Failure of Banks

Risks Associated with Banking Business

• Large deposit base is a liability for the banks.

• Credit created by banks lead to a liability that is much

higher than the cash holdings of the banks.

• Non performing assets of banks create burden on the

banks.

• Creating risky products for its clients increases bank’s

liabilities.
 Bank Failures
Year Bank / Market Causes
1970 US Penn Market liquidity
1973 US Secondary Banking Credit bank failures following trading losses
1974 Franklin National Poor Credit Control
1974 Bankhaus Herstatt Germany Forex overtrading credit / payments system
1980s Johnson Matthey UK Poor credit controls

1982 LDC Debt crisis Bank failures following loan losses

1983 Penn Square USA Industry concentration, excessive revenue
generation
1984 Rumasa Intergroup lending, nepotism
1984 Continental Illinois Industry concentration, poor credit controls
1985 Canadian Regional Banks Loan losses
1986 FRN Market Collapse of market liquidity and issuance
1986 US Thrifts Loan losses
1987 Stock market crash Price volatility after shift in expectations
1989 Collapse of US Junk bonds Collapse of market liquidity and issuance
Source: BIS, www.bis.org
 Bank Failures

Year Bank / Market Causes

1989 Australian Banking Loan losses
problem
1990 Norwegian Banking crisis Loan losses
1990 Swedish commercial paper Collapse of market liquidity and issuance
1991 Swedish banking crisis Loan losses
1991 Finnish banking crisis Loan losses
1991 Southeast bank, Florida Real estate concentration
1992 Japanese Banking crisis Loan losses
1992 ERM crisis Price volatility after shift in expectations
1992 BCCI Fraud, ambiguous domiciliation
1992 ECU bond market collapse Collapse of market liquidity and issuance
1993 Credit Lyonnais Excessive expansion, political corruption,
inadequate controls

Source: BIS, www.bis.org

 Bank Failures

Year Bank / Market Causes

1995 Barings Poor management controls

1995 Mexican crisis Price volatility and shift in expectations

1997 Asian crisis Price volatility and shift in expectations,

bank failures following loan losses – market,
credit, sovereign.

1998 Russian Collapse of market liquidity and issuance

1998 LTCM Collapse of market liquidity and issuance

2001 Allied Irish Rogue trader

Banks (USA)

Source: BIS, www.bis.org

 Bank Failures

Year Bank / Market Causes

2008 Washington mutual bank Poor credit control

2008 Bank united Poor credit control

2008 Colonian bank Poor credit control

2008 Guaranty bank Real estate concentration

2008 United Commercial bank Poor credit control

2008 Amtrust bank Price volatility

2009 Bank United FSB Poor credit control

2010 Western Bank Puerto Rico Poor credit control

Source: BIS www.bis.org

 Causes of Bank Failures

• Poor asset quality (98% of cases)

• Poor management (90% of cases)

• Weak economic environment (35% of cases)

• Fraud (11% of cases)

Source: BIS, www.bis.org

 Asset Quality
• Credit losses
• Connected lending
• Inherited portfolios
• Commodity shocks
• Excessive overhead
• Interest rate mismatch
• Foreign exchange mismatch
• Excessive diversification
• Fraud
• Flawed liberalization policies
 Warning signals in Predicting Bank Failures
• Excessive loan / asset growth
• Excessive lending concentration
• Deteriorating financial ratios
• Loan recoveries to gross loan charge-offs
• Deposit rates higher than market rates
• Off-balance sheet liabilities
• Creative accounting
• Delayed financials
• Change in auditors
• Change in management
 Warning signals in Predicting Bank Failures

• Use of political influence

• Rumours in money market

• Share price volatility

• Deteriorating economy
 Bank Support Mechanisms

UK Model

• Funded by large clearing banks by the Bank of England

• Initial liquidity support for viable banks

• Improving failed bank’s liquidity

• Bank of England taking over a failed bank and

subsequently privatizing (losses borne by the central
bank)
 Bank Support Mechanisms

US Model

• Federal Savings and Loans Insurance Corporation

(before 1989)

• Acquisition or Mergers

• Income maintenance programme

• Accounting prudence

• Bridge banks

• Management support
 Bank Support Mechanisms

US Model

• Resolution Trust Corporation (RTC) (After 1989)

• Concentration of failed assets with RTC

• Liquidation or sale of banks to private sector

• Losses borne by RTC (funded by federal guarantee)

 Bank Support Mechanisms

Spanish Model

• Bank “hospital” and carve-out mechanism

• Accordion principle

• Joint funding by commercial banks and the Bank of

Spain

• Deposit guarantee fund buys bad assets

• Provides banks with guarantee and long-term soft

loans

• Sale of banks to private sector

• Nationalization of failed bank

 Bank Support Mechanisms

Chile Model

• Central bank issues bonds to buy bad assets, with

buyback schedule

• Central bank loans to banks converted into equity

• Sale of banks to private sector