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The use of capital ratios to trigger intervention in problem banks: too little, too late

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  • Joe Peek
  • Eric S. Rosengren

Abstract

A wave of depository institution failures and dramatic losses to deposit insurance funds occurred in the 1980s and continued into the 1990s. In response, the Congress passed a series of bank regulatory acts intended to address the problems that led to the crisis and prevent its recurrence. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) was the capstone of this transformation of banking legislation, with two key provisions designed to reduce the cost of troubled banks to the deposit insurance fund: early closure of failing institutions, and early supervisory intervention in problem banks, referred to as prompt corrective action.> This article considers whether the capital ratio thresholds that trigger prompt corrective action intervention provide sufficient lead time for successful intervention at troubled banks. The study finds that because prompt corrective action is based on a lagging indicator of a bank's financial health, it is likely to trigger intervention in problem banks only after they have been identified by examiners, who rely on far more information that the capital ratio. The authors propose two simple measures to improve the current triggers for prompt corrective action.

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Bibliographic Info

Article provided by Federal Reserve Bank of Boston in its journal New England Economic Review.

Volume (Year): (1996)
Issue (Month): Sep ()
Pages: 49-58

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Handle: RePEc:fip:fedbne:y:1996:i:sep:p:49-58

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Keywords: Bank supervision ; Federal Deposit Insurance Corporation Improvement Act of 1991;

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Cited by:
  1. Jonathan Njoku, 2012. "Surveillance model of going concern in banking," African Journal of Accounting, Auditing and Finance, Inderscience Enterprises Ltd, vol. 1(1), pages 40-76.
  2. Joe Peek & Eric S. Rosengren, 1996. "Will legislated early intervention prevent the next banking crisis?," Working Papers 96-5, Federal Reserve Bank of Boston.
  3. George J. Benston & George G. Kaufman, 1997. "FDICIA after five years: a review and evaluation," Working Paper Series, Issues in Financial Regulation WP-97-01, Federal Reserve Bank of Chicago.
  4. Raj Aggarwal & Kevin T. Jacques, 1998. "Assessing the impact of prompt corrective action on bank capital and risk," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 23-32.
  5. Andrew Kuritzkes & Til Schuermann & Scott Weiner, 2002. "Deposit Insurance and Risk Management of the U.S. Banking System: How Much? How Safe? Who Pays?," Center for Financial Institutions Working Papers 02-02, Wharton School Center for Financial Institutions, University of Pennsylvania.
  6. Rahul Dhumale, 2000. "An Incentive Based Regulatory System: A Bridge Too Far," ESRC Centre for Business Research - Working Papers wp170, ESRC Centre for Business Research.
  7. Claessens, Stijn & Klingebiel, Daniela, 1999. "Alternative frameworks for providing financial services," Policy Research Working Paper Series 2189, The World Bank.

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