09/27/2009 05:12 am ET Updated May 25, 2011

FDIC Softens Its Proposed Rules For Buying Banks

As expected, the board of the Federal Deposit Insurance Corp. has approved controversial rules that will govern how risk-taking private equity firms can snatch up failing banks.

The new rules, approved recently by a 4-1 vote, represented a compromise. The FDIC attempted to impose standards on the private equity firms without discouraging them from jumping in when a bank fails.

The rules, FDIC Chairman Sheila Bair said in a statement, strike a "thoughtful balance to attract non-traditional investors" while also "maintaining the necessary safeguards to ensure that these investors approach banking in a way that is transparent, long term and prudent,".

But, as the Wall Street Journal points out, the rules are also "watered-down" from what the FDIC first proposed in July. From the Journal:

After a ferocious lobbying effort by the buyout industry, the Federal Deposit Insurance Corp. backed away from an initial set of tough proposals that would have imposed heavy capital requirements.

The private equity firms that buy banks will have to keep high-quality capital equivalent to 10 percent of the bank's assets, considerably lower than the FDIC's original plan for a 15 percent requirement that could rise in the event of another market collapse. The board also ditched a rule that would have required private-equity firms to act as a "source of strength" for banks they buy, according to news accounts.

The remaining rules still impose significant restrictions on the firms.

The new capital requirements (10 percent) are twice what traditional banks face. The firms also must hold on to failed banks they purchase for at least three years, another rule that doesn't apply to traditional banks.

Some suggest these new rules might put private equity at a disadvantage when competing with regular banks over new acquisitions.

The New York Times said the rules, "could wind up keeping those buyers in their seats."

The lone dissenting vote today came from John D. Bowman, the head of the Office of Thrift Supervision, who argued that private equity firms shouldn't face special regulations that aren't applied to other bidders.

"I am not a fan, or proponent, of private equity, but it is hard to know whether the restrictions are required," Bowman said at the board meeting.

The FDIC's decision marks a philosophical shift for the agency. Until now, the FDIC has largely avoided having private equity firms buy up banks. Only two such deals have been arranged this year.

So even if the rules aren't what the FDIC originally wanted, there was a sense of urgency to get something passed.

With bank failures at their highest level in 17 years, the FDIC's insurance fund, which essentially protects bank deposits from disappearing, was in some danger of disappearing itself.

So far this year, the FDIC has shut down 81 banks, shrinking the insurance fund to $13 billion, down from $52.8 billion a year ago. As private equity firms prowl the marketplace for these banks and their assets, the FDIC hopes the burden on the fund will be eased.

The FDIC will revisit the new regulations after six months to assess their impact.