Individual commercial bank

In the last century, there have been lots of commercial bank failures and some of the causes were due to external factors. The nature of banking is strongly related to the management and control of risks. The external factors are from political, economic, social and technology. There is also the other side to consider, which are the internal factors. These internal factors can be managerial weaknesses, poor internal routines and controls and fraud. These factors both play a large part in commercial bank failures.

I will be looking at bank failures in America, Japan and the United Kingdom, to see what the causes were of these failures. The external factors that can cause commercial bank failures can be analysed by using a PEST analysis. This will allow for a clear definition of the external factors. The first important area to look at is the political environment for banks and includes banking regulation, central banks, regulatory bodies and Government. The main law is the Basle agreement, which regulates banks. This meant that banks needed a minimum capital requirement of 8%.

Ggovernment also plays an important role with commercial banks as they have the power to let a bank failure or not, an example of this is Japanese banks who have had government bail them out (Resona a top five bank, received $17 billion1). There are also economic conditions that can cause bank failures. “A bank fails economically when the market value of its assets declines below the market value of its liabilities, so that the market value of its capital becomes negative. At such times, the bank cannot expect to pay all of its depositors in full and on time.

“2 Banks face credit risk, market risk, Interest rate risk, Liquidity risk and systematic risk, which will have an affect on banks. Systemic risk is thought to occur because all economic conditions are interconnected. This interconnection provides a chain along which shocks to any one agent are transmitted to others, i. e. The Domino effect. Credit risk is which supervisors of financial institutions pay the closest attention because it has been the risk most likely to cause a bank to fail. Credit risk has a strong relationship to the economic cycle.

Another key indicator is the stock markets as they can show the cyclical cycle. A Banks also face the social aspect, which is to do with culture, consumer confidence and history. The last area is technology and how this has affected banks. Technology is vital for a competitive advantage and is a major driver of globalisation. Technology has also been viewed as a way of reducing costs and making a bank become more efficient and productive. The internal factors also have large part to play for the causes of bank failures.

The main internal factors that can cause bank failures are poor management, fraud, rapid expansion, use of high-risk business models, lack of corporate governance, distortion of financial records, overpayment for assets or services, and concealment of information. Managerial weaknesses are found in virtually all bank failures. The problem is “directors who don’t direct and managers who don’t manage. “3 Weak management and oversight are typically linked to insufficient internal controls, which is another leading cause of bank failures.

Internal controls are the measures taken by an organisation to protect its resources against fraud, waste, and inefficiency. Fraud also emerges as a leading contributor in many failures. American System In America there has been various studies to see why banks failed and the causes. The main studies come from the 1960’s onwards and they show the causes can both internal or externally. The first study was done by the FDIC, who studied the 67 insured banks that failed between 1960 and 1974. The largest bank failure in this group was Franklin National Bank with total assets of $3.7 billion, which was closed in 1974.

The majority of these failed institutions had a total assets of less than $25 million. This study found the three major causes of the 67 bank failures. These were the due bad loans, fraud and poor management. There were 38 failures in bad loans, 21 failures in fraud and 8 failures poor management. 4 The first of two major recessions during the 1970s occurred from 1973 to 1975. The severity of that recession contributed to a large increase in commercial bank loan losses and an increase in both the numbers of problem banks and bank failures.

Bank failures peaked in 1976 at 17, the highest number of failures since 1942. The second major recession began in 1978 when interest rates on securities market outweighed the rates payable by depository institutions for savings and time accounts. In 1979 and early 1980’s, inflation burst upward and along with interest rates. This meant that there was a large increase the number of bank failures, peaking with an all-time high of 533 failures in 1989. A total of 1,617 banks closed between 1980 and 1994.

This period was characterised by economic, financial, legislative, and regulatory conditions that challenged many insured depository banks. Severe regional and sector recessions provided additional stresses. Finally, many institutions that were affected by regional or sector recessions assumed excessive risks and were not adequately protected by supervisory authorities due to staffing shortages and regulations. 6 Table below shows bank closures from 1980 through 1994.