Tuesday, August 18, 2009

FDIC's new rules on bank acquisition reek of socialism

The industry comments are in for the proposed FDIC rules dealing with failed bank acquisitions by private equity funds. If these rules go into effect as they are, the FDIC will not be able to sell another failed bank directly to an alternative investment firm - one of the few sources of private capital still available. And in some instances failed bank liquidation may become the only option, putting FDIC and the taxpayer deeper in the hole (see FDIC looking for half a trillion dollar life )

The rules, as proposed, make no sense. If a bank wants to acquire another bank, the target bank must have a post-acquisition capital ratio (book equity to assets) of 5%. If someone wants to start a brand new bank, the ratio needs to be 8%. But under the new proposal if a private equity were to purchase a bank, the capital ratio needs to be 15%.

One of the reasons the FDIC is pushing for this rule is their concern that private equity firms expect to make high teens to low twenties returns on their bank purchases. How dare they! Making money is a crime these days. So let's force them to put up more capital to bring the returns down to single digits. That will teach those PE firms. Now if you are a state pension fund and a private equity firm told you they are targeting an acquisition with a 9% expected return, would you invest? No way.

The other rule the FDIC is trying to impose is to force PE firms who have more than one bank in their portfolio to use profits from one bank that's in good shape to prop up another bank that may be struggling. If you are an employee or a creditor of the healthy bank and the regulator tells you that it's time to give up some profits to feed a failing bank that has nothing to do with you, you would call that socialism.

FDIC would also require that private equity firms hold on to banks they have purchased for at least 3 years. If you buy a bank, turn it around in a year, and now a larger bank offers to buy it from you, why should you be forced to wait?

Here is another example of a US agency cutting off the nose to spite the face. The FDIC should ensure that the new owners run the bank effectively and prudently, working to rebuild a failed institution. Setting up socialist type rules will only serve to keep private funds away from failed institutions, ultimately hurting the FDIC and the taxpayer.

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