updated 8/26/2009 8:40:04 PM ET 2009-08-27T00:40:04

Squeezed by rising bank failures, regulators made it easier Wednesday for private investors to buy failed institutions.

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The Federal Deposit Insurance Corp.’s board voted 4-1 to reduce the cash that private equity funds must maintain in banks they acquire.

Private equity funds tend to buy distressed companies, slash costs and then resell them a few years later. They have been criticized for excessive risk-taking. But the depth of the banking crisis has softened the FDIC’s resistance to them.

The agency’s deposit insurance fund, which insures customers’ deposits, has shrunk under the weight of collapsing banks. Analysts warn it could fall below zero by year’s end. At least in theory, having private investors buy failing banks would allow the FDIC to reduce the losses it would have to cover at a failed bank.

Under the new rules, a buyer would need to maintain the bank’s capital reserves equal to 10 percent of the failed bank’s assets, down from 15 percent under an earlier proposal. That compares with a 5 percent minimum requirement for banks that buy other banks. And the new policy limits the circumstances under which private investors must maintain assets that could be provided if needed to bolster banks they own.

But the FDIC sought to guard against private equity funds that might want to quickly buy and sell at a profit: It required the acquiring investors to maintain a bank’s minimum capital levels for three years.

Eighty-one banks have failed so far this year, compared with 25 last year and three in 2007. The closings have drained billions from the FDIC deposit insurance fund, which insures regular bank accounts up to $250,000 and is financed with fees paid by U.S. banks.

“The FDIC recognizes the need for new capital in the banking system,” the agency’s chairman, Sheila Bair, said before the vote.

The compromise struck among the FDIC directors “is a good and balanced one,” Bair said.

Banks need to be operated “profitably but prudently,” she said.

John Bowman, acting director of the federal Office of Thrift Supervision, was the lone holdout Wednesday. He said the new policy was still too strict and “could chase potential investors away.”

Douglas Lowenstein, president of the Private Equity Council, the industry’s advocacy group, said the new policy is an improvement over the proposal floated by the FDIC last month.

“But we continue to question the need to impose more onerous capital requirements on private equity firms,” he said in a statement. “At a time when the nation’s banks are struggling to raise capital, it is counterproductive to impose measures that could deter investors who are ready, willing and able to provide that capital. Higher capital thresholds could make it less likely that private equity investors will bid on failed banks.”

Rising loan defaults, fed by falling home prices and worsening unemployment, have hammered banks. The closings have drained billions from the FDIC deposit insurance fund, which insures regular bank accounts up to $250,000 and is financed with fees paid by U.S. banks.

The FDIC estimates bank failures will cost the fund around $70 billion through 2013. The fund stood at $13 billion — its lowest level since 1993 — at the end of March. It’s slipped to 0.27 percent of insured deposits, below a congressionally mandated minimum of 1.15 percent.

The FDIC seizes failed banks and seeks buyers for their branches, deposits and soured loans. Under the crush of failures, the agency says private equity can inject vitally needed capital into the system, especially with fewer healthy banks looking to acquire failed institutions.

“There’s an enormous need for private money to do this,” said Josh Lerner, a professor of finance at Harvard Business School. “There’s the sense that you have a lot of money which is currently sitting on the sidelines.”

Private equity firms invest their own capital to buy a company and pump it up with money from other investors. Such “leveraging” to buy companies amounts to, on average, three-to-one for private equity firms: They invest $3 in outside capital for each $1 they put up themselves.

The roughly 2,000 private equity firms in the U.S. have around $450 billion in capital to invest, according to the Private Equity Council.

Investors in private equity funds include pension funds, university endowments and charitable foundations.

Organized labor still denounces private equity as vultures and job-killers.

The private equity industry is exploiting the economic crisis to enrich itself, said Stephen Lerner, director of the private equity project at the Service Employees International Union. “They are trying to use their political and financial sway to get into what they see as bargain basement prices for very little risk.”

But with the financial crisis and recession causing banks to fail at the fastest pace since the height of the savings-and-loan crisis in 1992, support has been building among regulators to use private equity money to bolster the industry.

Copyright 2009 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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