Published: October 09, 2007 12:02 am         

Economist calls for banking overhaul

TERRE HAUTE — A financial economist speaking Monday at Indiana State University is calling for an overhaul of the nation’s banking regulatory system as a way to cut the costs of bank failures.

George G. Kaufman, a consultant to the Federal Reserve Bank in Chicago and professor at Loyola University, told a gathering in ISU’s College of Business that federal deposit insurance is a prescription for failure.

“That’s the wrong policy,” Kaufman said, adding, however, that deposit insurance, such as FDIC in America, is a “political reality” in most of the world.

One problem with government-provided deposit insurance is it encourages banks to behave in riskier ways than they would in the absence of taxpayer provided insurance, Kaufman said.

FDIC insurance guarantees Americans’ bank deposits up to a value of $100,000.

Federal deposit insurance helped pave the way for the $160 billion savings and loan crisis of the 1980s, Kaufman said.

Kaufman is calling for a new system that would allow banking regulators to legally close a bank before it goes bust. Under his proposal, a bank would be considered critically undercapitalized and subject to legal closure if its capital ratio is 2 percent or less, he said.

Closing a bank before its assets become negative would protect small depositors, prevent borrowers from losing access to lines of credit and reduce the chances that the bank’s failure would spread to other banks and result in widespread bank runs, Kaufman said.

“Runs are one of the great, frightening aspects of bank failures,” Kaufman told the gathering of around 80 at ISU’s College of Business in a talk sponsored by the Networks Financial Institute.

Other features of Kaufman’s proposal include allowing some uninsured bank stakeholders to suffer losses when banks are closed, prompt reopening of the closed bank under new ownership and management and the prompt privatization of the bank if still in government hands after reopening.

Kaufman’s talk Monday night comes on the heels of the recent failure of the online bank known as NetBank in Georgia.

The closure of NetBank marked the largest single failure of a savings institution in 14 years.

Kaufman said his system relies on accurate bookkeeping by regulated banks, adding that fraud is the single largest cause of bank failures. “There’s nothing you can do about fraud” except increase the regulatory controls, he said.

Despite the failure of NetBank, U.S. banks are generally much better capitalized today than they were in the 1970s, ’80s and ’90s, Kaufman said.

The Networks Financial Institute, based in Indianapolis, hosts educational talks by distinguished scholars at ISU at least once per semester, said Jack Tatom, director of research at the Institute.

The Institute’s speaker programs are open to the public, Tatom said.

For more information about the Networks Financial Institute, see the organization’s Web site at www.networksfinancialinstitute.org.

Arthur Foulkes can be reached at (812) 231-4232 or arthur.foulkes@tribstar.com.