Banks in Crisis

The Legal Response

Andrew Campbell, Peter Cartwright

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351724388
• Edition: 1
• Topic: Diritto
• Subtopic: Diritto finanziario

This title was first published in 2002: A detailed and critical analysis of the various legal problems that arise when banks are in serious financial difficulty, Banks in Crisis offers an invaluable, international perspective on the concept and causes of bank failure. It takes an authoritative and much-needed look at a number of key issues including: - Effective bank regulation as an instrument in the possible prevention of banking crises, with particular reference to the role of the Financial Services Authority in the UK, and the impact of the Financial Services and Markets Act 2000 - The role of the Bank of England in the new regulatory landscape, with particular reference to its function as lender of last resort - The legal controls on those involved in the management of banks - Insolvency procedures and bank liquidation - The use of depositor protection schemes. By drawing conclusions and weighing up the methods available to promote stability, prevent failure and promote rescues where appropriate, Banks in Crisis is an essential read and a welcome addition to this crucial area of research.

1 Banking Crises: The Background

Introduction

Risk taking is an essential element in dynamic financial markets, and it would be both unrealistic and wrong to aim for a zero-failure regime. Regulators should, however, target a low level of failures which bring losses to retail savers and investors.¹

Bank failures have a far greater potential to create collateral damage, and indeed produce victims who may have had no dealings whatsoever with the failed institution in question. So the supervisor's aim must be prevention rather than cure, with amputation as very much the last resort.²

These statements by Howard Davies illustrate the nature of the problem of banking crises. The fact that bank failures can have serious effects beyond the confines of the troubled bank means that banks have to be considered different from other types of businesses. As Davies states it would not be realistic to aim for a zero-failure regime and in certain cases the correct course of action may be to allow an institution to fail.

Banks are prone to risk for a variety of reasons and while bank failures are relatively rare in the United Kingdom (U.K.) they are far from unknown. According to the Bank of England, in the U.K. between 1984 and 1996 twenty-two banks either failed or experienced financial trauma. This book is concerned with the ways in which the law seeks to protect the interests of all those who may be affected by a banking crisis. The book considers the situation primarily from the perspective of the law which applies throughout England and Wales but most of what is written will also be applicable to Scotland and Northern Ireland. International comparisons will be found throughout the book with special emphasis on the United States (U.S.) and the European Union.

Statistics from the International Monetary Fund in 1996 show that banking crises had occurred in about 130 countries since 1980 and that as many as 40 countries were still experiencing difficulties in 1996.³ There have been further crises since then, for example in Russia in 1998 and 1999, Brazil in the early part of 1999 and most recently in Turkey.

It is beyond the scope of this study to analyse in detail the causes of bank crises but an attempt will be made to discover the principle causes and also to provide a brief historical study of bank crises and failures. Banking crises have a long history and at the time of writing there is much uncertainty as to the effect of the attacks on New York and Washington, D.C. on financial markets throughout the world. The financial crises which affected banks in the Far East and former Soviet Union have received much media attention and efforts to address the problems have been made in Japan, Malaysia, Indonesia and other South East Asian countries.

A Short History

Banking crises have occurred for as long as banks have existed and few, if any, countries have not had a banking crisis at some stage. One of the earliest examples was the collapse of the Bardi banking family of Florence as a result of the failure of Edward III of England to repay outstanding loans.⁴ In Victorian times in the U.K. there were some notable British bank failures. For example, Baring Brothers merchant bank, which will feature again later, experienced serious financial difficulties in 1890 as a result of non-performing South American loans. Although Barings was liquidated, it re-emerged, after assistance from the Bank of England, as a new institution with the involvement of the Barings family. Perhaps surprisingly the Barings collapse did not lead to a run on other banks. Twenty-four years earlier when Overend, Gurney & Co. Ltd collapsed there was a widespread run which led to the failure of a number of banks and which even led to a run on the Bank of England.⁵ The Bank of England had refused to provide financial assistance when Overend, Gurney & Co. Ltd reported its financial difficulties and there was no alternative but for it to be put into liquidation. When the Barings crisis occurred 24 years later, the Bank of England did agree to provide assistance and the effects of the crisis were contained. In the Overend, Gurney case the bank appears to have been operated by an extremely incompetent management team who had taken foolish and reckless risks.⁶ With Barings, speculation in Latin America was the cause of the bank's serious financial problems. In both of these cases foolish decisions were taken by incompetent management, but when the City of Glasgow Bank became insolvent in 1878 it was as a result of fraud.⁷

The Bank of England took action which saved Barings, but had refused to assist Overend, Gurney. Since these crises the Bank of England has had a role to play whenever a bank is in trouble, and although at the time of these crises in the nineteenth century it had no legal basis for doing so, the Bank has since been given statutory powers to regulate the banking industry in the U.K. and has had these powers taken away from it. However, the Bank of England still has an extremely important role to play in the prevention and resolution of banking crises and these are considered in Chapter 3.

The effects of the Wall Street crash included bank failure on a massive scale between 1930 and 1933. During this period approximately 11,000 banks, out of the 25,000 which existed at the commencement of this period, failed or were forced to merge with other banks. On the 6 March 1933 President Roosevelt closed all of the banks in the United States for a period of approximately nine days. After this "bank holiday" only those banks which were considered healthy were allowed to re-open. The reasons for the wave of bank failures are not universally agreed upon, and much has been written about this topic, but it seems reasonable to conclude that after the first wave of failures the main reason for the crisis to continue was a lack of confidence in the banking system which led to bank runs. Heffernan suggests that the U.S. banking crisis started in November 1930 with the failure of 256 banks, followed by a further 352 failures in December 1930.⁸ It is important to realise that some of the failing banks were large and important, such as the Bank of United States, and the crisis was not confined to small banks.⁹ A further wave of failures followed in March 1931, and this continued, spreading geographically across the United States, until action was taken by President Roosevelt in March 1933. The Bank Act 1933 (better known as the Glass-Steagall Act) was introduced and the Federal Deposit Insurance Corporation was established.¹⁰

In the early 1930s banks in certain parts of Europe were also experiencing difficulties, but nowhere was the problem as severe as in the United States. Austria and Germany were the most affected during this period. The U.K. banking system survived this period of financial crisis in surprisingly good shape.

In the U.S., the banking reforms of 1933, which, as already noted,. included the establishment of a deposit protection scheme, unquestionably brought stability to the U.S. banking system, and it was not until 1982, when a major bank, Continental Illinois, experienced serious financial difficulties, that the U.S. banking system faced a serious crisis. There were several reasons for the crisis at Continental Illinois, including poor lending policies and a restricted deposit base, but when rumours that the bank was in trouble started to circulate, a "run" on the bank took place.¹¹ Because of the size and relative importance of Continental Illinois, a package of financial assistance was organised by the bodies responsible for the regulation and supervision of U.S. banks, i.e. the Comptroller of the Currency, the Federal Reserve Bank and the Federal Deposit Insurance Corporation. This action package included an injection of capital from the FDIC and a number of U.S. banks and the Federal Reserve Bank agreed to cover any other liquidity requirements of Continental Illinois. The final part of the package agreed to provide complete cover to all depositors and other creditors of the bank. The FDIC assumed control of the bank.¹² The regulatory bodies and the other banks were worried that the panic could spread to other banks and the crisis had to be contained. This is often cited as an application of the "too big to fail" doctrine which means that "if a bank were big enough, it would receive financial assistance to the extent necessary to keep it from failing".¹³ Continental Illinois was a large and important bank and there was perceived to be a real risk that the crisis could spread and that even healthy banks could experience liquidity difficulties unless action to restore depositor confidence was taken quickly. The action taken was successful in containing the panic, but during the period from 1980 to 1993 the U.S. banking system experienced its greatest crisis since the 1930s with the failure of approximately 1300 savings and loans banks and a further 1500 commercial bank failures.¹⁴

After the troubles in the nineteenth century, bank failure in the U.K. was virtually unthought of, until the occurrence of a secondary banking crisis in the early 1970s. This severe crisis had the effect of highlighting many supervisory and regulatory failures in the U.K. and was an important factor in the introduction of the Banking Act 1979. The collapse of Johnson Matthey Bankers in 1984, which again highlighted failures in the regulatory system, led to further legislative enactment in the form of the Banking Act 1987 after a committee consisting of officials from the Treasury and the Bank of England and an externally appointed banking expert recommended changes. Johnson Matthey Bankers was rescued in what has been described as a "lifeboat operation" organised by the Bank of England.¹⁵ In the 1990s, two well publicised bank failures, Bank of Commerce and Credit International and Barings Bank, highlighted the urgent need for further action, but in recent years there have been other, smaller and less publicised bank insolvencies in the U.K.

In Scandinavia, a wave of bank failures which commenced in 1985 required action by the governments of Norway, Sweden, Denmark and Finland, while in Canada, a country not known for bank failure, there were problems in 1985 when it was discovered that five banks were in serious difficulties. The banking problems in the Far East and Russia in the late 1990s are receiving attention and in Japan action has been taken to stem the banking crisis. By the middle of 1998, the Japanese banking system, which had been experiencing significant difficulties, was on the verge of a major crisis. The Japanese Government decided to take action in the form of setting up a "bridge bank" which would take over non-performing loans of troubled banks in an attempt to prevent bank failures and to stem the spread of systemic risk. The Financial Supervisory Agency, which was established on 22 June 1998, immediately decided that 19 of Japan's major banks were to be subject to an inspection by the Agency.¹⁶

Prevention and Resolution of Banking Crises

An effective banking supervision regime will assist in the prevention of banking crises, but it must be stressed that the function of bank supervision is not to prevent the failure of an individual bank but to reduce systemic risk. The supervisor is not in a position to ensure that no individual bank will fail.

The Financial Services Authority¹⁷ in the United Kingdom now has responsibility for the prudential regulation of the b...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• Preface
• Table of Statutes
• List of Abbreviations
• 1 Banking Crises: The Background
• 2 The Regulation of Banks
• 3 The Role of the Bank of England in a Banking Crisis
• 4 Directors, Controllers and Managers
• 5 Insolvency Procedures
• 6 The Liquidation of a Bank
• 7 Protecting Depositors
• 8 Conclusions
• Index