banking system is dauntingly large. Just ask the US government, which has spent the best part of two years and billions of dollars trying to shore it up. But amid all the talk of fat cats, the evils of investment banking and the murmurings in the US capital of public trials for bonus takers, perfectly innocent smaller institutions, many founded as family businesses, are slipping into history.

The cascade of bank failures is even leading to whispered questions in some quarters about the sustainability of a US recovery. When will the disappearing banks act end? Sheila Bair, the chairman of the Federal Deposit Insurance Corporation (FDIC), said this month that next year would see a significant improvement. How significant that improvement turns out to be might decide if the number of failures are a function of the recession or a symptom and signal of more pain to come.

Last year, 145 banks failed across the US, the highest number since the savings and loans crisis of the early 1990s. And despite the growing evidence of an economic recovery, at this rate, this year is going to be even worse with bank closures passing the 160 mark. The names that are vanishing are many and varied, and the reasons are just as diverse. On the one hand there is old-fashioned alleged fraud. For example, Charles Antonucci, the former chief executive of Park Avenue Bank in New York, was arrested last month after the bank was shut down by regulators, for allegedly trying to steal from the Troubled Assets Relief Programme (TARP), the taxpayer-funded bailout programme.

Investigators claimed Mr Antonucci tried to fraudulently obtain US$11.3 million (Dh41.5m) from the Treasury department's TARP by lying about the bank's capital levels in its November 2008 application for bailout funds. The press photo of a bespectacled and seemingly dazed Mr Antonucci, unshaven and wearing a hastily donned red, hooded top, is an illustration of the economic woes of the past two and half years.

But the more worrying point is that the bank closures are by no means all about alleged fraud. Many of the lenders that have been forced to close have done so because of the "perfect storm" of market conditions during and after the recession. Two weeks ago, for example, US regulators shut down four banks in Arizona, Georgia and Florida, bringing the total for the year to 41. Most of these were small lenders who had struggled with bad loans tied to commercial property.

The banks seized in the most recent round, including Desert Hills Bank of Phoenix, Arizona, had total assets of $1.24 billion and deposits of $1.1bn, according to the FDIC. The addition of Desert Hills and the other three last week to the growing list of failures means regulators have now seized 181 US lenders since the start of last year. But despite the rate of collapses, some say the government needs to form a body with the power to properly dispose of the ailing, failing companies.

Paul Volcker, the former chairman of the Federal Reserve, said reforms being discussed by Congress touched on the "essential elements" of financial reform, but that a strong government arbitrator must emerge with the power to wind down companies. "There is a clear need for a so-called resolution authority," Mr Volcker told members of the Peterson Institute for International Economics, a Washington-based think tank.

He said huge government bailouts of the insurance giant AIG and other non-bank groups had raised expectations of a government safety net, which could deaden the fear of failure and create a "moral hazard". "There is an expectation that very large and complicated financial institutions will not be allowed to fail," Mr Volcker said. "Unless that conviction is shaken, the natural result is that risk taking will be encouraged and in fact subsidised ? and we may be headed full speed into the next crisis some years ahead. That seems to me to be the core challenge of financial reform."

Barack Obama, the US president, is pressing Congress to adopt sweeping reforms of the financial sector as he seeks to capitalise on the deep-seated anger in the US and beyond at the role banks played in the recession. And despite continuing challenges and uncertainty over future regulation, there are reasons to believe US small-bank lending could pick up by the end of the year, even though failures and industry challenges will be an ongoing issue, a Federal Reserve official said recently.

There could be signs that smaller banks are escaping the wrath that is still vented frequently and often unfairly at investment banks. Elizabeth Duke, a member of the Federal Reserve board of governors, said at a recent banking conference policymakers were sensitive to the challenges faced by smaller banks rather than their Wall Street rivals and wanted to encourage prudent lending. "Improvements in a number of the conditions that depressed lending in 2009, however, lead me to be somewhat optimistic that we will begin to see an increase in bank loans later this year," said Ms Duke.

She stressed that most of the nation's community banks were "fundamentally sound" but acknowledged some continued to face significant stress from problem loans, particularly in the commercial property sector. Bank failures could "remain elevated for some time", Ms Duke added. It seems clear that over the coming months banks will continue to fail and there will be more pain, some of it acute, to endure in the short to medium term.

But given a fair wind, a steady regulatory hand and a realisation on the part of consumers and lenders alike that the landscape has fundamentally and permanently changed, the banking system in the US could get back on track next year. Now for those Indian trains ?