Reasons of Recent Bank Failures in America

by Jason Shaw
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Introduction

In the United States, seven more local and regional banks have closed their doors, taking the cumulative number of US bank collapses to 103 this year, as reported by federal bank regulators. The figures reported by the Federal Deposit Insurance Corporation show that the loss rate was faster in 2010 than in the previous year. At this time last year, only 64 banks had gone under in the United States. According to the FDIC, a total of 140 bank defaults were reported in 2009.[1].

In recent years, the news of bank defaults is catching the headlines more often. As far as bank failures are concerned, America seems to be the number one country. “On average, 14 banks went belly up in every month of 2010 and the total failures are expected to surpass last year’s figure of 140”[2].

Reasons of Recent Bank Failures in America

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We will relate to it as bank defaults anytime a bank was unable to satisfy its commitments to its depositors or other creditors for different purposes. In banking terminology, as banks can become insolvent or too illiquid to satisfy their liabilities, banking collapses emerge. We will get a better view as we examine bank failures in economic or market terms; a bank falls economically when the market value of its liability reaches the market. We will refer to it as bank failures when, for multiple purposes, a bank has been unable to meet its responsibilities to its depositors or other creditors. In banking terminology, as banks can become insolvent or too illiquid to satisfy their liabilities, banking collapses emerge. We will get a better picture as we analyse bank failures in economic or market terms; a bank struggles economically when the market value of its liabilities exceeds the market value of its assets. Such a condition would keep the banks from satisfying the demands of customers. Maybe it is not possible in other words for a bank with less assets and more liabilities to satisfy the demands of all its depositors on time. In such situations, it is very likely that struggling banks may be taken over by regulatory authorities with the aim of securing the interests of their clients and shareholders.of its assets. Such a condition would keep the banks from satisfying the demands of customers. In other terms, it might not be feasible for a bank with less assets and more liabilities to satisfy the demands of all its depositors on time. In such situations, it is very likely that struggling banks may be taken over by regulatory authorities in order to safeguard the rights of their clients and shareholders.

Banking failures is considered as a serious matter because of the complex relations banks have with other organizations. A collapsed bank, for instance, may have a number of individual depositors, corporate deposits, and it may also have lent large sums of money to thousands of persons and organisations. In comparison, several persons may have invested in the same bank’s shares. Banking failures can often generate challenges for other organisations. Many individuals assume that a single bank failure due to the interconnection between banks will lead to several bank failures.

A collapsed bank, for instance, may have a number of individual depositors, corporate deposits, and it may also have lent large sums of money to thousands of persons and organisations. In comparison, several persons may have invested in the same bank’s shares. Banking failures can often generate challenges for other organisations. Many individuals assume that a single bank failure due to the interconnection between banks will lead to several bank failures.

Different Aspects of Recent Bank Failures in America

In America, savings and checking accounts are backed by the agency The Federal Deposit Insurance Corporation (FDIC). Each account owner is eligible to get a sum up to $250,000 in case of a bank failure.  In case of a bank failure, FDIC interfere in the matter take every possible steps to protect the interests of the stakeholders. In case of a bank failure, FDIC acts as the mediator and will take control of the failed bank’s assets and decides how to settle its debts. It is not necessary that the public may get prior information about a bank failure. It happens all of a sudden so that the public may not get enough time to withdraw their money.

Such defaults will cost the federal agency more than USD 347 million, according to the Federal Deposit Insurance Corporation (FDIC). About 8,000 US banks have deposits covered by the FDIC. Small and medium banks were the hardest hit, with rising levels of unemployment contributing to higher defaults.[3].

Banking failures can increase the unemployment problems immensely. In fact banking sector is one of the major employment sectors in America. Thousands of Americans are working in this sector because of the huge financial benefits offered by the banks. The future of these bank employees is in jeopardy because of the recent also suffering because of the bank failures. Most of the organizations depend heavily on the bank loans for the smooth functioning of their organizations. Frequent bank failures resulted in these organizations finding difficulties in obtaining bank loans and subsequently they will be forced to reduce their economic activities. The reduced economic activities may result in loss employment. In other words, bank failures can affect other organizations and its employees as well.

Reasons for Recent Bank Failures in America

The impairment of the resources of the bank by losses is one of the most important triggers of closure. When the auditor considers that the capital and surplus is serious because of bad loans, the reduction of the bank’s equity from defaults is one of the most severe reasons of closing. If the auditor considers that the capital and surplus have been substantially damaged because of bad loans, the depositors’ interests which need the company to be taken out of the hands of those who have brought the bank to this risky state. If it is a national bank, a recipient, who is normally a bank inspector, is named by the Comptroller of the Currency. An list of the properties and liabilities is made by the receiver. This may mean that the bank is stable and only momentarily humiliated by cash shortages. It could be necessary to turn enough of the deposits into cash for a few weeks or months to meet the depositors’ desires, and the bank would then reopen. The desires of the depositors would allow the corporation to be withdrawn from the possession of those who have taken the bank to this unstable situation. If it is a national bank, the receiver, who is usually a bank inspector, is selected by the Currency Control Officer. An list of the properties and liabilities is made by the receiver. This may mean that the bank is stable and only momentarily humiliated by cash shortages. It could be possible to turn enough of the savings into cash for a few weeks or months to satisfy depositors’ expectations, and the bank will then be reopened.[4].

The major reason for the recent bank failures in America can be attributed to the injudicious lending habits of the banks. The way of life of the citizens of the United States is totally different from that of the people of India or China. Americans believe more in spending rather than saving whereas the Indians or the Chinese saves more than what they spend. Americans approach the banks whenever they are in need of money and the banks were ready to lend as much as the people asked for. They never bothered to make sufficient investigations regarding the credit seeker’s financial capacity. When the financial crisis suddenly appeared on the horizon, people failed to repay the huge loan amounts they collected from the banks and many of the American banks started to collapse. “Bank of America, Citigroup, Wells Fargo and J.P. Morgan Chase have weathered the financial crisis in reasonably good shape, while Bear Stearns collapsed and Lehman Brothers has entered bankruptcy, to name but two of the investment banks which had remained independent despite the repeal of Glass-Steagall”[5] The allocation of resources in the case of a bank is mainly the loans of different forms to the customers. This allocation has not been done properly by the banks. They have allotted loans to all the people irrespective of the financial strengths of the customers. They have not conducted any reviews to assess the financial setups of the customer at present and also they failed to forecast the future. The arrogant consumers welcomed the banks’ offerings (loans) with both hands. They took everything to the banks, and the banks were able to satisfy their wishes. Banks have been miscalculated that the world economy can never exhaust, and benefit will be brought from whatever products and services sell on the market. The key trigger of the current crisis is such a reckless distribution of capital by the banks in the industry.  The banks has given  more focus to the goods or services sold rather than the goods or services bought. They were more interested in selling of their services. They never cared too hard about the proceeds from the programmes they rendered. The financial crisis came into the picture until the equilibrium between the utilities and the products sold and acquired was broken.

Wall Street firms, who paid too little attention to the quality of the risky loans that they bundled into Mortgage Backed Securities (MBS), and issued bonds using those securities as collateral. The Bush administration has failed to provide needed government oversight of the increasingly dicey mortgage-backed securities market[6]

Another major reason for the recent banking failure was the greedy Wall Street firms. These firms took easy loans from the banks and used that money in the share market for making more profits. When recession came quite unexpectedly, the share markets started to collapse and subsequently the Wall Street firms started to lose huge amounts of money. Nobody thought that the American economy may decline as it did during the recession period and even foreign investors in American share market suffered huge loss. The Wall Street Firms which took easy loans from banks and deposited it in the share market failed to repay the huge money they borrowed which gave momentum for the bank failures or collapses. 

 The banks miscalculated that the global economy as a renewable source. In other words, banks wrongly considered the American economy as an ocean of wealth which will never be exhausted. American banks failed to implement the great economic theory of supply and demand.  Most of the banks acted against the well defined theory of supply and demand. According to supply and demand theory, there should be a balance between supply and demand. In other words, supply should never exceed the actual demand and it should never be below the actual demand. The demand for loan was huge in America; but most of these demands were not legitimate. In other words, most of these demands were not aimed to spend the money in the constructive sector. The country will benefit only when the money lent was used in the constructive field. The banks had the moral and legal responsibility to evaluate the mode of operations of the lent money. But the banks failed to take control of the money they lent and the people or organizations who took heavy loans used this money in the non-productive sectors. The supply or loans should not be provided to all those who are in demand. It should be regulated to those who are capable of repaying it in time. Banks failed to assess the nature of the demand properly and they did everything possible to make all the loan seekers happier irrespective of their financial abilities.

Bank defaults are attributed to a number of reasons – weak loan management; corrupt officials that have used the funds of the bank for their own speculations; insolvency rumours that start a ‘race’ by terrified depositors; panics that impact the whole country; or breach of the laws under which the banks work. According to the yearly estimate of the Comptroller of the Currency, 60 per cent of the defaults were triggered by breaches of banking laws; 23 per cent by unequal banking; 13 per cent by a fall in the valuation and general rigidity of the money market; and 4 per cent were caused by the collapse of major debtors and other minor factors. 37 percent of the errors were caused by illegal breaches of the law, 23 percent were caused by corrupt administration, 7 percent by defalcations, and 7 percent were ruined by the cashier or other employee. Excessive lending accounted for 20% of the defaults, and heavy investments in real estate or mortgages accounted for nearly 3%. Former Comptroller Ridgely once stated: “The most frequent cause of bank disturbances, in fact the almost invariable cause of bank failures, is the granting of credit far beyond the legal and prudent limits of the officers or of one concern or group of allied concerns which are generally owned and administered by the bank’s officers and directors or in which they have, directly or indirectly, some large pecuniary assets.”[7].

Bad management is one of the key factors that poor management is for the bank failures. The jobs in banks are normally considered as a white collar job. Most of the employees working in banks are not much bothered about hard working. Instead of using their senses and intelligence, these people often make generalizations which may ultimately result severe bank failure as happened in the recent past. Proper training is not given to the employees by the bank managements. It is necessary for the bank employees to update their knowledge periodically in order to make effective decisions. Training is the only way to educate the bank employees about the new trends happening in banking industry and the recent market trends and business climate.

Mortgage problems persist, but banks specializing in loans to developers have been hit hard in 2009. KBW data show that, of banks that have failed since 2007, an average of 28.8 percent of loans outstanding were construction loans, compared to 9.8 percent for the industry as a whole. At Corus, which failed on Sept. 11, 88 percent of its lending was construction loans. “This year is dominated by construction lend[8]

Construction or real estate industry is the most severely affected business sector because of the recent global recession. No serious construction works were undertaken during the last two years and the real estate business people found difficulties in selling out the villas, flats and apartments they constructed before the recession. The demand for new buildings has come down drastically because of recession. Most of the real estate business in America depends heavily on bank loans. It is possible for this business people to repay the huge loan amounts only after they were able to sell out the apartments they constructed. But the decrease in demand forced the real estate people to keep their money stand still in the form of buildings and subsequently they failed miserably to repay their loans in time. It was difficult for the banks to do financial rolling since they failed to get the money they lent. As a result small and medium banks started to collapse and the even the bigger banks also followed the same pattern later.

Conclusions

Foolish lending habits of the banks were the major reason for the recent bank failures in America. Most of the American banks did nothing to assess the financial abilities of the loan seekers and they granted loans to all people who applied for it. Constructions sector was seriously affected by the recession and the real estate people failed to repay the heavy loans they taken from banks. Poor management was another major reason for the recent banking failures in America.

Bibliography:
  • 143 bank failures. 2009. Accessed on 26 October 2010 from http://chestofbooks.com/finance/banking/Money-And-Banking-Holdsworth/143-Bank-Failures.html
  • Bianco, Katalina M., J.D.2008. “The Subprime Lending Crisis: Causes and Effects of the Mortgage Meltdown”. 28 August 2009. http://www.business.cch.com/bankingfinance/focus/news/Subprime_WP_rev.pdf
  • Miller Joe & Jackson Brooks (2008) Who Caused the Economic Crisis? Accessed on 26 October 2010 from http://www.factcheck.org/elections-2008/who_caused_the_economic_crisis.html
  • The Times of India. July 24 2010. Seven more US bank failures bring year’s total to 103. Accessed on 26 October 2010 from http://timesofindia.indiatimes.com/business/international-business/Seven-more-US-bank-failures-bring-years-total-to-103/articleshow/6210623.cms
  • Steverman, Ben. 2009. Don’t be surprised to see more bank failures Closures have been relatively slow, but FDIC is accelerating shutdowns. BusinessWeek.  Accessed on 26 October 2010 from  http://www.msnbc.msn.com/id/32864659/ns/business-businessweekcom/
  • The Economic Times. 19 September 2010. US sees 14 bank failures on average in every
  • month of 2010. Accessed on 26 October 2010 from  http://economictimes.indiatimes.com/news/international-business/US-sees-14-bank-failures-on-average-in-every-month-of-2010/articleshow/6584147.cms
  • [1] The Times of India. July 24 2010. Seven more US bank failures bring year’s total to 103. http://timesofindia.indiatimes.com/business/international-business/Seven-more-US-bank-failures-bring-years-total-to-103/articleshow/6210623.cms
  • [2] The Economic Times. 19 September 2010. On average, the US sees 14 bank failures in each 2010 month. http://economictimes.indiatimes.com/news/international-business/US-sees-14-bank-failures-on-average-in-every-month-of-2010/articleshow/6584147.cms
  • [3] The Economic Times. 19 September 2010. US sees 14 bank failures on average in every month of 2010. http://economictimes.indiatimes.com/news/international-business/US-sees-14-bank-failures-on-average-in-every-month-of-2010/articleshow/6584147.cms
  • [4] 143 bank failures. 2009. http://chestofbooks.com/finance/banking/Money-And-Banking-Holdsworth/143-Bank-Failures.html
  • [5] Miller Joe & Jackson Brooks (2008) Who Caused the Economic Crisis?
  • http://www.factcheck.org/elections-2008/who_caused_the_economic_crisis.html
  • [6] Bianco, Katalina M., J.D.2008. “The Subprime Lending Crisis: Causes and Effects of the Mortgage Meltdown”. http://www.business.cch.com/bankingfinance/focus/news/Subprime_WP_rev.pdf
  • [7] 143 bank failures. 2009. http://chestofbooks.com/finance/banking/Money-And-Banking-Holdsworth/143-Bank-Failures.html
  • [8] Ben Steverman. 2009. Closures have been reasonably sluggish, but the FDIC is accelerating shutdowns. Don’t be shocked to see further bank defaults.BusienssWeek .http://www.msnbc.msn.com/id/32864659/ns/business-businessweekcom/

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