How sick is the banking industry? And when might we see bankers calling on growing small businesses again? Most experts say banks are using the current period of low-cost money and high yields on government securities to rebuild their balance sheets in anticipation of a new cycle of business lending. But economists Roger J. Vaughan and Edward W. Hill paint a much gloomier picture -- for borrowers, for investors, and, once again, for U.S. taxpayers.

In Banking on the Brink: The Troubled Future of American Finance (Washington Post Co. Briefing Books, 800-677-4560, 1992, $220) Vaughan and Hill provide a clear account of what happened to the financial markets during the 1980s. Within 200-plus pages of tables, they single out some 2,500 of the nation's 12,372 federally insured banks as being dead, dying, or crippled. What keeps those institutions going, they say, is the reluctance of Congress and the executive branch to face up to the extent to which the banks' assets have lost value. The first step to improving the health of the banking industry, argue Vaughan and Hill, is to admit the problem and begin revamping the industry. The weakest banks should be sold off or merged.

The two economists expect the future industry to look dramatically different from the one we knew in the '80s. Increasingly, say Vaughan and Hill, small-business lending will be left to "loan boutiques," which will know a lot about specific industries and local markets. -- Bruce G. Posner

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Looking to assess the condition of a bank? Many companies have learned it's easier to get what you need from a healthy bank than from a hurting one. A number of services sell information on the condition of banks for about $50. (See "Bank Watching," Banking & Capital, September 1991, [Article link].) But Roger J. Vaughan says you can get a reasonably good snapshot by zooming in on the following four areas:

Capitalization. This is the "padding" that protects the bank and its investors from weak assets. Banks are adequately capitalized, Vaughan says, if their capital is 6% or more of their assets; less than 4% is "reason to worry."

Rate of return. Don't look at quarter-to-quarter returns, look at the return over the last three to four years. A good rate is 12% or more before adjusting for inflation; less than 6%, Vaughan says, and the bank may be eating into its capital.

Percentage of assets in real estate. A bank that has 50% or more of its loans and leases in real estate, notes Vaughan, is probably overcommitted. Unlike other assets, real estate can't be easily liquidated and is often valued too optimistically.

Nonperforming real estate loans as a percentage of all nonperforming loans. If a bank acknowledges that its real-estate-loan problems are more than 50% of its overall loan problems, you may be looking at a serious situation.

"None of these measures will tell you everything," says Vaughan. "But if you get red lights on all four, you should think about changing banks."

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