A recent example with a bank in Illinois demonstrates why depositors need to look at more than savings account rates when choosing a bank.

How Safe Is Your Savings Account? A Recent Case Study Adds a New Perspecitve

If you think that choosing good savings account rates is all that goes into shopping for a bank account, consider the case of InBank in Oak Forest, IL. The fortunes of this bank changed almost overnight--and not for the better. Depending on how you look at it, this situation could be either disturbing or reassuring to depositors in other banks.

A Sudden Reversal of Fortune

What happened to InBank has to do with the capital banks are required to keep on hand to be considered solvent. Part of that capital can be the bank's loan portfolio--loans are assumed to have a current market value based on the future return of principal and interest. Of course, that market value only holds up if a sufficient portion of borrowers don't default.

In reality, 25% of InBank's loans were non-performing, severely damaging the value of its loan portfolio. However, InBank did not fully write down the value of these loans until forced to by regulators. Once the loans were written down, InBank's capital ratio suddenly plunged into negative territory.

More to Worry About than Savings Account Rates

This is all the more disturbing in view of the news that the list of troubled banks is growing. The FDIC's list of problem institutions rose from 305 in the first quarter to 416 in the second quarter. That puts the number of banks on that list at the highest level in fifteen years.

This news serves as a painful reminder that as important as it is to shop for savings account rates or compare fees and services, there is something more fundamental that goes into choosing a bank. The financial soundness of the institution is of paramount importance. As the InBank example shows, sometimes that financial soundness can be so fragile that a change in accounting treatment can wipe out its capital.

As Savings Rates Rise, Depositors Seek Reassurance

Against this backdrop, U.S. savings rates are actually rising, so depositors have more and more at stake in the financial soundness of their banking institutions. Is the InBank case more reason for depositors to worry, or is there a silver lining of reassurance in it?

Here are some positive takeaways from the InBank situation:

• While the list of troubled banks continues to grow, the InBank case suggests that this is often just a recognition of already-existing conditions. In other words, loan portfolios are not suddenly deteriorating again, but accounting for past problems--with a little push from the regulators -- is finally catching up with the extent of those problems.
• Taking a cue from the InBank case, you can ask a couple of probing questions about your bank's loan portfolio. It's worth knowing whether the value of that loan portfolio has already been written down to reflect non-performing loans, and whether bank regulators have reviewed this new valuation. A bank that has already fully accounted for its problems and is still on sound financial footing is more secure than one which has not yet come to terms with its loan problems.
• FDIC insurance remains the all-important backstop. There is only so much you can learn about a bank's internal accounting, so making sure you stay within FDIC coverage parameters is the ultimate safety measure.

If you want to make sure that you will have complete access to your money and no headaches, investigate your bank before depositing. This is especially important if you have large amounts to deposit. Even FDIC insurance doesn't guarantee that you won't have to wait for your funds in the event of a bank failure. If all you want is to know that your money will be returned to you eventually (usually in a matter of days with FDIC-insured institutions), just be sure that all of your funds are covered by FDIC insurance.

Source:

Mike Freeman • Number of problem financial institutions up 36% • Aug 28, 2009 • San Diego Union Tribune: http://www3.signonsandiego.com/stories/2009/aug/28/number-problem-financial-institutions-36/?business

Robert Barba • In a Blink, Bank's Assets Revalued, Capital is Gone • Aug 31, 2009 • American Banker: http://www.americanbanker.com/issues/174_167/in_a_blink_banks_assets_revalued_capital_is_gone-1001530-1.html?ET=americanbanker:e435:2242572a:&st=email