FDIC Problem Bank List Grows

63 U.S. Financial Institutions Face Special Monitoring Amid Rising Unrealized Losses

The Federal Deposit Insurance Corporation (FDIC) has recently updated its Problem Bank List, now including 63 U.S. financial institutions that require special monitoring. This rise from 52 problem banks in the fourth quarter of 2023 to 63 in the first quarter of 2024 highlights growing challenges in the banking sector, driven by increasing interest rates and significant unrealized losses. While the number of problem banks has grown, it still remains within historical norms for non-crisis periods, but the situation demands close attention.

Key Points of Concern

Problem Banks

The latest figures from the FDIC highlight that the 63 problem banks represent 1.4% of the 4,568 banks monitored by the agency. This increase, although notable, still falls within the normal range of 1-2% seen in non-crisis periods. The assets held by these problem banks increased by $15.8 billion, bringing the total to $82.1 billion in the first quarter of 2024. While this is a concerning trend, it doesn’t yet signal a banking crisis.

Unrealized Losses in the Banking Sector

One of the more pressing challenges facing the banking industry today is the accumulation of unrealized losses, which have surged to $517 billion—an increase of $39 billion from the previous quarter. These losses are largely tied to the rise in interest rates, which have eroded the value of fixed-income securities such as U.S. Treasury bonds and mortgage-backed securities (MBS) held by banks. The increase in mortgage rates, in particular, has severely impacted residential mortgage-backed securities, creating significant strain on financial institutions that rely on these investments.

The Impact of Rising Interest Rates

Interest rate hikes over the past two years have been the primary driver of these mounting losses. The Federal Reserve's efforts to combat inflation have resulted in the following:

• A decline in the value of fixed-income securities held by banks.
• Pressure on financial institutions heavily invested in mortgage-backed securities, as higher rates have depressed their market value.
• Nine consecutive quarters of elevated unrealized losses, dating back to when the Fed began raising interest rates in early 2022.

These rate hikes, while crucial for controlling inflation, have introduced considerable stress into the financial system, particularly for banks with significant exposure to interest rate-sensitive assets.

How the Banking Industry is Holding Up

Despite these significant headwinds, the banking industry has shown remarkable resilience:

• Net income for banks rebounded to $64.2 billion in the first quarter of 2024, an impressive increase of 79.5% from the previous quarter. This recovery comes after a challenging period, reflecting the industry's ability to adapt to difficult conditions.
• Asset quality metrics have generally remained favorable, though some areas of concern persist, particularly in commercial real estate (CRE) and credit card portfolios. The CRE sector has faced ongoing difficulties due to slow economic growth and changing work environments that affect office and retail property values.
• Liquidity in the banking sector has remained stable, providing some relief to regulators and investors alike. Liquidity ensures that banks can continue to meet customer withdrawals and loan demands, even in the face of market volatility.

However, it’s important to acknowledge the significant downside risks that remain in play. Economic uncertainty, inflationary pressures, and the continued volatility of interest rates could further strain bank performance. Additionally, funding and margin pressures—due to the need to offer higher interest rates to attract deposits—remain key areas of concern for regulators and bank executives.

A Balanced Perspective

While the increase in the number of problem banks and the surge in unrealized losses is concerning, the broader context remains relatively stable. The FDIC’s figures still fall within the normal range for non-crisis periods, and the banking industry has demonstrated resilience in the face of these challenges. Net income growth, favorable asset quality, and stable liquidity all suggest that, while risks are rising, the system is not on the verge of collapse.

That said, the ongoing economic uncertainty means that these issues will remain under close scrutiny. As the Federal Reserve continues to navigate inflation and market volatility, the banking sector's health will depend largely on how well financial institutions can manage their exposure to interest rate risks and maintain adequate liquidity. The FDIC, in the meantime, will keep monitoring problem banks and other emerging risks, ensuring that the system stays resilient in the face of new challenges.

The rise in the FDIC’s Problem Bank List and unrealized losses is a reminder of the delicate balance in the U.S. banking system, but it’s not yet a cause for alarm. As long as the FDIC continues its proactive oversight and banks adapt to the shifting economic landscape, the financial system should remain stable in the months to come.

The recent increase in the FDIC's Problem Bank List to 63 U.S. financial institutions invites comparisons to the failure of Silicon Valley Bank (SVB) in 2023, one of the most significant bank collapses in recent history. While both events reflect underlying vulnerabilities in the banking sector, they differ in scope, scale, and the specific drivers behind the stress these institutions face.

Scale of Individual Failures vs. Broader Systemic Risk

• Silicon Valley Bank (SVB) Failure (2023): SVB's collapse in March 2023 was one of the largest bank failures in U.S. history, with assets totaling $209 billion and deposits worth $175 billion. It was a single, high-profile failure that sent shockwaves through the banking sector and led to heightened scrutiny of banks' balance sheets, particularly those heavily exposed to interest rate risk. SVB’s collapse also triggered the failures of Signature Bank and First Republic Bank, exposing weaknesses in regional banks.
• Problem Bank List (2024): In contrast, the 63 banks currently on the FDIC’s Problem Bank List represent 1.4% of the 4,568 U.S. banks and hold $82.1 billion in assets. These institutions are smaller, and their combined asset size is still significantly less than the assets managed by SVB alone. The list reflects ongoing systemic risks but not immediate, dramatic failures like SVB's collapse. While the problem banks are under closer scrutiny, they are not necessarily at imminent risk of failure.

Primary Drivers: Interest Rate Risk and Asset-Liability Mismatch

• SVB's Failure: SVB’s downfall was primarily due to its concentration in long-term fixed-income securities, particularly U.S. Treasury bonds and mortgage-backed securities (MBS), which lost value as interest rates surged. The bank's business model also depended heavily on deposits from the tech sector and venture capital firms, whose cash needs became more pressing as the economy tightened. When SVB sold these securities at a loss to cover liquidity needs, it spooked depositors, leading to a classic bank run.
• Problem Banks in 2024: The banks on the FDIC’s Problem Bank List are facing similar pressures from rising interest rates. Like SVB, many of these banks are grappling with unrealized losses on fixed-income securities, which now total $517 billion across the banking industry. However, these banks have so far managed to avoid the acute liquidity crises that led to SVB's collapse, although the asset-liability mismatches caused by higher interest rates remain a key challenge.

Liquidity Crisis vs. Unrealized Losses

• SVB’s Liquidity Crisis: One of the critical elements that led to SVB's failure was its inability to raise enough liquidity when depositors started withdrawing their funds en masse. The bank was forced to sell its depreciated securities at a substantial loss, which eroded confidence and exacerbated the run on deposits. SVB’s failure highlighted the vulnerability of banks with large amounts of uninsured deposits, making them more susceptible to rapid withdrawals.
• Problem Banks and Unrealized Losses: The 63 banks currently labeled as “problem banks” are dealing with $517 billion in unrealized losses across the banking industry. However, as of now, they have avoided a liquidity crisis similar to SVB’s. Unrealized losses refer to potential losses on assets that haven’t been sold yet. As long as these banks can hold onto these assets without having to sell them at a loss, they may be able to ride out the storm—though this could change if liquidity becomes a concern.

Regulatory and Supervisory Responses

• After SVB’s Collapse: The failure of SVB prompted regulators, including the FDIC and the Federal Reserve, to reassess their oversight of banks with heavy exposure to interest rate risk. In the aftermath, regulators introduced stricter rules for capital requirements and interest rate risk management, particularly for regional and mid-sized banks. It also led to new discussions about deposit insurance limits to prevent future bank runs.
• Problem Bank List Monitoring: The banks on the current Problem Bank List are under heightened regulatory scrutiny by the FDIC, which monitors them closely to ensure they have adequate liquidity and capital buffers. The fact that the FDIC lists these banks as "problem banks" means they have already been identified as institutions that require additional oversight. However, being on the list does not necessarily mean that these banks will fail—it simply means they are under more intensive supervision to prevent issues from escalating.

Systemic Risk and Public Confidence

• SVB’s Ripple Effect: SVB's failure had a significant ripple effect, raising concerns about other regional banks, and leading to drops in stock prices across the banking sector. The collapse also triggered worries about systemic risk, as it raised questions about how exposed other banks were to rising interest rates and depositor runs. It led to the Federal Reserve establishing emergency funding measures like the Bank Term Funding Program (BTFP) to provide liquidity to banks struggling with interest rate risks.
• Current Problem Banks: While the number of problem banks has increased, the situation remains more contained compared to the SVB crisis. The 63 banks, although facing challenges, have not yet sparked a broader panic or systemic crisis. Regulators are more prepared, and the increased oversight aims to prevent a repeat of the 2023 crisis.

Comparisons and Key Takeaways

While both the inclusion of 63 banks on the FDIC’s Problem Bank List and the failure of Silicon Valley Bank reflect vulnerabilities within the U.S. banking sector, the current situation differs in scope and severity. SVB's collapse was a dramatic, acute event that exposed deep flaws in risk management and created widespread concern about systemic risk. In contrast, the current list of problem banks suggests that while challenges persist—particularly around unrealized losses due to rising interest rates—the situation is more contained and under closer regulatory supervision.?

However, the increase in problem banks and mounting unrealized losses serve as a warning that the U.S. banking system remains under pressure, especially in a rising interest rate environment. Regulators and banks must continue to manage interest rate risk, maintain liquidity, and avoid the kind of asset-liability mismatches that brought down SVB.