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 banks
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

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 banks 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