Question

In Ghana, the problem of financial distress of banks is not new. In 2000, two banks (Bank for Housing and Construction and the Ghana Co-Operative Bank) were liquidated. On Monday 14 August 2017, there was a breaking news of the collapse of two banks (Capital Bank and UT Bank) with the third (UniBank) receiving special attention from the Central Bank with the appointment of KPMG as Official Administrators following UniBank’s insolvency. In almost a year later, the Central Bank revoked the license of five insolvent banks ( Unibank, Royal bank, Sovereign bank, Beige bank and Construction bank) to form a new Consolidated bank owned by government. The number of banks failure is a concern to all stakeholders in the Ghanaian banking Industry.
Required: Answer the following questions from the above preamble.
a) Explain the term Bank Failure.
b) Explain three determinants of possible bank financial distress that could cause bank failure.
c) Discuss two economic implications of bank failure.

Answer 1

a) Bank Failure: A Bank failure is an event wherein a bank is not able to meet its liabilities towards its depositors and other third parties because of becoming insolvent or losing its liquidity to that level that it is unable to meet its liabilities. Usually in such events, the market value of a bank's assets decline to such a level, which is less than market value of its liabilities. In case of a Bank failure, Bank is formally closed by the regulator. The authority to close national banks which have failed lies with Comptroller of the currency and for state-chartered banks, banking commissioners in the respective states have this authority. In the event of a bank failure, the insured portion of depositor's balance is covered by Federal Deposit Insurance Corporation(FDIC),

In case of a Bank failure, failed bank either tries to borrow money from other solvent banks or sell off its assets to meet its liabilities. The FDIC may try to sell off the bank to an another solvent bank or take over the complete operations of the bank.

b) Three determinants of possible bank financial distress that could cause bank failure.

The three determinants of possible bank financial distress which can cause bank failure can be the following ratios- Capital to Deposits, Capital to Total Assets, & Loans to Total Assets

Capital to Deposits: This ratio provides accurate measure of appropriate capital level for a bank. Any large deviations could indicate a possible problem.

Capital to Total Assets: Similarly, Capital to Total Assets Ratio provide an accurate measure of appropriate capital level for a bank and significant deviations need to be scrutinised.

Loans to Total Assets: Lower the Ratio, better it is . A higher ration could create higher chances of a bank failure.

c) Two economic implications of a Bank Failure

1. Affects the local economies throughout the global market: Particularly in case of global banks, bank failure not only affect the country where its headquarters are, but all the countries with which it conducts business. This was quite evident during 2008 Financial crisis, when the failure of big banks had serious consequences for the local econonomies in the global market.

2. Multiplier effect on other banks and financial institutions : The failure of a Bank or financial institutions is no doubt more serious than any other business because of interrelatedness with other banks and financial institutions. The spill over effect of failure of one bank can quickly spread over entire economy and is most likely to result in failure of other banks as well as depositors may take out their deposits from the banks.