Saturday, August 13, 2011

Has FDIC created a new 'moral hazard'?

The discussion in the podcast (above) pretty much tells us that bank regulations are going too far in telling banks how to manage their portfolios. It cites a good example, Main Street Bank.  This small bank in Kingwood, TX is changing its business model mainly for one reason - too much regulation. As mentioned in the WSJ earlier this week, Main Street gave up the benefits of its deposits being insured by the FDIC; it is no longer a 'bank'.

The FDIC is basically discounting banks' incentives to manage their own risks. Most banks, with the FDIC deposit insurance, now have the incentive to hold more securitized assets and take other types of risks. But the smaller banks that are just fine with a portfolio of 90%+ small business loans (which are not usually securitized), are getting pressured and fined by the 'standards' that FDIC is enforcing, which are not necessarily applicable to those banks.

The capital standards that are being enforced are pushing banks to favor certain types of assets. Main Street Bank has basically said that it is not interested in deposits nor securitized assets. For this reason, it feels it can do better without the protection and bullying provided by the FDIC (sounds very similar to what the old-timer mafia bosses used to do). Hey, FDIC, 'say hello to da new moral hazard friend!' :)

Main Street will continue to lend to qualified individuals and small businesses. This actually helps increase productivity and growth. Its capital is in the form of equity (provided by other parties) rather than deposits. More detail regarding Main Street's decision is in this article - Fed Up: A Texas Bank Is Calling It Quits. The podcast is very interesting.

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