Five Observations About Banking Failures, Current Developments in Monetary and Financial Law, Vol. 2 (IMF 2003).

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Every Bank Failure Is a Regulatory Failure

Certainly banks do not fail only because regulators fail in their oversight responsibilities. Many other failures are typically involved in any bank failure, including failures of governance, internal controls, loan execution, and credit review. The impact of local, regional, and national economies is always a factor. Yet it is rare indeed for a bank failure, even in a banking crisis, not to have been preceded by numerous warning signals, such as excessively high levels of (i) connected (insider) lending; (ii) risk, including foreign exchange, interest rate and investment risk; (iii) direct investments in real estate; (iv) fraud and other criminal activity; and (v) spending on a headquarters building, typically with palatial executive suites and board rooms. In many cases, bank regulators exercise regulatory forbearance, a wink and a nod in the other direction, while the bank sinks toward and then past the point of insolvency. In fact, it is atypical to find insolvent banks at zero capital, but more often than not at a significant negative net worth, which, for large banks around the world, can amount to billions of dollars. Timidity in enforcement, supervision, examination, and regulation may have the effect of encouraging management to engage in the high levels of risk noted above, and therefore may result in greater losses by the bank. Bank failures are also a failure of external auditors, who may be negligent or engage in deliberate attempts to mislead the regulators and the public to protect their clients, as well as of negligent or willful acts by the bank’s management, its consultants, advisors, investment bankers, and yes, even lawyers. Banks that are already insolvent are often unmasked by a banking crisis, leading some to think that their insolvency was brought about by the crisis itself. The insolvent condition is sometimes mistakenly thought to be a result of the crisis.

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Published In: Administrative Agency Updates, Bankruptcy Updates, Finance & Banking Updates, International Trade Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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