How Do You Measure a Complex Bank's Risk?

Can all of a bank’s many operations be boiled down to a single measure of overall risk? And—given the ripple effect that a bank failure has on the economy—can that measure be corrected if it gets too high? The FDIC wants to find out by the end of the year. The agency is examining 105 banks with assets of more than $10 billion and creating for each a scorecard based on categories like earnings and heavy exposure to credit. The plan is to charge each institution based on the threat it poses to the global financial system—in theory, deterring future crashes. It’s a tricky task—one the American Bankers Association calls too new and subjective. “It was rolled out amid troubles in the industry. There hasn’t been a long-enough period to know what would work,” says James Chessen, the industry group’s chief economist. Then there’s the perennial question of how government regulators can ever keep up with private bankers’ complex inventions. “We all thought mortgage-backed securities were fine. Will the FDIC miss something comparable?” asks Lawrence J. White, a former bank regulator and an economics professor at NYU’s Stern School of Business. Still, White is in favor of action. Until now, agencies have used past performance as an indicator of which banks might fail. With banks more interconnected than ever, he says, the FDIC needs to be able to size them up in real time. Not updating the government’s tools, in other words, is a risk in itself.

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