Banking due diligence in the new financial world.

• Author: Evangelisti, Cynthia J.

The financial world is changing every day A record number of banks have gone under, and interest rates have hit rock bottom. What this means is that finance officers need to understand what is happening in the banking system and be more careful than ever about due diligence. And to do that, it is necessary take a step back and see what has been going on in this new financial world.

DISORDER IN THE BANKING SYSTEM

The current situation brings to mind a 1936 episode of"The Three Stooges" called "Disorder in the Court." The plot goes as you might expect: a debacle ensues as the Stooges provide testimony on a case. The word "disorder" especially resonates. This recession has created irregularity and a breach of stability in the U.S. banking system, causing confusion and public discord. While there is nothing laughable about the impact of the sub-prime market crisis and its continued rippling effect on the economy, the situation does at times seem like a farce.

In November 2008, a former vice chairman of the Federal Reserve was quoted as saying: "The public is left in the dark about the financial condition of all banks. How are people supposed to know what's going on in depths of the bank's balance sheets when the regulators, as we've learned in this crisis, don't even know?" (1) Since then, there have been signs that the economy is slowly stabilizing, yet hiccups in the recovery remain--including the continually escalating number of bank failures.To avoid future financial melt downs, new and proposed rules to overhaul the financial system require additional capitalization by the banks, potential consolidation of the regulators, and the imposition of further regulations on the system.

THE FDIC'S GROWING PAINS

It has been said that the Federal Deposit Insurance Corporation (FDIC) was born of a crisis and made for a crisis. (2) Congress created the FDIC in 1933 as an independent agency in response to the Great Depression, a period when approximately 4,000 banks collapsed. The agency's original purpose was twofold: to insure bank deposits and to close failing banks. The FDIC also shares regulatory duties with other federal agencies, including the Office of Thrift Supervision, which oversees chartered savings and loans, and the Comptroller of the Currency, which monitors national banks and state banking regulators' review of state-chartered banks. (3) The Obama administration's proposed financial oversight plan includes a recommendation to consolidate all the federal bank regulatory agencies into a single one, the Consumer Financial Protection Agency The agencies and a number of industry associations oppose this proposal, arguing that it will create more confusion and public discord about the banking system.

Part of the FDIC'S mission is to monitor the safety and soundness of financial institutions, especially banks on its list of troubled institutions--which reached a 15-year high of 416 as of June 30, 2009 (in an effort to maintain stability and confidence in the banking system and to prevent a run on the banks, the list is not made publicly available). More than 100 banks are expected to fail in 2009, and more than 1,000 are expected to fail from 2009 through 2012, costing the FDIC approximately $70 billion. The string of banks failures has also brought the insurance fund to $10.4 billion, its lowest level in more than 10 years. In spring 2009, the FDIC sought to shore up its insurance fund by asking Congress to grant the agency $100 billion in borrowing authority. It received that authority, along with an increase in its credit line to $500 billion. The agency is also considering imposing an additional special assess ment fee on the banks before the end of the year, which may further add pressures on already struggling banks.The current situation is a matter of concern for finance officers on two fronts: 1) the continual increase in the number of bank failures, and 2) the impact of such failures on the ever-dwindling insurance fund. These issues might eventually affect taxpayers and even government agencies because they could cause banks to charge higher fees for conducting day-to-day business transactions.

At the same time, the FDIC is seeking to broaden the agency's powers by obtaining further authority over the banks, arguing that the agency has a vested interest, since it insures approximately $4.3 trillion in bank deposits...