On banks failing:
Why Banks Fail
After many years of working to counter the effects of financial crises, we
have developed a point of view about why banks fail. The simple causes, in
our opinion, are traceable to errors made while underwriting loans.
However, this answer is not very satisfying in itself and it leads to more
questions, such as: Why were these underwriting errors made in the first
place? What impacts do special conditions that are generally not present in
more developed and stable markets have in these bank failures? Do these
banks operate in dangerous markets?
Bankers operating in economies hit by financial crisis recognize that
corporate sector underperformance places enormous pressure on banks.
They can trace the effects of real sector underperformance on their loan
portfolios. Since loan portfolios in most countries are kept on the balance
sheet, without being marked-to-market, it is nearly impossible for bankers
(or regulators) to fully and fairly assess the value of their portfoliosâand
the state of health of their banks. Moreover, because the banks themselves
provide the lionâs share of financial intermediation in these countries, the
capital market trading that would force visible repricing in a more advanced
economy generally does not exist. In crisis conditions, many banks simply
will not recognize the extent to which their asset values have declined, since
they fear a collapse of confidence.
Even those who knew before the crisis that they were on perilous ground,
and who could have possibly reshaped their portfolios, generally did not. As
we showed in Figure 3.7 above, Colombian bankers deepened their commitments
to the very companies whose declining performance was threatening
them. This phenomenon is common in many developed economies as well.
from
DANGEROUS MARKETS
Managing in Financial Crises
Wiley Press
Why Banks Fail
After many years of working to counter the effects of financial crises, we
have developed a point of view about why banks fail. The simple causes, in
our opinion, are traceable to errors made while underwriting loans.
However, this answer is not very satisfying in itself and it leads to more
questions, such as: Why were these underwriting errors made in the first
place? What impacts do special conditions that are generally not present in
more developed and stable markets have in these bank failures? Do these
banks operate in dangerous markets?
Bankers operating in economies hit by financial crisis recognize that
corporate sector underperformance places enormous pressure on banks.
They can trace the effects of real sector underperformance on their loan
portfolios. Since loan portfolios in most countries are kept on the balance
sheet, without being marked-to-market, it is nearly impossible for bankers
(or regulators) to fully and fairly assess the value of their portfoliosâand
the state of health of their banks. Moreover, because the banks themselves
provide the lionâs share of financial intermediation in these countries, the
capital market trading that would force visible repricing in a more advanced
economy generally does not exist. In crisis conditions, many banks simply
will not recognize the extent to which their asset values have declined, since
they fear a collapse of confidence.
Even those who knew before the crisis that they were on perilous ground,
and who could have possibly reshaped their portfolios, generally did not. As
we showed in Figure 3.7 above, Colombian bankers deepened their commitments
to the very companies whose declining performance was threatening
them. This phenomenon is common in many developed economies as well.
from
DANGEROUS MARKETS
Managing in Financial Crises
Wiley Press
