Actions to support failing banks and financial companies now total $8.7 Trillion as the amount of taxpayer money to fund equity investments, troubled asset purchases, government guarantees of loans, and various other schemes to jumpstart the failing American economy continue to mount. I recognize that global financial institutions are considered too big to fail and must be supported through government intervention in times of great distress and widespread panic or fear. However, actions taken by the Feds intended to help the “bad” are wounding the “good”. Regional and community banks properly managed risk, maintained adequate loan loss reserves for such apocalyptic times, and ignored the short-term profits of “toxic assets”. However, recent actions by the Feds increase the challenge on these banks to make loans and grow profits.
In an attempt to calm the markets, deposit insurance amounts at banks were raised from $100,000 to $250,000. In exchange for deposit insurance, banks pay an insurance premium to the Federal Deposit Insurance Corporation (“FDIC”). The premium is based on their level of risk as assessed by the FDIC and most banks pay anywhere between 5 -43 cents for every $100 deposited. Starting January 1, 2009 insurance rates will go up 7 cents across the board. The higher insurance premium will eat into the profits of banks, which for most are tight or nonexistent in this current market. I expect that consumers will pay for this added expense through higher fees implemented to help generate more revenue. In addition, fewer profits provide less cash available for banks to lend, so credit will remain tight for the consumer. I would add this strategy is different than the one used in the 80’s, when all banks paid a flat rate of 23 cents for every $100 deposited.
Banks are competing aggressively for new deposits and easily noticed when you walk into your branch and see that some CDs are offered with a 4% yield and money market accounts that yield 3%. According to Bankrate.com, the average yield offered on a one-year CD is 3.22%, but prime rate has fallen to 4% in the last year. The most creditworthy borrowers’ access debt at prime rates, so this move is good for them, however, banks’ net margins are pressured, which is the difference between what they can buy the capital at (3.22%) and what the market bears as an effective interest rate (4.00%). The tight profit margin on loans is squeezing banks’ interest income, which is the cash flow they generate from their loan portfolio. More specifically, those banks that operated under good stewardship are most impacted by this squeeze, because it prevents “good” banks from having capital available to lend.
Credit Unions have virtually come through this crisis unscathed due to their conservative risk management principles, but they are restricted to keeping their commercial loan portfolio to 20% of total assets. Several credit unions are well positioned to extend credit to businesses, but are unable to further grow their loan portfolio due to this restriction. Increasing the ceiling would help to spur small business growth on “Main Street”, because most credit unions are driven by the communities where they are located.
Restarting the credit markets is critical to getting our economy stabilized and on the road to recovery with traction, but as moves are taken to protect the big banks from sinking, regulators must not do unintended harm to those banks that managed their shops effectively. Regional and community banks are the lifeblood of Main Street, so in these unprecedented times, elected leaders must protect them and assure their leadership decisions consider the benefits and harm done to one and all, large and small.
