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 FailuresYear 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 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