Large Bank Failures Research Articles

The Failure of Silicon Valley Bank and the Panic of 2023

The failure of Silicon Valley Bank on March 10, 2023 brought attention to significant weaknesses across the banking system, leading to a panic that spread to other vulnerable banks. With subsequent failures of Signature Bank and First Republic Bank, the United States had three of the four largest bank failures in its history occur over a two-month period. Several features of the Silicon Valley Bank failure make it an ideal teaching case for explaining the underlying economics of banking (in general) and banking crises (specifically). This paper tries to do that.

Breaching-related turbidites in fluvial and estuarine channels: Examples from outcrop and core and implications to reservoir models

An understanding of the paleoenvironment and the main sedimentary processes behind preserved deposits is crucial to correctly interpret and represent lithofacies and facies associations in geomodels that are used in the hydrocarbon industry, particularly when a limited dataset of cores is available. In this paper a fairly common facies association is discussed containing massive sands - here defined as thick (>0.5 m) structureless sand beds devoid of primary sedimentary structures, or with some faint lamination - deposited by mass failures of channel banks in deep fluvial and estuarine channels. Amongst geologists it is generally accepted that liquefaction is the main trigger of large bank failures in sandy subaqueous slopes. However, evidence is mounting that for sand deposits a slow, retrogressive failure mechanism of a steep subaqueous slope, known as breaching, is the dominant process. A model of breaching-induced turbidity current erosion and sedimentation is presented that explains the presence of sheet-like massive sands and channel-like massive sands and the sedimentary structures of the related deposits. Sheet-like packages of spaced planar lamination that are found together with massive sand bodies in deposits of these environments are identified as proximal depositional elements of breach failure events. The model, acquired from sedimentary structures in deposits in the Eocene estuarine Vlierzele Sands, Belgium, is applied to outcrops of the Dinantian fluvial Fell Sandstone, England, and cores of the Tilje and Nansen fms (Lower Jurassic, Norwegian Continental Shelf). The possible breach failure origin of some other massive sands described in literature from various ancient shallow water environments is discussed. Breach failure generated massive sands possibly also form in deep marine settings. The potentially thick and homogeneous, well-sorted sand deposits bear good properties for hydrocarbon flow when found in such an environment. However, in case of deposition in an estuarine or fluvial channel, these sand bodies are spatially constricted and careful facies interpretation is key to identifying this. When constructing a static reservoir model, this needs to be considered both for in-place volume calculations as well as drainage strategies.

BANKING AND PUBLIC POLICY: TOO BIG TO FAIL

“Too big to fail” (TBTF) is a major policy issue in banking. Large bank failures may impose losses on depositors and creditors that may impose large collateral damage on other financial institutions and beyond. Regulators are frequently incentivized either to delay recognizing a bank's insolvency or fail the bank but protect its creditors against loss. This paper argues that, while there is wide agreement that the cost of protecting creditors in the resolution of large financial institutions is excessively high, it is difficult to prevent this practice for a number of reasons. Until these disagreements are settled, TBTF will survive. (JEL G01, G18, G28)

Cross-Border Bank Resolution - Recent Developments

Developing an effective framework for cross-border resolution is a key priority in international regulatory reform. Large bank failures during the global financial crisis brought home the lack of adequate tools for resolving “too-big-to-fail” institutions. In cross-border cases, misaligned incentives and lack of robust mechanisms for resolution and cross-border cooperation left some country authorities with little choice but to take unilateral actions, which contributed to the high fiscal costs of the crisis and resulted in disorderly resolution in some cases

(Reforming Financial Resolution Regime for Financial Stability)

Korean Abstract: 금융의 글로벌화로 금융기관간 상호연계성이 확대되어 과거와는 달리 금융불안정은 특정 금융부문이나 특정 국가의 문제에 그치지 않고 순식간에 전세계 금융시장 및 실물경제로 전파되는 속성을 드러내었다. 이에 반해 기존의 금융정책체계는 글로벌 금융불안정에 대응하기 위한 국제적 기준이나 협조체제가 잘 갖추어지지 않았고, 대형화된 복합금융그룹의 부실시 순차적인 정리제도가 미흡하여 금융안정을 확보하는 데 한계가 있다. 따라서 시스템 리스크를 야기할 수 있는 금융기관의 부실화에 대한 금융규제감독 및 공적 금융안전망 체계를 새로이 정립할 필요성이 절실하게 대두되었다. 우리나라의 경우 이번 글로벌 금융위기 과정에서 상대적으로 금융기관의 부실 발생도 적었고 금융위기도 빠르게 극복하고 있으나, 금융안정을 유지하고 향후 시스템 리스크를 예방하기 위해 금융기관 부실정리제도를 정비할 필요성이 높아지고 있다. 이에 본고는 국경간 정리제도 정비, 복합금융그룹의 부실시 정리방안 마련, 금융위기시 한시적 예금보호 확대 등에 대한 제도적 검토와 함께, 예금보험공사의 부실금융기관 정리비용 개선을 위한 정보공유의 확대 및 정보수집 능력 강화, 적기시정조치 참여, 정리절차 개선 등에 관한 개선방안을 제시하고 이를 논의한다. English Abstract: Due to rapid financial globalization and deepening interconnectedness among financial institutions, the insolvencies of large complex financial institutions(LCFIs) operating globally can threaten global financial markets and the real economy by creating a rapid contagion of negative impacts. The effects of the large bank failures were so huge that the current financial regulatory and supervisory regime was unable to secure the financial stability by regulating the financial institutions properly during the recent crisis. It was apparent that effective global standards and orderly resolution procedure for insolvent LCFIs must be established and that the financial regulatory and supervisory framework and the financial safety net need an overhaul to stabilize insolvent financial institutions which may trigger a systemic crisis. This paper aims to review the current resolution regime of the Korean financial market and make some suggestions to improve its effectiveness. Though there were no severe insolvencies in the Korean financial market during the crisis, the need to improve the effectiveness of the resolution regime for the financial institutions in order to prevent any financial instability and systemic crisis became apparent after the collapse of global LCFIs, such as Lehman Brothers, Northern Rock Bank, etc. This paper covers the following topics that are separate but closely related for the financial stability in Korea; cross-border resolution regime, resolving insolvencies of LCFIs, adopting a blanket guarantee scheme for deposit insurance during a financial crisis, reinforcing the role of the KDIC to maximize the efficiency in resolution by improving information sharing and collection, prompt corrective action, and resolution procedure.

Pre-positioning for effective resolution of bank failures

Large bank failures are often handled differently to other firm failures because suddenly closing a large bank and consequently freezing otherwise liquid claims raises financial stability concerns. As a result, substantial public funds are often used as part of the resolution process, which can undermine market discipline and longer-term financial stability. We propose a resolution scheme that enables the good portion of creditors’ claims to be quickly made available to them in way that maintains market discipline while managing the liquidity effects of large bank failures. We report on a New Zealand study into making the scheme work in practice.

The impacts of “shock therapy” on large and small clients: Experiences from two large bank failures in Japan

A “shock therapy” might have different impacts between large and small firms. In this paper, we focus on the clients of two large failed Japanese banks; LTCB and NCB. We first show that subsequent events after the bank failures allowed new LTCB to adopt a “shock therapy” but new NCB to keep “soft budget constraints”. We then show that the different therapies made performances of these two banks' customers very different. Under the shock therapy, large firms showed significant recovery of their profits but small firms did not. In contrast, under the soft budget constraints, large firms did not show recovery and small firms terminated the relationship by the new bank experienced significant decline in their profits.

Resolving Large Financial Intermediaries: Banks Versus Housing Enterprises

This paper examines the policy issues with respect to resolving the possible failure of housing enterprises Fannie Mae or Freddie Mac. The authors compare and contrast these issues with those raised in the context of large bank failures and also identify important differences in the extant supervisory authorities. Based on these discussions, they offer a number of policy suggestions designed to minimize the cost of resolution and protect taxpayers from loss should a large bank or housing enterprise fail.

Resolving large financial intermediaries: Banks versus housing enterprises

This paper examines the policy issues associated with resolving the possible failure of Fannie Mae or Freddie Mac (housing enterprises). It compares and contrasts these issues with those raised in the context of large bank failures and also identifies important differences in the extant supervisory authorities. Based on these discussions, a number of policy suggestions are offered to minimize the cost of resolution and protect taxpayers from loss should a large bank or housing enterprise fail.

Self-Organized Criticality in Riverbank Systems

Where and when do natural rivers become unstable? To answer this question, we visually estimated bank-failure extent in 100-m increments along 180 km of riverbanks in three watersheds of the northern Yellowstone ecosystem. The riverbank data reveal precise power-law relationships between the number of bank failures of a given size throughout each watershed and the magnitude of those bank failures. The slopes of log-log graphs (i.e., the exponent τ) of bank-failure magnitude versus failure frequency in alluvial reaches vary from 1.07 to 1.44, while τ for all reaches combined (alluvial, colluvial, and bedrock) varies from 1.18 to 1.53, suggesting that lower-gradient, alluvial streams are more susceptible to large bank failures. Cellular automata simulations of riverbanks show similar power-law failure relationships, as do bank-erosion data from a long-term independent dataset from another location. These power-law structures can be interpreted as the spatial signal of a self-organized critical (SOC) system, in which local instabilities function to generate broader-scale order. SOC systems are considered to be at the “edge of chaos,” where local processes interact to make prediction of specific failure events impossible, although probability distribution prediction of the magnitude and spatial frequency of those events is possible. A critical structure of this sort is to be expected in bank failures along a stream given a nonlinear diffusive system such as a drainage basin. If riverbanks are, in fact, part of a critical system, then long-term local or watershed-wide stability is an unlikely or even impossible engineering or restoration goal. The existence of criticality in natural stream settings suggests that local human alterations designed to increase channel stability, while changing the local frequency of small failures, will only encourage an increase in the magnitude of system-wide, low-frequency large failures. A restoration or stabilization effort will not eliminate the bank instability. Instead, it will transfer that instability to neighboring riverbank areas.

The value of banking relationships during a financial crisis: Evidence from failures of Japanese banks

Previous literature suggests that banking relationships can enhance the value of client firms in the presence of asymmetric information problems. Hence, severance of banking ties due to a bank failure can have adverse consequences for the clients of the failed bank. In this paper, we provide evidence on the value of banking relationships by examining the impact of three large bank failures in Japan on their clients and the clients of surviving banks. We find that, as in previous studies, the market value of customers of the failed banks is adversely affected on the date of the failure announcements. In addition, the effects are related to the financial characteristics of both the client firms and their primary banks. Firms that have greater access to alternative sources of funding experience a less severe adverse impact from bank failure announcements. Similarly, clients of banks that are more profitable, better capitalized, and have lower loan loss reserves suffer less from the failure announcements. However, we also find that these effects are not significantly different from the effects experienced by all firms in the economy. That is, the bank failures represent “bad news” for all firms in the economy, not just for the customers of the failed banks.

The Value of Banking Relationships During a Financial Crisis: Evidence from Failures of Japanese Banks

In this paper, we provide evidence on the value of banking relationships by examining the stock market valuation impact of three large bank failures in Japan in 1997 and 1998 on their clients and the clients of surviving banks. Bank failures are theorized to have adverse consequences for other firms in general, and for customers of the failed institutions in particular. Firms that are customers of the failed institution may be adversely affected because, among other things, they may lose an ongoing source of funding and need to incur the expense of search and providing financial and other information about themselves to new lenders. Hence, severance of banking ties due to a bank failure can have adverse consequences for the clients of the failed bank. In addition, firms that are not customers of the failed bank may be adversely affected because the failure may signal existing but yet unrecognized problems at other banks, ignite problems at other banks through spillover or contagion, or foretell adverse economic conditions for the economy in the region or nationwide. Unlike previous studies of this type, we examine not only the impact of bank failure announcements on the market valuation of the client firms of the failed banks, but the impact of the announcements on all firms including the clients of surviving banks. By also examining the stock valuation of the failure announcements for firms that did not have relationships with the failed institutions, we can identify any differences in the effects on clients and non-clients of the failed banks. This is particularly important when the distress or failure announcements occur in the midst of an on-going financial crisis, and therefore, can have strong implications for the viability of surviving banks and their relationships with client firms. We find that, as in previous studies, the market value of customers of the failed banks is adversely affected at the date of the failure announcements. In addition, the effects are related to the financial characteristics of the client firms and their primary banks. Firms that have greater access to alternative sources of funding experience a less severe adverse impact from bank failure announcements. Similarly, clients of banks that are more profitable, better capitalized, and have lower loan loss reserves suffer less from the failure announcements. However, we also find that these effects are not significantly different from the effects experienced by all firms in the economy. That is, the bank failures represent bad news for all firms in the economy, not just for the customers of the failed banks.

Predicting large US commercial bank failures

The present study applies empirical methods to the problem of predicting large US commercial bank failures. Due to sampling limitations, scant research has examined the feasibility of using computer-based early warning systems (EWSs) to identify pending large bank failures. In the late 1980s and early 1990s numerous large banks failed in the US enabling us to collect adequate samples of large banks with more than $250 million in assets for empirical analyses. Both the parametric method of logit analysis and the nonparametric approach of trait recognition are employed to (1) develop classification EWS models based on original samples and (2) test the efficacy of these models based on their prediction accuracy using holdout samples. Both logit and trait recognition performed well in terms of classification results. However, with regard to the prediction results using holdout samples, trait recognition outperformed logit in most tests in terms of minimizing Type I and II errors. Other results from the trait recognition models reveal that complex two- and three-variable interactions between financial and accounting variables contain additional information about bank risk not found in the individual variables themselves. We conclude that computer-based EWSs can provide valuable information about the future viability of large banks.

The importance of breaching as a mechanism of subaqueous slope failure in fine sand

Large bank failures, comprising up to 106 m3 of sediment, are common features along steep channel banks in estuaries and large rivers that consist of clean, fine sands, and are mostly assumed to be generated by sudden liquefaction of large masses of very loosely packed sand. Another less commonly recognized type of failure is manifested by the gradual retrogression of a very steep wall, steeper than the angle‐of‐repose. Instead of the voluminous surging plastic sediment‐water flow, or hyperconcentrated density flow (sensu Mulder & Alexander, 2001) generated by liquefaction, this type of failure, known as breaching by dredging companies and hydraulic engineers, produces a sustained quasi‐steady, turbidity current. To date, sedimentologists have not recognized the process of breaching as such. In this paper, it is suggested that breaching may be the origin of many thick, massive sand layers known from ancient deposits from various environments, notably in some turbidite successions. Possible differences in the sedimentary structure of the deposits produced by breach failures vs. liquefaction slope failures (=liquefaction flow slides) can be deduced from a knowledge of the sediment transport processes initiated by the failure. A field study is presented on some poorly structured beds in the Eocene Vlierzele Sands in Belgium, which are supposed to have originated from liquefaction failures, but are reinterpreted to be the products of breaching. It is postulated that the local steep slope disturbance required to initiate an active breach can be produced by a small liquefaction slope failure (=liquefaction flow slide failure) or local erosion by river or tidal channel flow at the initial stage of the failure event.

Regulatory distortion of management compensation: The case of golden parachutes for bank managers

This paper examines whether golden parachute adoptions in the banking industry during the eighties aligned the interests of CEOs with those of regulators and or shareholders. Our results provide evidence supporting concerns expressed by regulators: that boards of directors behaved opportunistically by adopting golden parachutes prior to large bank failures in order to exploit the FDIC guarantee. Parachute adoption was correlated with poor performance ex ante and ex post. Moreover, adoption of parachutes virtually ceased when the FDIC guarantee was withdrawn by FDICIA.

Additional evidence on the information-based contagion effects of bank failures

Recent theoretical models addressed the question of the nature of bank runs and what triggers them. Two competing hypotheses emerged: pure panic and information-based contagion. This study provides additional evidence consistent with the latter hypothesis. Three observable bank characteristics are examined as proxy measures for the interim private information used by rational depositors in assessing the riskiness of a bank's long-lived assets that may trigger bank runs. The three factors are (1) the distance of the solvent banks' headquarters from the headquarters of each failed bank; (2) the size of the solvent banks; and (3) the capital ratio as a proxy for their solvency. The analysis is conducted in the context of the five large bank failures that occurred in the Southwest region of the US during the mid-1980s. Weekly abnormal returns of 33 Southwestern BHCs, in ten critical failure-related event dates are regressed on the three observable bank characteristics. Our findings suggest that distance and capital adequacy are negatively related to the magnitude of the contagion effect, whereas size is positively related.

ARE SOME BANKS TOO LARGE TO FAIL? MYTH AND REALITY

At the time of the Continental Illinois National Bank insolvency, bank regulators considered some commercial banks “too large to fail” (TLTF) and were reluctant both to legally fail such banks and to impose pro rata losses on any of the uninsured creditors of these insolvent banks and their parent holding companies. This policy was introduced due to widespread fears that large bank failures would set off a domino effect bringing down other banks and possibly even the macroeconomy as it did during the 1930s. Also, because these banks are considered special in that they provide money and credit to their communities, many feared that their failure could reduce greatly the availability of these services.This paper analyzes the validity of these fears by examining both theory and the historical record. It concludes that neither theory nor history provides strong support for either fear. In addition, the paper finds that the costs of regulatory forbearance granted to insolvent banks and their creditors greatly exceed the alleged benefits. It also reviews how policy makers apply the TLTF principle in practice. The paper concludes that the policy has been modified progressively over time so that some large banks now are declared legally insolvent and all creditors of bank holding companies—and some uninsured creditors of the banks themselves—incur losses. One may reasonably expect that TLTF will be modified further as the large societal costs become more evident to the public and regulators alike.

Some Results on Bond Yield and Default Probability

Fisher [5] suggested that the difference between a corporate bond's promised yield-tomaturity (YTM) and the YTM of a government bond of the same maturity is composed of the sum of the corporate default risk, the variability of the firm's earnings, the firm's reliability in meeting its obligations, its capital structure, and the bond's marketability. Since then, Fisher's measure has often been used to measure bond risk. For example, Fraser and McCormack [6] have used the spreads between newly issued bank bonds and Aaa bonds of compatible maturities (as substitutes for riskless government bonds) to measure the changes in banks' borrowing risk after two large bank failures. In their paper, spread is intended to provide for intra-firm (industry) default risk comparisons over time. Radcliffe [15] uses yield spreads to differentiate the riskiness among corporate bonds. In this case, the spread is used for inter-firm risk comparisons. Sharpe [18] has suggested a similar measure of bond default risk which is the YTM less the expected rate of return. However, most of these papers do not provide a bond pricing model which would furnish the link between a firm's riskiness and the YTM and default risk of its bond. Without this, it is difficult to draw inferences between YTM's and default risk.

THE ANALYSIS OF OUTLYING DATA POINTS USING ROBUST REGRESSION: A MULTIVARIATE PROBLEM‐BANK IDENTIFICATION MODEL*

ABSTRACTBecause the eight largest bank failures in United States history have occurred since 1973 [24], the development of early‐warning problem‐bank identification models is an important undertaking. It has been shown previously [3] [5] that M‐estimator robust regression provides such a model. The present paper develops a similar model for the multivariate case using both a robustified Mahalanobis distance analysis [21] and principal components analysis [10]. In addition to providing a successful presumptive problem‐bank identification model, combining the use of the M‐estimator robust regression procedure and the robust Mahalanobis distance procedure with principal components analysis is also demonstrated to be a general method of outlier detection. The results from using these procedures are compared to some previously suggested procedures, and general conclusions are drawn.

Large Bank Failures and Investor Risk Perceptions: Evidence from the Debt Market

The commercial banking industry has been buffeted by a variety of forces in recent years. Alternating periods of intense monetary restraint and the severity of the 1973–74 economic contraction (especially as it affected the real estate industry), huge losses on loan portfolios, a heavy commitment of funds to less developed countries on the part of a few major banks, and the failures of a number of individual banks have created considerable discussion about the stability of the banking system. Questions have been raised about the risk involved in committing funds to the securities of banking organizations. Moreover, the importance of these questions has been underscored for bank management by the necessity for many banking organizations to raise substantial amounts of external funds to prevent further depletion of existing capital ratios.