Leaving Small Bank Regulation to the States with a Caveat

On Friday evenings I always put up a short post chronicling the banks seized by the FDIC. One constant that kept popping up was the high number of Georgia banks that kept popping up on the list each Friday. I asked several times if anyone knew why there were so many but never got any satisfactory answer. Well, the WSJ provided it yesterday.

It turns out that I wasn’t hallucinating. There is a disproportionate number of failures in Georgia and even after the crisis ebbs it’s unclear that the underlying cause is going to be addressed. Here’s the Journal’s analysis:

The state is home to just 4% of all U.S. banks, but 20% of the nation’s bank failures since August. More banks have collapsed in Georgia than in any other U.S. state, even foreclosure-racked California and Florida. Six Georgia banks have been seized by regulators this year, burned by too much expansion in the past decade and bad real-estate bets.

Given the high level of delinquent loans haunting the remaining Georgia-based banks, more failures are expected. About 30 banks in the state are at risk of failing, according to bankers and lawmakers.

“Georgia is basically the Chernobyl of banking right now; it’s radioactive down there,” said Camden Fine, head of the Independent Community Bankers of America, a trade group.

Even after the recession ends, the problems dragging down Georgia banks could resurface in the next downturn, because the regulatory revamp being drawn up by the Obama administration likely won’t tackle one cause of the problem: the division of power between state and federal regulators.

Looks like the age old problem of shopping for the least bad regulator. Make sure that your primary regulator is compliant and under staffed and away you go. You’re always going to have to deal with the FDIC but odds are you won’t really butt heads with them unless things really fall apart.

Interestingly, Tyler Cowen this morning had a post on regulation that plays into this issue a bit. Towards the end, he offered two ideas he would like to see take root in regulatory reform. They were:

a. Do not trust the states with anything really important.

b. Do not trust international agreements with anything really important.

We’ll just deal with point a. The question that seems to me to arise is should we really worry about these penny ante banks in Georgia and elsewhere? Note Cowen says not to trust the states with anything really important. I might be willing to submit that worrying about several hundred or even several thousand small banks isn’t really that important and is just as well left with the states.

Maybe the regulators should just concentrate on the big banks or more appropriately on the banks that hold a disproportionate percentage of the assets of the system. Now it might turn out that a lot of small banks hold a fairly high percentage of the assets but the ownership is so dispersed as to limit any one bank or even regional group of banks from taking down the house. In that case, let them and the state regulators go their merry way and spend your resources on policing the banks that individually can destroy the system.

One option might well be to leave regulation to the states but put them on notice that they have a certain amount of FDIC insurance that will be available to support existing and new banks in their states. Bank failures under their watch will result in a diminishing quota. Now there’s an incentive to aggressively regulate. It will be up to them to explain to prospective new bank investors, who generally tend to be well connected, why they can’t get deposit insurance.

Georgia is clearly over-banked and the implications are pretty clear. It’s a problem created by the state which looks to the federal government for help when the going gets bad. At the same time they want the federal government to keep the support (FDIC insurance) flowing regardless of their inability to control the banks under their purview. The solution doesn’t need to be elegant. Make them accountable for their responsibility.

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