Factors related to the failure of FDIC-insured US banks
| DOI | https://doi.org/10.1108/JFRC-08-2020-0075 |
| Published date | 20 August 2021 |
| Date | 20 August 2021 |
| Pages | 82-106 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Mario Jordi Maura-Pérez,Herminio Romero-Perez |
Factors related to the failure of
FDIC-insured US banks
Mario Jordi Maura-Pérez and Herminio Romero-Perez
Department of Business Administration, University of Puerto Rico in Carolina,
Carolina, Puerto Rico
Abstract
Purpose –This study aims to analyze the factors related to the failure of 535 Federal DepositInsurance
Corporation(FDIC)-Insured United States banks in conjunctionwith the 2008 financial crisis.
Design/methodology/approach –The research consists of an analysisof the following three five-year
partitions: pre-crisis(2002–2006), crisis (2007–2011) and post-crisis (2012–2016).The main hypothesis is that
the factors explainingbank failures vary by period. Using logistic regression analysis,the authors identify the
desirablemodels by period based on three model selectionstrategies.
Findings –Liquidity and non-risk-based capital ratios are important explanatory factors in all three
periods. As the authors can see from the results, when comparingthe full period (2002–2016) and the three
five-year period partitions (2002–2006,2007–2011 and 2012–2016), the ratios change from period to period,
but they measure the same financial areasof concern in different contexts as follows: liquidity, leverage/risk
exposureand capital adequacy. Risk-based capital ratios are not effectivepredictors of bank failures.
Originality/value –Recent academic studies have analyzed bank failures during periods that cover the
years before, during and after the crisis, but most of these studies discuss bank failures in the forecasting
context only. This study includesan analysis of failure determinants during pre-crisis,crisis and post-crisis
subperiodsbased on the FDIC monitoring system of bank failures and identifies what ratiosare more relevant
during eachperiod and how they change from period to period.
Keywords Logit model, Financial institutions, Bank failures, LASSO technique
Paper type Research paper
1. Introduction
A total of 535 Federal Deposit Insurance Corporation (FDIC)-Insured United States (US)
banks failed during the 15-year period ending in 2016 (Table 1). The financialcrisis of 2008
started a downward spiral in theUSA and other international economies generating a great
amount of instability and uncertaintyin international financial markets. This financial crisis
has been documented as the most severe,as the Great Depression of the 1930s (Shomali and
Giblin, 2010). The crisis was mostly driven by the collapse of the US housing market
(Trussel and Johnson, 2012) and the subsequent collapseof the subprime mortgage market,
which expanded dramaticallybetween 2001 and 2006, together with a high rate of mortgage
defaults and delinquencies, among other economic factors. Croci et al. (2016), stated that
FDIC receivership of failed banks, during the crisis period, was more than 10 times higher
than that of the expansion period that preceded the credit crisis. The low number of bank
failures during this expansion period could also be attributed to inefficient “prompt
corrective action,”a concept placed into law in the US in the 1990s as part of the FDIC
The authors appreciate the comments of Javier Rodríguez, John Ashton (the editor), and three
anonymous referees. In addition, the authors appreciate the feedback of workshops participants at
the 2018 Multinational Finance Society Conference and University of Puerto Rico. This research was
supported by funding from the University of Puerto Rico in Carolina.
JFRC
30,1
82
Received17 August 2020
Revised15 February 2021
4 May2021
11July 2021
Accepted18 July 2021
Journalof Financial Regulation
andCompliance
Vol.30 No. 1, 2022
pp. 82-106
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-08-2020-0075
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1358-1988.htm
Improvements Act of 1991, thoroughly discussedin Cole and White (2017). This change in
the US economic landscape, during the crisis, led to a series of bank failures. In response to
the global crisis that ensued and because banks entered the crisis with excessive leverage
and inadequate liquidity combined with poor risk management and governance, the Bank
for International Settlements’(BIS) Basel Committee on Banking Supervision strengthened
its existing capital accord, giving way to the creation of the Basel III Accord and leverage limits
(Bis.org,2018a, 2018b). Basel III introduced the following five categories of capitalization for
insured depository institutions to satisfy Prompt Corrective Action as follows: well-capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. Banks were required to have a greater common equity component in Tier 1
and Total Capital. Also, as part of the subsequent administrative law and financial sector
reform, the US Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection
Act (2010) (Dodd-Frank Act; P.L. 111–203, 124 Stat.1376).
The leverage ratio was introduced in 1981, in the case of the USA, by bank
regulators concerned about rising failures and falling bank capitalization across the
banking system, resulting in the establishment of uniform capital requirements
(Volcker, 1987;Wall and Peterson, 1987;Wall, 1989;Brei and Gambacorta, 2014;
Table 1.
Number of FDIC-
insured US banks
failures
No. of failures Total assets ($)
FDIC estimated
loss ($)
FDIC estimated loss
/total assets (%)
Panel A: By year
2002 6 1,526,009 126,084 8.3
2003 5 156,348 14,386 9.2
2004 1 56,774 2,998 5.3
2006 1 15,760 9,438 59.9
2007 4 2,670,674 162,986 6.1
2008 44 381,371,700 20,431,195 5.4
2009 160 182,351,083 30,159,381 16.5
2010 142 79,784,408 13,529,458 17.0
2011 82 29,851,614 6,024,199 20.2
2012 39 7,308,484 1,425,202 19.5
2013 25 6,303,043 1,247,716 19.8
2014 17 8,495,045 1,118,534 13.2
2015 5 473,796 68,549 14.5
2016 4 210,067 35,518 16.9
Panel B: By period
P1: 2002–2006 13 1,754,891 152,906 8.7
P2: 2007–2011 432 676,029,479 70,307,219 10.4
P3: 2012–2016 90 22,790,435 3,895,519 17.1
Panel C: Full period
2002–2016 535 700,574,805 74,355,644 10.6
Notes: Total assets and FDIC estimated loss is expressed in thousands. Based on the failure effective date, we
found 541 bank failure cases for the considered study period from 2002 to 2016. For regression analysis
purposes, we classify the bank failure cases by year based on the quarter of the last available financial
statement. There are 6 bank failure cases at the beginning of the year 2002 that were excluded for the analysis
because the last quarter of available data is in the year 2001. Total assets and FDIC loss presented in Table 1
correspond to the amount estimated by the FDIC at the failure effective date, but the cases are classified by the
year of the last quarter of available data. Although the analysis is done for the 535 bank failure cases, there may
be some regressions that include less cases due to missing values of explanatory variables
FDIC-insured
US banks
83
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