The Determinants of Bank Failure: A Qualitative Review - Modern Banking

The previous section reviewed the details of a large number of bank failures from around the world. These cases make it possible to make a qualitative assessment of the causes of bank failure. The list of causes as they appear below is for ease of exposition – it is rare to find a single cause for bank failure; rather, there are a number of contributing factors. For example, poor management can be the source of a weak loan portfolio or sloppy supervision, and regulatory forbearance can make conditions ripe for rogue traders and fraud.

Poor Management of Assets

Weak asset management, consisting of a weak loan book, usually because of excessive exposure in one or more sectors, even though regulators set exposure limits. When these are breached, the regulators may not know it or may fail to react. Examples of excessive loan exposures that regulators failed to control effectively are numerous. Perhaps the most glaring example is the failure of US commercial banks in the south-west, with a similar episode a few years later in the north-east which regulators (and managers) failed to spot, despite a similar build-up of bad loan portfolios in the south-west a few years earlier.

It is possible to look at almost any western country and find examples of excessive exposure by banks in one particular market, which eventually led to failure. In other cases, such as the collapse of Barings (February 1995), the failure was not caused by the excessive loan exposure, but by uncovered exposure in the derivatives market. Usually, the regulatory authorities knew guidelines (or rules) on exposure were being exceeded but took no action.

Internal and external auditors also failed to detect any problem. All of these countries tightly regulate their banking sectors, yet no system has managed to resolve this problem. In the USA, the case of the thrifts illustrates how far regulators are prepared to go to protect a sector, even though such action prolongs the pain and raises resolution costs.

Managerial Problems

Deficiencies in the management of failing banks is a contributing factor in virtually all cases.

The Credit Lyonnais case is a classic example of how poor management can get a bank into serious trouble. It was not discussed in the previous section, but a brief review is provided here. Jean Yves Harberer was atypical French meritocrat. He earned an excellent reputation at the Treasury, heading it inhis forties. In 1982, after the newly elected socialists had nationalised key banks, President Mitterand asked Harberer to take charge of Paribas, where he was responsible for one of the worst fiascos in Paribas’ history. Removed from office when Paribas was re-privatised in1986, Harberer was appointed chief executive of Credit Lyonnais (CL), a bank which had been state owned since the end of the Second World War. Harberers principal goal was growth at any cost, to transform the bank into a universal, pan-European bank. This rapidgrowth caused CL to accumulate a large portfolio of weak loans, which could not survive the combination of high interest rates and a marked decline in the French property market.

By 1993, Harberer had been dismissed and made the head of Credit National, but the post was terminated after the CL 1993 results were published later that year.

Though weak management was the key problem, it is difficult to disentangle it from government interference in the operations of the bank. The government, through its direct and indirect equity holdings, had a tradition of intervention by bureaucrats in the operational affairs of state owned firms, commonly known as dirigisme. It is consistent with French industrial policy where a proactive government role in the economy is thought to be better than leaving it to the mercy of free market forces.


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