Stay Ahead of the Game: What To Advise and Educate Your Clients On With The Latest Bank Failures Today

In the wake of the most recent bank failures, like most business advisors, I have been thinking of the following:?

• What can we do to protect our clients??
• Why didn't we see this coming?
• Can we tell them when the next bank failure will occur??
• What will happen in the next few months?

Here are a few ideas:

As Trusted Business Advisors, we can advise our clients by educating them on how the U.S. banking system works and how to identify risk. This education will empower our clients and hopefully remove some vulnerability and helplessness with clients.

We should start by explaining to our clients that information on the banking system is readily available and disclosed on the banking regulator's websites:

Federal Deposit Insurance Corporation (FDIC)

National Credit Unions Administration's (NCUA)

On the bank regulators’ website, the government provides quarterly financial statements which identify the following:

• the number of troubled institutions the government has currently recognized as of date.
• financial statements upon which you can see the estimated and contingent losses the government has recognized on their balance sheet based on the risk to the banking system;
• the reserve ratio is the ratio the regulator maintains due to the deposits within the banking system.

On a QTRLY basis, both agencies (FDIC and NCUA) report on the state of the banking system and cover the following topics:

• Number of problem institutions
• Provisions for possible losses (risk bank reserve), and
• Reserve Ratios

Below, I am providing a look at the FDICs 4th QTR 2022 report on the number of troubled banking institutions. From what we can see, it is clear that the number of troubled institutions has decreased over some time.?

Number of FDIC-Insured Institutions on the "Problem Bank" List 2012–2022

From the problem institutions listed above, the FDIC reported that the number of troubled institutions decreased from 2021 to 2022. However, you can see that while the number of troubled institutions decreased from 2021 to 2022; the number of troubled assets increased by approximately $110 Billion at the end of 2022. While it is unclear what institution the risk is related to, it provides insight that a sizable institution is having some issues.

From the chart, we can also see that though not occurring daily, “bank failures” often occur enough, even though we don’t always hear about them. This is a good point to emphasize with clients, so they don’t process these events as apocalyptic or one-offs.

Provisions for Possible Losses

Another area to watch and advise on is the Balance Sheet of the two banking regulators (FDIC & NCUA). Specifically, you should monitor their respective balance sheets for the “Provision for Insurance Losses” section. This is a leading indicator of what is to come as it relates to future losses to the banking system. If the regulators see additional risk to the system, you can bet in the following quarterly report that a larger provision will be recorded in accordance with GAAP.

From the Income Statement gathered from the FDIC website (see below), you can see that the “Provision for insurance losses” decreased in Q3 of 2022. This tells us in quantitative terms that the FDIC believed they had accounted for the contingent losses adequately based on the information that had at the time in Q3 2022. It will be interesting to see if this provision increases and by how much in the upcoming quarters.

Reserve Ratio

Lastly, you should educate yourself on the “reserve ratio.” The “reserve ratio” is a heavily watched indicator of the banking industry. The reserve ratio is the percentage of insured deposits banks must hold in reserve with the FDIC to ensure there is enough money to pay out insurance claims if a bank fails.

For example, if a bank has $100 in deposits insured with the FDIC and the reserve ratio is 1%, the bank must hold $1.00 in reserves with the FDIC. In case of a failure, the FDIC uses that dollar to provide deposits back to the customers of that failed bank. The reserve ratio is very important in this instance because there is reserve ratio is how the FDIC determines how much money banks need to set aside to protect customers’ deposits in light of expected future losses.

As a result, a higher reserve ratio is a leading indicator that more bank failures or risks are in the banking system, of which more funds will be required by the banking regulators.

From the table above, you can see that the Insurance ratio has been decreasing since COVID-2019. If the government sees additional risk to the banking system, it will require additional premiums paid to the banking regulators to protect it from losses. As a result, an increasing Reserve ratio can be a leading indicator to anyone wanting to get some insight into where the banking system is headed.

Written by Jeff Wilson CPA, Principal of the W2 Group, an Accounting and Advisory firm in Prince George’s County, MD. An experienced CPA with working knowledge and expertise in the financial sector and regulatory system.