Fed cites interest rate risk in community bank enforcement action

Adobe Stock

The Federal Reserve Board of Governors issued an enforcement action against an Illinois community bank, citing concerns about liquidity and interest rate risk management, among other issues.

The Fed entered into a written agreement with Du Quoin, Illinois-based Du Quoin State Bank and its holding company, Perry County Bancorp Inc., on April 26. The agreement did not specify the issues at the $137 millon-asset bank, but noted that multiple "deficiencies" were identified during a recent exam by supervisors from the Federal Reserve Bank of St Louis.

Until the various regulatory issues are resolved, the bank will be prohibited from taking on debt, redeeming its own stock or paying out dividends or distributions without the approval of state and federal regulators. It will also be barred from buying or selling assets that would exceed 5% of its total assets without its regulators signing off.

The root cause of Du Quoin State Bank's issues were not discussed in the 10-page written agreement. Such enforcement actions generally do not include summaries of bank shortcomings, but rather focus solely on the requirements being imposed. 

Du Quoin could not immediately be reached for comment on Thursday.

Still, the order comes at a time when supervisors, and particularly the Fed, are on high alert for both interest rate risks and problems with liquidity management. Both issues have played a central role in the recent bank crisis, contributing to the failures of Silicon Valley Bank, Signature Bank and First Republic Bank in the past two months.

Along with creating plans for addressing policies for managing liquidity and funding as well as interest rate risks, Du Quoin is also required to devise a new capital plan, an investment policy and a board oversight regime.

The Fed also wants Perry County Bancorp to serve as a source of strength for its bank, and to ensure that necessary steps are taken to keep the bank in compliance with regulatory requirements going forward.

Du Quoin and Perry County Bancorp will also have to submit quarterly progress to the Fed and state regulators in Illinois.

As the Fed has rapidly increased its benchmark interest rate to combat inflation — hiking rates by 5 percentage points since last March to their highest level since 2007 — many banks have taken paper losses on government-backed debt investments. As interest rates rise, the trading value of older bonds declines because market participants can get better returns from new bonds that pay out at higher rates.

An American Banker investigation in March found that dozens of community banks throughout the country have seen these unrealized losses pile up on their balance sheets. Such depreciation is only problematic if banks actually sell the bonds and crystalize their losses. If the bonds are held to maturity, they will deliver their full expected returns. Yet, amid the recent crisis of confidence in small and regional banks, the prospect increases that some banks will have to take losses in order to satisfy customer requests to withdraw deposits.

Community banking

How interest rate risk sneaked up on dozens of community banks

March 27, 2023 7:30 AM

Bank supervisors have been keyed into the issue since at least last fall, when the Fed flagged it as a top concern in its biannual report on supervision and regulation. Still, officials say most depositories handle this set of risks well.

"Most banks are highly effective in managing interest rate risk and liquidity risk," Fed Vice Chair for Supervision Michael Barr told the Senate Banking Committee in March. "It is the bread and butter kind of work of bank management."

Earlier this week, Fed Chair Jerome Powell said that supervisors have been focused on improving liquidity and risk management in the banking system and noted that many banks have taken it upon themselves to address the matter directly.

"Many banks are now attending to liquidity and taking the opportunity now, really since the events of early March, to build liquidity," Powell said during a press conference this week.