Reasons of Bank Failures in the US - Term Paper Example

 Bank Failures Introduction Seven more local and regional banks have closed their doors in the United States, bringing the total number of US bank failures to 103 this year, federal bank regulators announced. The numbers released by the Federal Deposit Insurance Corporation indicate that the failure rate in 2010 was quicker that the year before. Only 64 banks went under in the United States by this time last year. A total of 140 bank failures were registered in all of 2009, according to the FDIC1. The news about bank failures are a catching the headlines more frequently in recent times. America seems to be the number one country as far as bank failures are concerned. “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. When a bank becomes unable to meet its obligations to its depositors or other creditors because of various reasons we will refer it as bank failures. In Banking terms, banking failures occur when the banks may become insolvent or too illiquid to meet its liabilities. When we analyses bank failures in economic or market terms, we will get a clearer picture; a bank fails economically when the market value of its liabilities exceeds the market value of its assets. Such a scenario will prevent the banks from meeting the customer demands. In other words, a bank with fewer assets and more liabilities may not be able to fulfill the demands of all of its depositors on time. In such cases, it is quite possible that the failed banks may be taken over by the regulating agencies to protect the interests of its customers and the shareholders. Banking failures is considered as a serious matter because of the complex relations banks have with other organizations. For example, a failed bank may have lot of individual depositors, deposits from organizations and also it may have lent huge amount of money to thousands of individuals and organizations. Moreover, many people might have invested in the shares of the same bank. Banking failures sometimes causes problems to other organizations also. Many people believe that a single bank failure can lead towards multiple bank failures because of the interconnection between banks. The recent financial crisis resulted in multiple bank failures not only in America, but in Europe and other parts of the world as well. Lehman Brothers, Bank of America, AIG etc like big financial institutions suffered major setbacks during recent recession. This paper briefly analyses various aspects of bank failures and the reasons for the recent banking failures in America. 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. According to the Federal Deposit Insurance Corporation (FDIC), these failures would cost the federal agency more than USD 347 million. FDIC insures deposits at over 8,000 US banks. Small and medium banks were the most badly hit, with soaring unemployment levels resulting in increased defaults3. 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 of recent bank failures in America One of the most common causes of closing is the impairment of the bank's capital by losses. If the examiner finds that by reason of bad loans the capital and surplus have been seriously impaired, the interests of the depositors may require that the business be taken out of the hands of those who have brought the bank to this dangerous condition. If it be a national bank, the Comptroller of the Currency appoints a receiver, who is usually a bank examiner. The receiver makes an inventory of the assets and liabilities. This may show that the bank is solvent and has only been temporarily embarrassed because of scarcity of cash. In the course of a few weeks or months, it may be possible to convert enough of the assets into cash to meet the demands of depositors, and the bank may then be opened again 4. The major reason for the recent bank failures in America can be attributed to the injudicious lending habits of the banks. The life style of American people is entirely different from that of the people in 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 about conducting proper enquiry about the financial capabilities of the loan seeker. 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 greedy customers accepted the offers (loans) from the banks with both hands. They have approached the banks for everything and the banks were ready to fulfil their dreams. The banks were miscalculated that the global economy will never exhaust and whatever the goods and services sold in the market will bring profit. Such irresponsible allocation of resources by the banks in the market is the main cause of the current problem. 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 though too much about the returns against the services they provided. Once the balance between the services and goods sold and bought were destroyed, financial crisis came into the picture. 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 market6 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 failures are due to a variety of causes - bad management in making loans; dishonest officials who have used the bank's funds for their own speculations; rumors of insolvency which start a "run" by frightened depositors; panics, affecting the whole country; or violation of the laws under which the banks operate. According to an annual report of the Comptroller of the Currency: 60 per cent of the failures were caused by violations of the banking laws; 23 per cent by injudicious banking; 13 per cent by shrinkage in values and general stringency in the money market; and 4 per cent resulted from the failure of large debtors and other minor causes. Criminal violations of the law caused 37 per cent of the failures, 23 per cent being caused by fraudulent management, 7 per cent by defalcations, and 7 per cent were wrecked by the cashier or other employee. Excessive loans caused 20 per cent of the failures, and heavy investments in real estate or mortgages about 3 per cent. Former Comptroller Ridgely once said: "The most frequent cause of bank troubles, in fact the almost invariable cause of bank failures, is the granting of credit far beyond the legal and prudent limits to the officers or to one concern or group of allied concerns generally owned and managed by the officers and directors of the bank, or in which they have, directly or indirectly, some large pecuniary interest7. Poor management is one of the major reasons 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 lend8 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 1. 143 bank failures. 2009. Accessed on 26 October 2010 from http://chestofbooks.com/finance/banking/Money-And-Banking-Holdsworth/143-Bank-Failures.html 2. 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 3. 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 4. 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 5. Steverman, Ben. 2009. Don’t be surprised to see more bank failures Closures have been relatively slow, but FDIC is accelerating shutdowns. BusienssWeek. Accessed on 26 October 2010 from http://www.msnbc.msn.com/id/32864659/ns/business-businessweekcom/ 6. 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 Read More