Unwise Lending Proves to Be the Culprit in Most Bank Failures

By Stephens, D. R. | American Banker, January 24, 1986 | Go to article overview

Unwise Lending Proves to Be the Culprit in Most Bank Failures


Stephens, D. R., American Banker


AT INDUSTRY CONFERENCES, cocktail parties, and dinners, the question most frequently addressed to the chief executive officer of a bank is, "Why do banks fail?" Since this appears to be an issue of broiad interest, I thought I would provide our clients, friends, and shareholders with an outline of our views regarding the reasons for the numerous recent failures among banks and savings and loans.

The banking business is a fairly simple one. We take customer A's money as a custodian prepared to return it to him on demand or according to agreement, and we lend it to customer B, who covenants to return it to us on demand or according to agreement. Customer A is paid a lower rate of interest than is charged customer B. From that differential or "spread," we pay our costs of operations and deliver a profit to our shareholders.

The key to a successful banking business lies in the precautions taken to assure that the loan to customer B is underwritten properly so that it is repaid. This is true whether customer B is a partner in a San Francisco law firm, the owner of a mid-sized business, or Brazil. Banks fail because they make bad loans.

How bad is it?

* Last year, 120 banks closed, compared to fewer than 50 in 1983 and only 10 in 1981.

* An Arthur Andersen & Co. study estimates that the number of U.S. banks will drop from the 14,000 presently operating to 9,500 by 1990, a decrease of 32%.

* Bank regulators have put more than 800 of the nation's banks on their "problem bank" list. The list includes some of the country's largest money center banks.

Analyses by regulators reveal that loans to which bank failures can be attributed fall into four categories:

Insider Loans: Loans to officers, directors, and affiliates that are improperly underwritten due to the "friendly" relationship. In my opinion, these activities constitute fraud and are unforgivable.

Petrodollar-generated overlending: The energy price increase caused the revenues of smaller, petroleum-exporting nations to rise dramatically in the late 1970s. Major banks, recipients of these "petrodollars," were forced by the influx of new, costly deposits to seek loans aggressively.

This aggressive posture, fed by the deposit influx, led to the granting of large, unsecured loans to lesser-developed countries with no discernible means of repayment, under the "sovereign credit" theory that a nation cannot become bankrupt, and led to participation in lending schemes propounded by unqualified, poorly managed institutions whose sole reason for existence was their location in the "oil patch" (e.g., Penn Square Bank in Oklahoma).

According to Time, "problem foreign loans represents a disturbing 157% of the major banks' capital."

Deregulation/recession-generated bad loans: Deregulation of financial institutions, started in the mid-1970s, allowed banks and savings and loans to engage in areas of business from which they had previously been excluded and in which they were poorly prepared to participate (e.g., the newly granted authority for savings and loans to make commercial loans and equity investments).

Deregulation, which included the elimination or reduction of restrictions on interest paid on deposits, allowed banks and savings institutions to compete aggressively for deposits based on price. Free competition, with federal insurance of depositors' money up to $100,000, allowed institutions access to virtually unlimited funds. This influx of purchased funds made growth easily accessible as long as the increase in deposits (liabilities) could be matched with earning assets (loans). …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Unwise Lending Proves to Be the Culprit in Most Bank Failures
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.