FORBEARANCE - AN EMPIRICAL-ANALYSIS

Several recent articles have analyzed conditions under which allowing capital-deficient banks to continue to operate may be optimal policy. This article examines the performance of banks admitted into the FDIC' s Capital Forbearance Program between 1986 and 1989 and finds that, fo r the majority of these banks, there was no substantial improvement in their capital ratios. We use a legit regression analysis to attempt t o identify those banks whose financial condition improved with forbear ance and find that banks which did improve are not clearly identifiabl e from pre-forbearance financial data. Instead, the banks which improv ed did so due to infusions of new capital, extraordinary income, and i mprovements in the local economies, factors which are not easily ident ifiable ex ante by regulators. The conclusion is that, while some gran ts of forbearance may result in large savings to the FDIC, in the majo rity of cases granting forbearance to troubled banks is unlikely to re duce the expected loss to the deposit insurer.