Transcript European Business School London Regents College

Sapienza Università di Roma
International Banking
Lecture Nine
Bank Failures
Prof. G. Vento
Agenda
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Bank failures: some definitions
US approach to bank failures
Regulation of failing banks
Contagion theories
Failed bank resolution strategies
The determinants of bank failure
The Icelandic banks’ failure
April 2013
1. Bank failure: some definitions
• Normally the failure of a firm is defined as the point of
insolvency, where the company’s liabilities exceed its assets
and its net worth turns negative.
• In US there were cases of banks failures, whereas in Europe
and Japan these are very rare.
• Bank failure: a bank is deemed to have failed if it is liquidated,
merged
with
a
healthy
bank
under
central
government/supervision pressure, or rescued with state
financial support
• Some think a failing bank should be treated the same way as a
failing firm in any other industry; others claim that failure
justify government protection because of its potential
systemic effect on an economy
April 2013
2. USA approach to bank failures
• In the US legislation, since 1991, has
required the authorities to adopt a
least cost approach, from the
standpoint of the taxpayer, to resolve
bank failures
• According to this, most troubled banks
have to be closed, unless a healthy
bank is willing to engage in a takeover
• Takeover includes taking on the bad
loan portfolio or any other problem
that got the bank into trouble in the
first place
April 2013
2. 2008-2010 bank failure in USA
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Twenty-five banks failed and were taken over by the Federal
Deposit Insurance Corporation (FDIC) in 2008, while 140 failed in
2009. In contrast, in the five years prior to 2008, only 11 banks had
failed.
• The FDIC seizes a bank's assets when its capital levels are too low,
or it cannot meet obligations the next day. After seizing a bank's
assets, the FDIC acts in two capacities
1. it pays insurance to the depositors, up to the deposit insurance
limit, for assets not sold to another bank.
2. as the receiver of the failed bank, it assumes the task of selling and
collecting the assets of the failed bank and settling its debts,
including claims for deposits in excess of the insured limit.
• Updated list of US failed banks:
http://www.fdic.gov/bank/individual/failed/banklist.html
April 2013
2. Deposit insurance and failures in US
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The FDIC insures up to $250,000 per depositor, per insured bank,
as a result of the Emergency Economic Stabilization Act 2008,
which raised the limit from $100,000. This will revert to $100,000
in 2014.
The receivership of Washington Mutual Bank by federal regulators
on September 2008, was the largest bank failure in U.S. history.
Shareholders of various failed banks have alleged that the
government regulatory agencies acted in an arbitrary and
capricious manner and seized banks for political reasons or in
order to benefit other banks that could then purchase them for
very small amounts of money.
Washington Mutual shareholders have claimed that as of the date
of the takeover, the bank had enough liquidity to meet all its
obligations and was in compliance with the business plan, but was
nevertheless taken over and sold off to JPMorgan Chase at a
fraction of its market value.
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3. Regulation of failing banks
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There are three ways regulators can deal with the
problem of failing banks:
Put the bank in receivership and liquidate it. Insured
depositors are paid off and assets are sold
Merge a failing bank with an healthy bank. The healthy
bank is often given incentives, like purchasing the bank
without bad assets; often it involves the creation of an
agency which acquires the bad assets
Government intervention, ranging from emergence of
lending assistance, guarantees for claims on bad assets
or even nationalisation of the bank
April 2013
4. Contagion theories
• Contagion arises when healthy banks become the target of
runs, because depositors and investors, in the absence of
information to distinguish between healthy and unhealthy
banks, rush to liquidity.
• Bank contagion spreads faster in the banking sector compared
to other sectors
• Bank’s contagion and bank runs are largely firm-specific and
rational: depositors and investors can differentiate between
healthy and unhealthy banks
• Bank contagion results in a larger number of failures
• Little evidence that runs of bank cause insolvency among
solvent banks
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5. Failed bank resolution strategies and who
loses
Resolution
option
Shareholders
– lose money
Creditors –
lose money
Taxpayers –
Government
injection
Managers –
lose jobs
Employees –
lose jobs
Capital
injection by
shareholders
Yes, in the
short term
No
No
Yes, likely
Possibly, in
case of cost
cuts
Government
injection
Likely
Likely
Yes
Likely
Likely
M&A – state
funded
Partly
Possibly
Yes
Yes
Likely
M&A – private
Likely
Likely
No
Yes
Yes
Purchase &
Acquisition
Yes
Yes if
uninsured
Possibly
Yes
Yes
Bridge bank/
nationalisatio
n
Yes
Possibly
Yes
Yes
Possibly
Liquidation
Yes
Yes if
uninsured
No
Yes
Yes
April 2013
6. The determinants of bank failure: poor
management of assets
• Weak asset management, consisting of a weak loan
book, usually because of excessive exposure in one
or more markets, although regulators set exposure
limits
• Weak asset management often extends to the
collateral of security backing the loan, because the
value of the collateral is highly correlated with the
performance of the borrowing sector
• Example: Barings collapse in 1995 due to uncovered
exposure in the derivative market.
April 2013
6. The determinants of bank failure: managerial
problems
• Deficiencies in the management of failing banks is a
contributing factor in virtually all cases
• i.e. ‘bonus driven behaviour’ may have serious
consequences in financial sector because of the
maturity structure of the assets: what looks
profitable today may not be so in the future.
• Example Credit Lyonnais in 1993 had severe
problems because the president wanted to grow at
any cost, regardless the asset quality.
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6. The determinants of bank failure: fraud
• Benston noted that 66% of US bank failures from
1959 to 1961 were due to fraud and irregularities;
the percentage raised to 88% in the period 1960-74,
according to Hill
• The FDIC reported that about a quarter of bank
failures in the period 1931 – 1958 were due to
financial irregularities by bank officers.
• There are links between frauds and bad management
• Internal auditing should prevent frauds
April 2013
6. The determinants of bank failure: the role of
regulators
• Regulatory forbearance: putting the interests of the
regulated bank ahead of the taxpayer
• There are lacks of communication between external
auditors and supervisory authorities
• Most failures depended on cross border activities,
which are difficult to be supervised
• Financial groups are more and more internationally
based, thus ‘college of supervisors’ have been
created
April 2013
6. The determinants of bank failure: “Too BIG
to fail”
• In France and in Japan safety net is close to 100%,
rarely letting any but the smallest banks fail, and
nationalising any large one that are effectively
insolvent.
• In UK the regulators operate a policy of deliberate
ambiguity with respect to bank rescues (see
Northern Rock case).
• In US the “least cost approach” has been introduced
for dealing with bank failures.
• One of the biggest US companies referred to as too
big to fail is American International Group (AIG).
April 2013
6. The determinants of bank failure: clustering
• Bank failures in a country tend to be clustered
around a few years, rather than being spread
evenly through time.
• A possible reason for clustering may be the
failure of timely intervention by the
government/regulatory authorities
• Also macroeconomic environment may play a
role.
April 2013
6. The determinants of bank failure:
miscellaneous factors
• Ownership structures affects the probability of bank
failure. The decline in mutual ownership of thrifts
could be a partial explanation for thrift industry crisis
in US.
• Banking structure/competition is a second possible
factor.
• 100% deposit insurance creates moral hazard
problems because banks have an incentive to
assume greater risks than they would in absence of
deposit insurance and depositors have less reason to
monitor banks.
April 2013
7. The Icelandic bank’s failures
• The 2008–2009 Icelandic financial crisis is a major
on going economic crisis in Iceland that involves the
collapse of all three of the country's major banks
following their difficulties in refinancing their shortterm debt and a run on deposit in the UK.
• Relative to the size of its economy, Iceland’s banking
collapse is the largest suffered by any country in
economic history
• Bank Glitnir was placed in receivership.
April 2013
Next Lecture:
FINANCIAL CRISES
April 2013