Topic 10 – Bank Failure
Lecture Outline
Bank Failure
Defining Terms in Bank Failure
Causes of Bank Failure
Bank Failure Case Studies
Barings
Banco Ambrosiano
BCCI
Bank Failure
 Banks are more vulnerable than other
commercial firms
 Low cash to assets ratio - may require sale of earning
assets to meet deposit obligation
 Bank failures are important to understand b/c
crises spread.
 1997 Asian Crisis: Indonesia, Thailand and
Korea.
 Failure spread through out the banking system as ‘sick’
institutions infect the ‘healthy’ and drag them down into
insolvency
Defining Terms in Bank Failure
 Crash: It is the collapse of the price of an
asset, or perhaps the failure of an important
firm or bank.
 Panic: A sudden fright without cause - may
occur in asset markets, or involve, a rush
from less to more liquid assets
 A panic starts with a run (mob of depositors
appear at the bank and its branches,
demanding their money)
To fulfil their demand, banks may call loans,
refuse to lend new credit or sell assets
Defining Terms in Bank Failure
A financial crisis may involve a crash, a
panic or both.
Contagion: Contagion is a systematic
risk that cumulative losses will occur
from an event that puts in motion a
series of successive losses along a
chain of institutions or markets that
constitute a system.
Causes of Failure
Goldstein and Turner (1996)
 Macroeconomic volatility: both external and
domestic.
 A period of significant innovation
 Lending booms
 Long-term maturity / currency mismatches
 Heavy government involvement
 Inadequate preparation for financial liberalisation
 Weakness in accounting, disclosure or legal
standards
 Fraud
 Inefficient regulators
Franklin National Bank (1974)
 20th largest bank in USA - quick expansion.
 Unsound loans as a part of expansion strategy.
 FR refused permission to take over another
bank.
 Large depositor’s withdrawal.
 Emergency borrowing of $1.75 billion from FR.
 Taken over by a consortium of seven European
banks
did not fail completely due to deposit insurance.
Continental Illinois (1982)
 American investment bank, involved in heavy lending in
real estate and energy sector along with Penn Square.
 Lack of procedures to vet new loans.
 Poor quality loans to US corporate sector.
 Rumours spread that the bank was facing difficulty.
 Bank runs started and it became difficult to raise new
funds.
 Comptroller of Currency intervened, and a private ‘life
boat’ was organised, but not sufficient.
 FDIC and Comptroller announced assistance.
 All CI directors were asked to resign in return.
Johnson Matthey Bankers (1984)
 An arm of Johnson Matthey, gold bullion dealer (5th
Largest in London). Significant volume of lending to
Nigeria.
 Auditors did not show responsibility.
 They agreed with presentation of accounts jointly with the
director of the bank.
 Poor communication between auditors and BOE (who
were relatively ‘soft’)
 Lifeboat operation launched by BOE with the help of
private banks.
“Too Big to Fail”
 Amendment of Banking Act (1987).
Prompted the establishment of committee
(Treasury, BOE, and external experts).
Barings Crisis (1995)
 ‘Barings Securities’ (part of the market
making arm of the bank) was a leading equity
broker in Asia and Latin America.
 About 1/3 employees based in Asia and more
than half outside UK.
 The fund management operation (headed by
Nick Leeson) had a reputation for its
expertise in Eastern Europe and Asia.
Leeson’s Activities
 Overexposure to risk in the Far East was the
main reason for Barings downfall.
 Mr Leeson was supposed to have been trying
to profit by spotting differences in the prices
of Nikkei-255 future contracts listed on Osaka
securities Exchange (OSE) and the
Singapore Monetary Exchange (SIMEX).
 Leeson seems to have decided to bet on the
future direction of the Nikkei index after the
Kobe earthquake.
Account 88888
 Mr Leeson used a secret error account 88888
to hide trading losses. Barings London was
deceived into thinking Mr Leeson made
profits from arbitrage.
 But losses were accumulating in the 88888
account. It was reported that more than ¾
profits was earned through Mr Leeson’s
business. All the time auditors failed to detect
any wrongdoing.
 During the process of selling and buying, Mr
Lesson’s action accumulated £827m losses.
Failure of Internal Controls
 Segmentation of the Barings group – a
‘bewildering’ structure.
 Lack of understanding the nature of trading
and the risks involved at a management level.
 Management failed to take action when
numerous warning signs became evident
(letters from SIMEX etc.)
 Lack of any internal body monitoring risk
exposure in Singapore.
 No checks as to where the money from the
Barings parent group was going
External Regulatory Failings
 BOE granted Barings solo status (Barings
bank and Barings securities required to meet
a single set of capital and exposure
standard).
 BOE inexperienced and the rule of not taking
more than 25% maximum equity capital
exposure into single investment was not
spotted.
 Coopers and Lybrand and Deloitte and
Touche (external auditors of Barings) failed to
conduct comprehensive tests that would have
detected large funding requests from
Singapore.
Banco Ambrosiano(1982)
 Italian bank based in Milan.
Quoted on the Milan stock exchange.
Subsidiary companies overseas (e.g. BAH).
 Massive fraud by chairman of the bank (and
others).
 Chairman departed Milan for London after
receiving a letter from BOI to reduce and explain
overseas exposure.
 Chairman later found dead in London. Former
Italian PM was also involved in fraud.
 Mass deposit withdrawal after confidence lost.
Banco Ambrosiano(1982)
 Bank of Italy launched life boat operation. Seven
banks provided money.
Later declared bankrupt by Italian court and taken
over by another bank.
 BAH also suffered from losses of deposits , but
Bank of Italy refused to launch life boat
operation. BAH defaulted on loans and deposits.
 Weak relation b/w senior management and Bank
of Italy are considered the root cause of this
bank failure.
Significant supervisory changes after this failure.
Bank of Credit and Commerce
International (1991)
 In the UK, initially given the status of deposit
taker but after amendment to Banking Act
became full bank.
 Customers included Manuel Noriega (Panamian
dictator) and international terrorist Abu Nidal.
 BCCI bought a Colombian bank with branches in
Medellin and Cali (centre for cocaine trade and
money laundering).
 International repute for capital flight, tax fraud
and money laundering.
Bank of Credit and Commerce
International (1991)
 Indicated in Florida, raided by British customs
and executive imprisoned in Florida for money
laundering.
 BOE and Price-Waterhouse failed to
communicate with American regulatory
authorities.
 Amendment of Banking Act (closing UK branches
of an international bank if deemed necessary).
 Financial community began to realise importance
of cross-border supervision.