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Explanations

Why do Banks Fail?

Geoff Riley

21st March 2023

In this short video, we explore some of the reasons behind the failure of banks such as Silicon Valley Bank, Credit Suisse, Northern Rock and Lehman Bros.

Why do Banks Fail?

Commercial Bank Failures in the UK

  • Northern Rock: Failed in 2007. Government nationalized the bank in 2008. Eventually sold to Virgin Money
  • RBS (Royal Bank of Scotland) : RBS required bailout in 2008 due to its exposure to bad loans and toxic assets. UK government took a majority stake, and it eventually returned to private ownership.
  • Lloyds TSB: Bailout in 2008 due to its acquisition of Halifax Bank of Scotland (HBOS), which had significant exposure to bad loans and toxic assets. The government took a majority stake, and it eventually returned to private ownership. In 2018, TSB Bank was acquired by Spanish Banco Sabadell.
  • Bradford & Bingley: Failed in 2008 due to a lack of liquidity and a decline in the value of its assets. The government took over the bank's deposits and sold the remainder of the bank to Santander UK.

Main causes of commercial bank failures

  1. Poor management: Taking on too much risk, making bad loans
  2. Lack of diversification in the bank’s loan portfolio
  3. Insufficient capital reserves to cover bad loans: Banks must set aside a certain amount of money to cover the possibility of loan defaults
  4. Run on the bank: A bank can fail if too many depositors withdraw their money at the same time, this is called a run on the bank and creates a liquidity crisis.
  5. Economic downturns: Recessions and higher interest rates lead to an increase in loan defaults and a fall in the value of the bank's assets
  6. Regulatory failure: Inadequate regulatory oversight can lead to risky practices, fraud and corruption, and ultimately commercial bank failure

Here are Martin Wolf's thoughts on bank reforms

Geoff Riley

Geoff Riley FRSA has been teaching Economics for over thirty years. He has over twenty years experience as Head of Economics at leading schools. He writes extensively and is a contributor and presenter on CPD conferences in the UK and overseas.

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