Friday, March 18, 2016

This Week in Bank Failures

Bank regulators can reduce the risk that a bank will fail, but banks will still fail sometimes, New York Fed President William Dudley said today. Congressional committees in particular have asked if the Fed and other regulators can do more to prevent bank failures. Similar questions have come up in Spain and other places where major banks have gone under with only a few days of warning. In my opinion, the banks themselves, not the regulators, have to take on the primary responsibility for avoiding failure. Most recent large bank failures have been the result of a pattern of high-risk transactions that regulators couldn’t be expected to uncover quickly. Often the high-risk transactions were undertaken in an obscure corner of the bank that kept the nature of the risks they were taking hidden from senior management. In other cases, senior management was in on the coverup, betting the bank’s future on loans to faltering businesses that either the bank or its executives had an interest in. Either way, bank examiners and auditors tend to find out about these practices only after it is too late to save the bank.

If it is considered essential as a matter of policy to reduce the number of large bank failures, that will require new laws to change the incentives at work in banks. Rules that delay the vesting of bonuses were a very crude way of addressing this issue. There is much more that could be done to reduce bank officers’ incentives to take risks and to obscure the risks they have taken.

In Spain, Bankia is paying out compensation to small investors who bought stock in the state-created bank during its one year in operation before it failed and was taken over by the state. The bank had challenged the requirement in court, but ultimately lost, with courts finding that the bank did not properly disclose to the investors, most of whom were the bank’s accountholders, that the financial instruments they were selling were a form of stock. It is the largest misselling case in Spanish history. The average individual investor is being compensated €5,000. The question of compensating institutional investors is still open, but that would be a much harder case to make. Institutional investors would have to show that the offering documents misled the institutional investors’ lawyers, but that’s possible if the bank provided a false description of the investments in the documents. All these issues have to be resolved before the rescued bank’s planned 2017 stock offering.

Stealth malware installed in the central bank of Bangladesh was probably there undetected for weeks or months before criminals used it to steal $80 million from the bank’s account at the Federal Reserve Bank. Investigators suspect that the theft was carried out using credentials taken from the bank’s internal email system.

The former CEO of the failed Anglo Irish Bank is out on bail, but in Ireland now. A trial on his role in the failure of what was then the largest player in Irish real estate is not expected until next year. Convictions of other bank officers in the failure have been overturned on appeal.