The Federal Deposit Insurance Corp. has issued a cease-and-desist order against the Bank of Harlan "for hazardous lending and lax (loan) collection practices."
The agency ordered management changes and an end to shareholder dividends until the problems are resolved.
The FDIC, which insures the nation's bank deposits, also cited Citizens Union Bank of Shelbyville in a separate order for not keeping adequate flood insurance on properties held as collateral for loans.
The Shelbyville bank agreed to pay a fine of $8,650 to settle the issue without admitting guilt.
The Bank of Harlan also accepted a consent agreement without admitting guilt, but bank officers did not return a reporter's calls on Wednesday to comment on allegations in the cease-and-desist order.
In the 32-page order, the FDIC said the bank had engaged in "unsafe and unsound banking practices" in 11 areas involving lending and management.
The agency ordered the bank to hire a new chief executive officer and a bank management consultant, and to set up a new audit program.
The FDIC told the bank to stop lending to borrowers whose loans are in default until repayment is made and to collect or charge off problem loans on its books.
The bank was ordered to increase its loan-loss reserve by at least $600,000 and to keep its primary capital equal to at least 8 percent of its total assets by selling stock in the bank or by collecting delinquent loans.
The bank also was told to stop paying dividends to stockholders without the approval of the FDIC and the Kentucky Department of Financial Institutions, which joined with the FDIC in the order.
The agencies said the bank had been operating with "inadequate" loan-loss reserves and paying "excessive dividends in relation to the bank's capital position, earnings capacity and asset quality."
The bank's management practices were "detrimental to the bank and jeopardize the safety of its deposits," and the bank's board of directors had failed to adequately supervise managers, the order said.
The bank was the second largest of the four banks operating in Harlan County, according to FDIC data as of June 30. It had $111.4 million in deposits and a 30.2 percent market share.
Citizens Union Bank of Shelbyville was Kentucky's 30th largest bank on June 30. It was the largest in Shelby County with $376.7 million in deposits, including 24.9 percent of all deposits in Shelby County.