Bank Failures in Mature Economies potx

Basel Committee

on Banking Supervision

Working Paper No. 13

Bank Failures in Mature

Economies

April 2004

The Working Papers of the Basel Committee on Banking Supervision contain analysis carried out

by experts of the Basel Committee or its working groups. They may also reflect work carried out by

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ISSN 1561-8854

Contributing authors

Ms Natalja v. Westernhagen Deutsche Bundesbank, Frankfurt am Main

Mr Eiji Harada Bank of Japan, Tokyo

Mr Takahiro Nagata Financial Services Agency, Tokyo

Mr Bent Vale Norges Bank, Oslo

Mr Juan Ayuso

Mr Jesús Saurina

Banco de España, Madrid

Banco de España, Madrid

Ms Sonia Daltung Sveriges Riksbank, Stockholm

Ms Suzanne Ziegler Schweizerische Nationalbank, Zurich

Ms Elizabeth Kent Bank of England, London

Mr Jack Reidhill Federal Deposit Insurance Corporation, Washington, D.C.

Mr Stavros Peristiani Federal Reserve Bank of New York

Table of Contents

Introduction...............................................................................................................................1

The Herstatt crisis in Germany.................................................................................................4

Summary.........................................................................................................................4

Banking industry characteristics......................................................................................4

The case of Herstatt........................................................................................................5

The Japanese Financial Crisis during the 1990s .....................................................................7

Summary.........................................................................................................................7

The early stage, before mid-1994 ...................................................................................7

The beginning of the crisis, mid-1994 to 1996 ................................................................7

The financial crisis of 1997 .............................................................................................9

The financial crisis of 1998 ...........................................................................................10

Systematic management of the crisis, late 1998 to 2000..............................................11

Causes of the financial crisis in 1990’s .........................................................................12

The Banking Crisis in Norway ................................................................................................15

Summary.......................................................................................................................15

Prior to the crisis ...........................................................................................................15

Description of the crisis.................................................................................................20

Resolution of the banking crisis ....................................................................................21

Conclusions ..................................................................................................................25

Bank Failures in Spain ...........................................................................................................27

Summary.......................................................................................................................27

Prior to the crisis ...........................................................................................................27

Description of the crisis.................................................................................................28

Conclusions ..................................................................................................................31

The Swedish Banking Crisis...................................................................................................34

Summary.......................................................................................................................34

Prior to the crisis ...........................................................................................................34

Description of the crisis.................................................................................................37

Regulatory responses ...................................................................................................39

Conclusions ..................................................................................................................40

The Swiss Case .....................................................................................................................43

Summary.......................................................................................................................43

Banking industry characteristics....................................................................................43

Description of the crisis.................................................................................................44

The banking crisis .........................................................................................................46

Case Studies of UK Bank Failures .........................................................................................49

Summary.......................................................................................................................49

Bank of Credit and Commerce International.................................................................49

Small banks crisis .........................................................................................................51

Barings..........................................................................................................................53

The US Experience ................................................................................................................56

Summary.......................................................................................................................56

Prior to the crisis ...........................................................................................................56

The Savings and Loans crisis .......................................................................................58

Case studies of bank failures........................................................................................61

Continental Illinois National Bank: the pitfalls of illiquidity.............................................62

Bank of New England: the perils of real estate lending.................................................63

Bank failures after Basel I: the collapse of sub-prime lenders ......................................63

Conclusions ..................................................................................................................65

Summary of Bank Failures in Mature Economies ..................................................................66

Introduction

Many highly developed economies that have sophisticated markets and long functioning

banking systems have had significant bank failures or banking crises during the past 30

years. Central bankers fear widespread bank failures because they exacerbate cyclical

recessions and may trigger a financial crisis. It is not surprising that these failure episodes

have resulted in numerous legal and regulatory changes in the affected countries that were

designed to decrease the probability of future bank failures and lessen the cost of the bank

failures. Bank capital is meant to be a buffer during periods of economic instability and

increasing capital levels or making capital more sensitive to the risks in banks should help

stabilise the banking system, decreasing the incidence and cost of bank failures.

A number of recent official working groups and academic studies have analysed the causes

and policy responses to bank failure across countries.1

The Groupe de Contact (1999)

examined the causes of banking difficulties in the EEA since the late-1980s.2

Evidence was

based on (117) individual bank problems in 17 countries and national country reports from a

few countries (France, the UK and the Scandinavian countries). The majority of banking

difficulties were manifest as credit problems and sometimes as operational risk. Market risk

was rarely a significant problem. Management and control weaknesses were significant

contributory factors in nearly all cases. However, 90% of the banks reported capital ratios

about the regulatory requirement when difficulties emerged.3

The internal report of the

Groupe de Contact concluded that this suggested loss provisioning did not accurately

reflected asset impairment and thus capital ratios were overstated. And more generally, even

where asset impairment had been properly measured, such quantitative measures might not

capture qualitative problems, such as poor management.

The key role played by poor management in crises has also been highlighted by various

academic studies. In a sample of 24 systemic banking crises in emerging-market and

developed countries, Dziobek and Pazarbasioglu (1997) found that deficient bank

management and controls (in conjunction with other factors) were responsible in all cases. In

a study of 29 bank insolvencies, Caprio and Klingebiel (1996) found that a combination of

macroeconomic and microeconomic factors was usually responsible. In particular, on the

macroeconomic side, recession and terms of trade were found important. Also, on the

microeconomic side, poor supervision and regulation and deficient bank management were

often significant.

On banking crisis resolution, the OECD (2002) recently compared (based on questionnaire

response) the techniques and practices used in member countries. In addressing problems,

typically the central bank or government agency stepped in fairly early to supply liquidity

which in most cases helped to avert a panic by investors. Most governments protected

depositors, in whole or part, up to the statutory minimum. Liquidations were used just

occasionally and typically only for smaller institutions or where only a small part of the

banking system was impaired. When large commercial banks have been in trouble, problems

1 A recent paper by the Basel Committee (BIS (2002)) has also set out guidelines for dealing with weak banks,

including early indication of problems and alternative resolution measures.

2 ‘Difficulties’ covered a wide range of events including bankruptcy, payment default, forced merger, capital

injection, temporary state support, significant falls in overall profits or profits in particular areas of business.

3

The capital ratio in 90% of cases was above the requirement imposed by the supervisor.

1