The U.S. banking system has been battered by recessions, high interest rates, falling energy prices, the debt crisis in Latin America and the risky lending practices of some big and small banks alike.
Bank failures, troubled banks and problem loans are at or near record levels.
Profits at many banks, especially the biggest, are lower than would be expected nearly two years into an economic recovery. Banks have been salting away profits to boost their reserves for possible loan losses. But their profits also are being hurt because many borrowers aren't paying their loans on schedule, and some aren't paying at all.
Nevertheless, regulators and analysts say that the worst seems to be in the past. By the end of the year, the nation's banks as a whole should be improving, although problems will remain among energy and agricultural lenders.
The nation's 15,000 banks are not isolated from the rest of the economy. Like their consumer and business customers, the banks have been through the nation's worst economic performance in the postwar era.
Still, if there is one common theme in nearly all bank failures, it is bad management, said William M. Isaac, chairman of the Federal Deposit Insurance Corp. Good economic times -- or even rising inflation -- can cover up bank errors. It is when times get tough that poor lending practices -- such as excessive loans to marginal risks or concentration of too many loans in one industry -- become apparent.
Analysts and regulators say that the shakeout that occurs in the aftermath of a recession is over. Most banks always have been healthy, and they weathered the recession as most companies did: with reduced earnings. The banks that were not so healthy are starting to get better now, and the bulk of the worst cases have failed or are nursing themselves back to health.
"The system is in reasonable shape, and the situation is improving," according to Federal Reserve Board Governor J. Charles Partee.
"That should come as no surprise," Partee said. Just as banks hurt when their borrowers are weakened by a recession, so banks find themselves in better shape when an improving economy increases their customers' profits and cash flow, making it easier for them to repay their debts, the Federal Reserve governor said.
The surprise is that the recovery of the banking system is taking so long.
Generally, bankers do not begin to see their problem loans rising and their profits eroding until well after a recession has begun. Similarly, the recovery at banks usually starts well after the Commerce Department detects recovery in the nonfinancial economy.
But by now, the regulators' list of problem banks should be shrinking, not merely rising at a far slower pace than in 1983 or 1982, according to Comptroller of the Currency C. T. Conover.
FDIC Chairman Isaac said one explanation for the delay in the recovery of the banking system is that the problems of the last eight to 10 years "simply were more serious" than those plaguing the economy and the banking industry earlier in the postwar era.
"Interest rates were much higher, the recession was much deeper. It's taking them a longer time to come back," Isaac said.
Part of the problem is the spottiness of the economic recovery, Isaac said. "Some industries are doing very well. Others are not." Banks whose primary customers are in energy or agriculture have benefited little from the rebound. But even if more agricultural and energy lenders see their fortunes decline, they should be dwarfed by the numbers of banks who see their prospects improving.
The residue of the serious economic problems and the spottiness of the recovery can be seen in the statistics:
*U.S. banks are failing at a rate unmatched since the Great Depression. Regulators say privately they expect more than 60 banks to fail this year, more even than in 1939 when the Depression was ending. So far this year, 55 banks have failed, compared with 48 during all of 1983. The recent failures are of bigger banks, too. During the last three years, banks with combined assets of $25 billion have failed. In the previous 47 years, the assets of failed banks added up to about $9 billion. By next year, however, regulators think the pace of bank failures will slow substantially.
*Regulators still are adding more banks than they are removing from their problem lists, although the number of problem banks -- those that regulators think are in danger of failing or have serious problems -- is growing far more slowly today than in 1982 and 1983. FDIC Chairman Isaac said that 725 banks -- about 5 percent of the nation's total -- are on the so-called problem lists. Those banks control a similar percentage of the system's $2.5 trillion in total assets. Most of them will get better rather than fail. There are about 75 more problem banks than there were nine months ago. But last year their numbers were growing by 30 a month. Another 1,400 of the nation's 15,000 banks whose problems are less serious are being watched carefully by regulators.
Problem loans and problem banks have been around since the advent of the industry. But the growing proclivity of big depositors to pull their funds when a bank is in trouble adds a new dimension to the problems of the banking system and the regulators.
The essence of banking is confidence. If depositors lose confidence in a bank, whether or not the bank is financially healthy, the bank is at risk. A solvent bank that can't attract enough funds to finance its loans and assets cannot stay in business.
That's what happened to Continental Illinois National Bank, not long ago the nation's sixth-biggest bank. Depositors finally deserted the institution in droves last spring in the biggest run on a financial institution in history.
The bank had been plagued by rising problem loans, many of them to oil and gas borrowers, since the middle of 1982. But no new developments emerged in mid-May, when suddenly depositors -- many of them foreign -- began to pull out their funds. Federal banking regulators worried that the failure of the multinational bank could sabotage the entire banking system -- the Chicago bank had $41 billion in assets last March. The government stepped in with the biggest rescue package in history.
Continental is the most vivid example of the role of confidence in banking. Although it was a weakened institution, the bank is solvent today even after regulators forced it to write off about $1 billion in problem loans.
Other, far smaller, banks have faced similar runs. The depositors most likely to pull out are not small consumer depositors. Their deposits are insured up to $100,000 by the FDIC. Those most likely to panic are the professional investors with deposits in excess of the $100,000 insurance limit.
The bigger the bank, the more likely it is to have a heavy concentration of large-sized deposits. Bankers say privately they worry that a similar crisis in confidence -- founded or unfounded -- could touch off a run at another major bank with an overload of problem loans.
But in the end, the run at Continental may have calmed the big depositors.
"The health of the system has been underwritten by the fact that Continental Illinois didn't go under," said James Wooden, chief banking analyst for the brokerage firm Merrill Lynch, Pierce, Fenner & Smith.
Comptroller Conover said that the government's Continental package demonstrated to the world that the U.S. government is willing to stand behind its banking system.
But even during the height of the run on Continental -- when the markets were exceptionally nervous and the government's response was unclear -- Manufacturers Hanover Trust Co. was able to stop rumors that it was in trouble, with no help from the government.
Manufacturers, the nation's fourth-largest bank, has the largest concentration of loans to Argentina, the debtor nation that has had the most problems coming to terms with its lenders and its deteriorating economy. It was a likely target for rumor mongers. That Manufacturers staved off rumor problems helped assure regulators and bankers that the lack of confidence in Continental has not spilled over and does not pose a threat to the health of the system.
If the first line of defense against banking problems is a healthy economy and good management, the second line is good regulation. The last is the massive trust fund run by the FDIC.
Regulators have faced increasing criticism from Congress and others in recent years. The problems at Penn Square National Bank -- whose failure in the middle of 1982 triggered the events that led to Continental's disaster -- were well-known to regulators, who tried to correct the situation for years.
Regulators let Continental flounder for a year and a half, as depositor confidence in the bank's management eroded. By the time Conover forced the bank's board to replace Chairman Roger E. Anderson last February, confidence in the big bank's management apparently had sunk too low.
Isaac, Conover and Partee all concede that regulators have missed some problem banks. But they also say that, despite some glaring gaffes, they have a good handle on the system as a whole. They say their job is not to prevent all bank failures but to make sure the system as a whole is healthy. The government's handling of the Continental disaster will be the subject of House Banking Committee hearings next week.
The FDIC's trust fund not only permits the government to pay off depositors in the event of a bank failure, but also gives the government the wherewithal to assist a healthy bank in acquiring a failed one or, as in the case of Continental, to make an investment in an institution to keep it from failing.
Even though the trust fund has had to deal with more and bigger bank failures than at any time in the nation's history, Isaac said that, with the assessments it levies on bank deposits, the income it receives from the government securities it invests in and the funds it collects on the assets of failed banks that it is forced to acquire, the fund has grown by $5 billion in the last three years.
It is the existence of the trust fund -- which can draw on Treasury funds if it needs to -- that is supposed to underwrite the confidence in the banking system as a whole. Regulators said it would take a wholesale economic collapse -- perhaps on the scale of the Great Depression -- to trigger enough big bank failures to threaten the trust fund.
The economic collapse itself would be far more dangerous to the nation than the banks it pulled down in its wake.
"If you really worry about depleting the trust fund, you're worrying about the wrong thing," a key government official said.
To say that the banking system is fundamentally healthy is not to say that there are not possible cata-See BANKS, F7 clysms that would jar the system severely. But regulators think most of the identifiable problems -- in Latin American lending, energy lending and farm lending -- can be coped with and that new shocks from those sectors are unlikely.
Comptroller Conover said that a sudden change in the Latin American debt picture could pose a grave threat to the nation's banks -- which have loaned about $86 billion to the Latin American borrowers. But he said the likelihood that major borrowers such as Mexico, Brazil, Venezuela or even Argentina would default seems remote. If anything, prospects for a resolution of the Latin American debt crisis seem brighter than they have at any time in the last two years.
Even if all major borrowers were to default, regulators and banks feel they could handle it -- in part by spreading the shock to bank balance sheets over a period of years and in part by ensuring that banks had enough funds to keep them afloat. But a default would impair banks so seriously that their ability to make new loans would be restricted and could hurt the overall economy.
A severe and sudden collapse in energy prices also would hurt the banking system. "We'd all be better off if oil prices were $20 a barrel rather than $29," Conover said. But if prices declined precipitously, a number of energy borrowers would be hurt and the quality of their loans impaired. On the other hand, if the decline were gradual over a number of years, the borrowers and the banks would be able to adjust.
The Fed's Partee, like Conover, thinks the possibility of another sudden plunge in energy prices is remote.
The farm sector remains in trouble, in part because the land farmers use as collateral on their loans has been declining in value at the same time the prices they receive for their crops is declining. But while a number of smaller banks are primarily farm lenders -- bad farm loans triggered the failure of a $24 million-asset Nebraska bank last week -- and will feel the pinch, farm lending makes up too small a portion of the overall system to pose much of a threat.