Introduction
The Bank of Industry, Commerce and Agricultural (BICAL) was opened in 1962 by Henry and Cecil Pace. This was not their only investment but they were also the shareholders and directors of numerous companies which covered the whole economic spectrum such as hotels, finance, manufacturing and motor vehicles.
Although Cecil Pace was seen as a successful business man it was eight years after that the crises started to develop. The Bical bank was used a merchant bank by the Pace brothers to finance their investments.
Development of the crises
The crises was first identified in 1970 where inspectors of the Central Bank of Malta pointed out that the Bical Bank was in a bad situation and exposed to great risk due to a shortage of liquidity, and excessive loans beyond the bank's means. This was shown in a report which was verified by the accountants Coopers Brother Ltd and in which they suggested the importance of the appointment of a controller to regulate the bank's dealings.
The inspectors concluded that these loans were concentrated on a small number of industries in which the president and one of the directors of Bical had major interests, a practice not in conformity with banking practice.
In 1971, the Finance and Customs Minister Guze Abela gave orders for the immediate examination of Bical affairs by Central Bank inspectors.
The year after, the bank was no longer of the Pace Brothers and a DOI statement announced that the bank was to be closed for a time to allow for talks with the Finance Ministry. Central Bank manager RJA Earland appointed Karmenu Mifsud Bonnici as the controller of Bical Bank to take over the bank's and its associated companies' assets and sell off as much as is needed to clear all the bank's and its companies' debts and liabilities.
The brothers were accused of resorting to irregular and criminal devices and it was because of this that the Central bank and the government had to take action in terms of the Banking Act.
In fact, in 1977 following four years of imprisonment and house arrest, Cecil and Henry Pace were convicted for misappropriation, fraud and forgery. Cecil was sentenced to 14 years, and his brother 9 years.
Causes of the Crises
One of the causes of the BICAL bank crises was that the loans issued by this bank were to a small number of industries. This could mean that if one of the industries experience problems such as liquidity problems then this will leave a serious impact on the bank.
Another cause of such crises was that the books of Bical bank and other records showed favourable balances when the reality was completely the opposite. The hidden transactions are in fact fraud of which Pace brothers were accused. This was also evident in the fact that there were no transparency between the Bical Bank and the Central Bank of Malta, where the latter having the supervisory powers to ensure that banks and other financial institutions do not behave fraudulently, should have been well informed of every transaction going on in the Bical bank.
The case of the Bical bank took a span of about seven years and this in fact shows how the length of time and the cost of process became issues in themselves and which made the case even worse and difficult.
Lessons learnt
The main important lesson from this crisis is diversification.
By investing in different areas similar situations would end up affecting these areas differently. Although it does not eliminate failures like these, diversification would in fact help to minimize this risk and promote financial stability.
Following this, one such other important point is that in Bical Bank the president and the director had major interests in this same bank.
Ultimately, the local regulator which in this case is the Central Bank of Malta must know all that is happening within the bank. Since the Central Bank is seen as being also the lender of last resort, then being well informed of its banks' transactions is of major importance since the latter take on excessive risks or even try to hide transactions from the Central Bank knowing that it will help them in case of financial problems.
Continental Illinois national bank and trust
Introduction
Continental Illinois found its origin back from two Chicago banks, the Commercial National Bank, founded during the American Civil War, and the Continental National Bank, founded in 1883. In 1910 the two banks merged to form the Continental & Commercial National Bank of Chicago which was considered a large bank at the time. Then, in 1932 the name changed to the Continental Illinois National Bank & Trust Co.Continental Illinois National Bank And Trust
Between the years 1976 and 1981 the Continental Illinois National Bank and Trust grew very fast. To strengthen the expansion of the bank, Continental formed a relationship with Oklahoma-based Penn Square Bank, a bank that specialized in oil and gas sector loans.
The news of Continental's relationship with Penn Square caused great anxiety among investors and many stock analysts quickly halved earnings estimates and also changed their opinions.
Continental also expanded its assets in another sector by lending to lesser-developed countries in Latin America such as Mexico. Continental had unusual credit funding strategies. In fact in 1981 it hit a high point in terms of the assets size, while in 1984, it was the 6th largest bank in the U.S.
Development of the Crises
After years of oil price rises and industry expansion, oil prices began to drop in April 1981. Exploration and drilling companies were inevitably among the first to suffer the consequences of this industry deterioration. Then, as a result of this, Continental's share price began a steep decline, losing over half of its value from mid 1981 to mid 1982.
Through the first half of 1982, most analysts continued to think that any fall in Continental's credit portfolio would threaten the bank's profitability, not its solvency. After all, Continental was considered as a very strong bank, with a good earnings record and an AAA agency rating for its debt.
However in summer of that same year Continental's reputation distorted. The situation of this bank continued to worsen with the collapse of Penn Square Bank in July 1982 mainly caused by poorly underwritten loans to the weak energy sector. The collapse revealed the extent of the bank's lending in Penn Squares, and highlighted the damage that was being brought on other banks, which like Continental, they had specialized in energy-linked lending.
Continental was forced to report $1.3 billion in non-performing assets in the second quarter of 1982. The Penn Square collapse was closely followed by Mexico's debt default in August 1982, which triggered the 1980s LDC crisis.
During the first half of 1983 Continental's situation appeared to have stabilized somewhat, but the bank's recovery was far from certain. Although the bank apparently had made efforts to tighten its internal controls and lending procedures but its nonperforming loans continued to mount.
However in 1984, with non-performing loans increasing substantially, Continental's solvency became a serious issue and this in fact was the year when Continental nearly collapsed.
The $33-billion asset bank had compounded its mistakes by lending large amounts to lesser-developed countries prior to the August 1982 start of the major LDC crisis of the 1980s. With investors and creditors being influenced by rumors that the bank might fail or be taken over, Continental was suffering from its usual domestic and international wholesale funding markets. As Continental was facing such problems it was forced to borrow through the Fed discount window; this is an instrument of monetary policy that allows banks and other financial institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions.
By May 17, the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) feared a failure could cause widespread financial trouble. To avoid this, regulators prevented the loss of virtually all deposit accounts and even bondholders, thus extending a guarantee to uninsured depositors and creditors at the bank promoting the fact that some banks should be considered too big to fail. This in fact made Continental, the largest bank in the history of US banking ever to be rescued by government agencies.
Since it was difficult to find a purchaser for the bank, regulators worked with Continental to devise a solution. This in fact was that the bank had to be nationalized using FDIC funds.
It was in 1991 that the FDIC sold off its last equity stake in Continental, drawing the rescue program to a close, seven years after the banks near collapse.
Lessons Learnt
The first important lesson that came about in this bank crisis and similar ones is diversification. The incentive to offer loans to the same industry sectors should be balanced by ensuring that the extent of risks involved had been taken into account prior to the lending process. Also it is more important to diversify even among different industries.
Control and risk monitoring is of extreme importance when a bank would be lending high amounts to a particular lender; this being because if this lender fails because of taking on excessive risks, then it will leave financial damage to the bank itself. Therefore one can conclude that there should be large bank supervision so as that there will be diversification to reduce the credit risk and also systemic risk.
Also it is important to highlight that deteriorating credit portfolios, leading to market rumor, can cause a bank failure. This is so as in this bank failure, rumors where circulated widely about the banks financial condition. These rumors then resulted in charges of higher rates for funds from international banks to Continental. And also the rumors had resulted that the international money markets would not invest in such banks.
State bank of South Australia
Introduction
On July 1 1984, two banks owned by the State Government of South Australia: the Savings Bank of South Australia and the former State Bank of South Australia, merged together to form the State Bank of South Australia.
The main roles of the bank were retail banking activities and some commercial lending within South Australia.
Causes of failure
State Bank of South Australia collapsed in 1992 where it had caused one of the largest Australian banking crises. As a result of this the South Australian Government had appointed a Royal Commissioner to investigate the causes of this failure.
After such investigation it resulted that one of the main concerns of this failure was the 'round robin' approval process when coming to lending applications. A round robin was a vote on a lending proposal where a number of directors were given a written proposal and requested by the Bank officers to assess the qualities of the proposal and to form a view on it. This process was used so as to make decisions quickly when faced with urgent proposals.
However this approval process was weak in itself. This is so as because of this process the Board failed to properly supervise and control the affairs of the bank. The absence of a sufficient internal control over the process lead to a failure to meet the standards required for the prudent management of the Bank's affairs.
Thus, concluding from this point that this was an informal method which was not sufficient to be used by a bank of this type.
The commissioner also analyzed a weakness in Board meetings. The latter were called up on short notice and so they lacked the appropriate preparations for such meetings. As a result of this, the members would not have had enough time in which to consider which the most critical lending submissions were; though the business was transacted all the same with no priorities.
To make the situation even worse, such meetings were also short and thus this resulted in not dedicating the appropriate time the discussions required.
The State Bank of South Australia had also lack of organisation which was shown in the fluctuating and unpredictable composition of it Board Sub- Committee. Also, the Lending Credit Committee had its weaknesses. Mainly, they lacked the monitoring of the Bank's loans transactions which is crucially important. In addition it did not clearly segregate the responsibility for supervision and scrutiny of the Bank's lending policies between the Board, the Chief Executive Officer and the Committee.
The lack of definition of responsibilities resulted in having monitoring of customers varying from manager to manager and therefore being conducted unsystematically.
They did not only have lack of methods of guidance already referred to above but also managers were not directed to monitor the performance of their customers, but instead they performed only an annual review of each customer and otherwise examined only customers who exceeded approved credit limits. This approach did not enable timely identification of weakening credits in order to forecast potentially adverse consequences for the Bank.
The Lending Credit committee also had the absence of a procedure under which lending decisions would be analyzed by an independent person. All officers of the Bank who participated in lending decisions had in mind the growth in assets and this would sometimes result in not considering certain risks involved in every consideration.
Moreover, given that the manager responsible for monitoring a particular loan was often the same manager who had initially approved that same loan, there was often an unwillingness to admit certain deteriorating loan settlement and to take remedial action.
Such failure has also been the result of having no transparency among the members of the bank. This being that in many cases events associated with the management of exposures were either not reported or else becoming identifiable when it is too late. As a result of this the decisions in such circumstances where thus reactive rather than pro-active making the problem even more difficult to solve.
Lessons learnt
The first important lesson from this failure is the management of credit risk. Credit risk, defined as the potential that a bank borrower will fail to meet its obligations, make loans the largest and most obvious source of credit risk.
Banks need to manage the credit risk arising both from individual creditors and individual transactions, and the risk inherent in the entire portfolio. Furthermore, banks need to consider the relationship between credit risk and other risks. The effective management of credit risk thus is essential to the long term success of any banking organization.
This failure highlights the importance of board meetings, being the second lesson which must be learnt. The latter are the only opportunity for the directors of the bank to stop from the daily fast routine of a bank and to analyze what is going on and which are the critical transactions which need to be taken into consideration.
Failure to regularly attend board meetings or to not dedicate enough time for them just like what happened to State Bank of South Australia likely signals a director's inability or unwillingness to meet the director's fiduciary duties to the organization and its mission. Ultimately, the meetings should be productive and what is discussed should be practiced.
The concept of transparency brings to us another lesson which must be learnt.
Banking transparency and disclosure of bank activities are suggested to prevent future banking crises. Therefore in the case of our bank disclosing the appropriate information to the appropriate members of the bank and at the appropriate time could have surely prevented its failure.
Different people mean different ideas and obviously the last lesson which can be identified is the importance of segregation of duties. The latter means that fraud can be prevented because it requires collusion of two or more persons and that it is much more likely that innocent errors will be found.
State bank of South Australia could surely have identified bad performing loans which were the main cause of this failure.
