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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 problem
Loan losses
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
Banks (USA)
Rogue trader
Source: BIS, www.bis.org
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
Bank Failures
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