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Continued from: Banks Lend (or Not) Based in Part on Their Ability to Meet FDIC Rules

So what does all this mean for you? If you went through the ringer during the downturn (say you lost a good-paying job or maybe even lost your home to foreclosure), you may have thought that those setbacks represented the single-biggest impact on you resulting from the financial crisis. If you believe that, however, you are sadly mistaken. Don’t get me wrong: Unemployment and foreclosure are major challenges, and they can have a host of far-reaching implications. But in the scheme of things those are one-time obstacles. In truth, the single-biggest impact on you stemming from the financial crisis is that the credit environment has dramatically changed, mainly because the entire banking landscape has been forever altered. This new economic environment has the power to impact you, your family, and your financial dealings for decades to come, likely for the rest of your life. You might miss that old job or your previous home, but their loss will not impact your credit or your ability to get a loan a decade from now, let alone two or three decades into the future. The new credit environment, however, will continue to have reverberations for decades.

Considering the enormous upheaval the financial community has undergone, can you see why banks and credit-card companies have become a lot pickier about to whom they lend money? They had to. It’s a matter of survival. Otherwise, making too many bad loans can mean the death of a financial institution—even a century-old bank that was once seemingly rock-solid. Look no further than the spectacular collapse of Washington Mutual in September 2008 and its takeover by Chase. WaMu was founded in 1889. For many decades it was considered a mighty financial powerhouse. But with $307 billion in assets and $188.3 billion in deposits at 2,239 branches, WaMu went under in what is to date the single largest bank failure in U.S. history. In fact, as of October 2009, if you examined the biggest American bank failures ever, you’ll find that 72% of those collapses (more than 7 out of 10!) occurred in 2008 or 2009. These bank failures have cost the FDIC billions of dollars and, some say, threatened the stability of the FDIC, the very institution that is supposed to back up banks.

Is the FDIC on Shaky Financial Ground?

As of June 2009, the FDIC had about $42 billion in total resources. This includes money in its Deposit Insurance Fund plus amounts set aside in the agency’s “contingent loss reserves,” funds earmarked for current and future losses. While the FDIC takes pains to tell the public that the agency is in no imminent financial danger and that it will not need to be bailed out by U.S. taxpayers, the agency in November 2009 adopted a new plan requiring all insured banks to pre-pay (on December 30, 2009) their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012.

FDIC Says Costs of Covering Failed Banks Is Taking a Toll

These quarterly premiums are the fees that banks pay in order to receive FDIC deposit insurance. The FDIC asked for $45 billion worth of early payments from its member institutions because the FDIC said that it had underestimated the cost of taking over failed banks and needed immediately to replenish its available funds. In 2009, 140 banks collapsed in the U.S. However, some observers saw the FDIC request as a “gimmick” to help the banking industry because the $45 billion would be treated as an asset on banks’ balance sheets (a prepaid expense, to be exact) and would not diminish banks’ capital or hamper their ability to lend money.

Excerpted from Perfect Credit: & Steps to a Great Credit Rating

Next: Credit Delinquencies on the Rise

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Continued from: The FDIC, Banks, and Your Ability to Get a Loan

There are currently about 8,100 FDIC-insured financial institutions in America. In order for a bank to declare that it is FDIC-insured, it must meet certain financial requirements by the FDIC. Specifically, banks must maintain healthy, federally mandated “capital ratios.” This refers to the amount of capital (or dollars) a bank must have set aside in reserves in order to guard against potential losses. One key capital ratio for banks is called a “risk-based capital ratio,” which measures the capital a bank has (such as its common stock, preferred stock, and undistributed net income/profits) versus the amount of its “risk-weighted” assets. These risk-weighted assets can be anything from corporate bonds and consumer loans (including mortgages, auto loans and leases, student loans, credit cards, and personal lines of credit) to government notes and cash. Corporate bonds and consumer loans all carry a risk rating of 100%, meaning they are highly risky since there’s no guarantee at all that they will be repaid. In contrast, government notes and cash are deemed risk-free.

If the notion of a loan’s being both an “asset” and something “risky” seems a little tricky, let me explain it briefly. A loan/credit line is called a “risk-weighted” asset because, on the one hand, it is an asset, inasmuch as it represents a promise by a borrower to repay that loan/credit line (most often with interest). At the same, a loan is also considered risk-weighted because there’s always a chance that the borrower will not repay a bank as agreed.

Okay, now stay with me here. To get the highest stamp of approval from the FDIC, a bank’s capital must total 10% or more of its risk-weighted assets. Put another way, for every $10 that it loans, a bank must maintain $1 in capital reserves. For example, if Bank A has $1 billion in capital, and that bank has made $10 billion in loans (or extended $10 billion in credit to its customers), then Bank A’s capital ratio is 1 to 10, or 10%. But if Bank B also has $1 billion in capital, and has made $20 billion in loans (or extended $20 billion in credit to its clients), then Bank B’s capital ratio is 1 to 20, or 5%. These are critical measures because the FDIC insists that member banks have a more than ample amount of capital on hand to deal with any financial scenario. Thus, the FDIC categorizes banks into five groups:

FDIC Classification of a Bank Capital Ratio

Well Capitalized                                               10% or higher

Adequately Capitalized                         8% or higher

Undercapitalized                                               Less than 8%

Significantly Undercapitalized                Less than 6%

Critically Undercapitalized                                 Less than 2%

As you can see, the more credit a bank extends, the more capital it must be able to show the FDIC as proof of its financial strength, especially in the event of potential losses or other unforeseen circumstances. Without a healthy amount of capital, a bank runs into trouble with federal regulators. Once the FDIC labels a bank as “Undercapitalized,” it issues a warning to that institution, telling it to shore up its reserves. If the bank fails to perform, and its capital ratio falls below 6%, into “Significantly Undercapitalized” territory, the FDIC has the right to step in, change the company’s management, and insist that the bank take appropriate steps to remedy its capital shortfall. If a bank’s finances become so dire that its capital ratio drops to less than 2%, and it is deemed “Critically Undercapitalized,” that’s the point at which the FDIC declares the bank insolvent and can take over management of the institution. These banks are either run by the FDIC, as is currently the case with IndyMac, which failed in 2008, or the insolvent institutions get sold off by the FDIC to another bank.

Next: The Long-Term Implications of the Financial Meltdown

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It is important to note the FDIC’s role in keeping banks healthy and how that affects their ability to extend credit or loans to you. In 1933, under the Glass-Steagall Act, President Franklin D. Roosevelt created the FDIC to provide deposit insurance to banks. The goal was to assure the public that money put into any FDIC member bank was safe, secure, and “backed by the full faith and credit of the United States government.” So since January 1, 1934, the FDIC has insured bank deposits in America. Back then FDIC coverage guaranteed deposits to the tune of $2,500, a lot of money during the Great Depression. Before then, if you had money in a bank that failed, your hard-earned savings were completely wiped out.

Fast-forward some 65 years. If you had money in a deposit account, and that bank was FDIC-insured, then your money was protected up to $100,000. In 2008, during the height of the biggest financial crisis most of us have ever experienced, the FDIC raised the limits on insured accounts to $250,000. This limit will be in place until January 1, 2014, at which time it is scheduled to revert to $100,000. The FDIC insures deposit accounts that include the following:

• Checking
• Savings
• Negotiable order of withdrawal (also called NOW accounts, which are savings accounts that allow you to write checks on them)
• Time-deposit (including Certificates of Deposit or CDs)
• Negotiable instruments (such as interest checks, outstanding cashier’s checks, or other items drawn on accounts of the bank)

The good news for most people is that, if you’ve put your money in a FDIC-insured institution, it is perfectly safe up to the indicated limits. In fact, since the FDIC’s inception, not a single dime of insured deposits has ever been lost. Excerpted from Perfect Credit: & Steps to a Great Credit Rating

Continued: Banks Lend (or Not) Based in Part on Their Ability to Meet FDIC Rules

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There are roughly 50 million adults in the United States who operate outside the credit mainstream. They have no credit file whatsoever. Many never had a credit card; never took out a mortgage; never had a student loan; never paid a car note. Nothing. Granted, a lot of these individuals are potential newbies to the credit world – maybe they’re students, widows, recent immigrants, and so on. For whatever reason, they’ve not gotten around to even applying yet for credit. However, a sizeable portion of these people have also consciously chosen not to participate in the credit system.

Some People Consider Credit Poison

Some will proudly tell you: “I’ve never had a credit card – and never will.” Others actually previously did have credit. But because of bad experiences in the past, or due to perceived or real injustices they suffered, they now stay away from all things credit-related. “I don’t mess around with credit cards anymore; they’re nothing but trouble,” these people will tell you. In fact, tens of millions of people go so far as to check out of the entire financial system, having not only no credit, but also no checking or savings accounts, and no dealings with any major banks or financial institutions.

Bucking the Entire Financial System

Did you know that there is an entire cottage industry within the financial services community whose whole reason for being is to reach out to so-called “unbanked” consumers? According to estimates from the FDIC, there are approximately 28 million unbanked or under-banked households in America. That’s just over 25% of the nation’s 110 million total households. The FDIC says the problem of being “unbanked” hits poor and minority communities disproportionately, with seven out of 10 unbanked households earning less than $30,000 a year. Half of the unbanked used to have a bank account, but now choose not to, and instead use high-cost services from check-cashing firms and payday lenders.

The Unbanked Often Pay A Steep Price For “Credit” By Using Payday Loans

The unbanked don’t get traditional loans. If they need a short-term loan, they get “credit” from payday loan outfits. I call payday loans “credit” because these are “signature loans,” meaning you sign on the dotted line, just like when you sign a credit card agreement. But with payday loans, you’re signing an authorization agreeing to give the lender cash from your next paycheck, in exchange for getting a cash advance today on that future check. Unfortunately, for a single loan, payday lenders routinely charge interest rates of about 400% on an annualized basis.

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