Regulators give bleak forecast for banks

Banking on more problems

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NEW YORK (CNNMoney.com) -- Several top banking regulators warned lawmakers Thursday of more troubles ahead for the industry, including additional writedowns and the possibility that bigger banks could fail.

Speaking before the Senate Banking Committee, officials said most U.S. banking institutions are in relatively good health but remain challenged by continued woes in the housing market and the broader economy.

"We clearly are not out of the woods," said John Dugan, who heads the Office of the Comptroller of the Currency, which oversees banks with a nationwide footprint.

One shortcoming, argued Federal Reserve Vice Chairman Donald Kohn, is that banks have not allocated enough money to keep up with the growth of their problem assets. As a result, they may have to boost their skyrocketing loan loss reserves even further.

Banks insured by the Federal Deposit Insurance Corporation set aside $37.1 billion in loan-loss provisions in the first quarter of this year - four times more than the $9.2 billion in the first quarter of 2007, the FDIC reported last week in its quarterly review of the industry.

Regulators added that they were bracing for an uptick in the number of bank failures, at least in the near term.

So far this year, just four banks have collapsed, including the most recent downfall of the Staples, Minn.-based First Integrity Bank, which shuttered its doors last Friday.

While most of the failures have so far been smaller community banks, FDIC Chairwoman Sheila Bair said her staff was preparing for the possibility of a large failure as a precaution.

"I don't see that happening," she said. "But we have to be prepared for all contingencies."

Kohn and Dugan added that many institutions will require additional capital injections in the months ahead and may have to go so far as to cut their dividends.

In early March, many of these regulators met with lawmakers to discuss the state of the banking industry. But the dramatic collapse of Bear Stearns and the Federal Reserve's controversial rescue of the Wall Street firm since then have raised new fears about the industry.

Now, rumors are swirling about the health of other large financial institutions, most notably Lehman Brothers (LEH, Fortune 500). During the hearing, Sen. Richard Shelby R-AL., asked about the likelihood of another investment bank needing to be bailed out.

Kohn declined to comment on the health of specific companies but said that Wall Street firms have learned a great deal from Bear Stearns and have reduced leverage and built up their liquidity.

"I think we have a stronger set of investment banks than we had a month-and-a-half ago," said Kohn.