Good Example Of Why Banks Fail Essay

There are various reasons hat may lead to the collapse of banks. If the banks take big risks in the form loans, the probability of the banks failing increase significantly. Primarily, loans form a substantial part of most banks as well as depositions. Although most banks invest a lot in risk analysis, competition in the market may be stiff necessitating a reduction of the prior checks on the abilities of the clients to repay the loans (Santonu Basu, 2003) i.e. the banks lowers the credit standards to attract more customers. However, in more than often, the lowered credit standards attract clients who cannot service their loans fully or on time. In addition, some banks may advance loans to foreign countries without assessing the risks accurately. These countries fail to service the loans, creating a financial crisis. When the banks draw the balance sheets, they remove bad loans from them and consequently, reducing the worth of the assets of the bank. When the net worth of the bank’s assets is below the depositors’ value, the need to pay the depositors forces the bank to close down by auctioning its property to pay the creditors. On the same note, when the stability of the bank is questionable, the depositors, they tend to withdrawal all their money. That leads to closing of the bank as it must sell its property at very low prices to repay the creditors. The mortgages market usually proves to be a challenge for many banks. In most instances, many factors affect the real estate businesses both locally and globally. Therefore, banks dealing with the real estate markets take huge risks. The volatility of the mortgage markets thus affects most banks negatively. For examples, the mortgage industry was at the center of the 2007 financial crisis in the USA (Larry Elliot, 2011). Moreover, the reputation of the bank is critical in attracting investors. If the reputation lowers, investors lose trust in the bank. The bank’s revenues decrease. The bank may fail to refinance or pay its debt(s) leading to closure.
Apart from the bank policies and practices as described above, other factors also contribute significantly to the failure of the banks. The incompetence or ignorance (actions or inactions) of the employees contributes to the failure of many banks. Rogue traders may destabilize the economic base of the bank with collaboration of some of the staff in the bank. Such usually have far reaching effects since it may be very difficult to detect the errors especially if the cartel is well-planned. Recession also adds to the list of reason banks fail. During the recession times, the demand for loans reduces significantly. Deposits also go down as many people get retrenched. Upon retrenchment, most of the people may withdrawals all their deposits. When such happens, the banks begin making losses. Prolonged periods of recession may eventually see the bank close down. Further, some banks venture into traditionally non-banking activities such as leasing companies that have high risks of failure. Therefore, the bank may collapse due to the huge losses it incurs from the numerous non-banking activities. Moreover, some banks give inappropriate loans to insiders. Some banks have a policy of giving very low-interest rate for their workers. Such may lead to huge losses if the investing of the loans is not in appropriate sectors resulting in high rates of defaulting since they are no different from the other clients.

References

Santonu Basu (2003). Why do Banks Fail? International Review of Applied Economic. Vol. 17, No. 3, July 2003. Retrieved on March 29, 2015 from http://heterodoxnews.com/htnf/htn71/10466211.pdf
Larry Elliot (2011, Aug. 7). Global financial crisis: five key stages 2007-2011. The Guardian August 7, 2011. Retrieved from http://www.theguardian.com/business/2011/aug/07/global-financial-crisis-key-stages