Financial Times - Bank Failures in 2023

The Financial Times has this excellent in-depth video exploring some of the bank failures that happened in 2023 and casting a critical eye on the wider fragility of the banking system as we head into a new year.

Recent Commercial Bank Failures: An Academic Summary of Causative Factors

While commercial bank failures have become relatively rare compared to historical periods, the recent occurrences still warrant closer examination. Here's an academic summary of some key reasons behind these failures:

1. Shifting Economic Landscape:

• Rising Interest Rates: Tightening monetary policy by central banks can put pressure on bank profitability, particularly for institutions heavily reliant on net interest income from traditional lending.
• Economic Slowdown: Concerns about recession or economic slowdown can lead to decreased loan demand and increased loan defaults, impacting asset quality and ultimately capital adequacy.
• Geopolitical Uncertainty: Global events like the ongoing war in Ukraine and ongoing supply chain disruptions can create increased volatility and risk aversion, affecting banks' funding and asset values.

2. Specific Risk Management Issues:

• Concentration Risk: Over-reliance on specific sectors or borrowers can amplify losses during downturns. This was seen in the case of Silicon Valley Bank's exposure to the technology sector and their heavy buying of US government bonds, whose price fell when the Federal Reserve started raising policy interest rates.
• Credit Underwriting Standards: Lax lending practices during periods of economic optimism can lead to a build-up of bad loans when conditions worsen. For more on this, try a google search for the Minsky Financial Instability Hypothesis.
• Internal Control Weaknesses: Inadequate risk management and oversight systems can exacerbate other vulnerabilities and hinder timely corrective action.

3. Regulatory and Technological Challenges:

• New Regulatory Requirements: Implementation of stricter capital adequacy or liquidity requirements can strain smaller banks' resources and profitability.
• Cybersecurity Threats: Sophisticated cyberattacks can lead to financial losses, operational disruptions, and reputational damage, impacting customer trust and confidence.
• Fintech Competition: The rise of innovative financial technology companies disrupts traditional banking models, forcing banks to adapt and potentially exposing them to new risks in their digital transformation efforts.

4. Additional Factors:

• Management Misconduct: Fraudulent activities or deliberate mismanagement by bank executives can also contribute to failure.
• Local Market Dynamics: Regional economic conditions or specific events like natural disasters can disproportionately impact smaller banks operating in concentrated markets.

Further Research:

This summary provides a general overview, but each bank failure has its own unique context and contributing factors. Further research should delve deeper into:

• Case studies of specific bank failures: Examining individual cases can highlight unique combinations of factors and shed light on specific vulnerabilities.
• Comparative analysis across different jurisdictions: Comparing bank failures across countries with different regulatory regimes and economic structures can provide valuable insights.
• The role of regulatory responses: Evaluating the effectiveness of regulatory interventions in preventing or mitigating bank failures.

By analysing the reasons behind recent commercial bank failures, researchers and policymakers can develop strategies to strengthen the banking system, improve risk management practices, and safeguard financial stability.