A meaningful analysis of causes of bank distress and the options for resolution would probably need to be preceded by a brief discussion of the roles of banks in an economy. Bank’s role in any financial system is quintessentially financial intermediation. In this regard, bank’s mobilize financial resources from surplus economic units for on lending to the deficit units. In mobilizing deposits, banks issue demandable claims in favour of the surplus units. However, these savings are pooled and extended to deficit units as illiquid loans and advances with definite and invariably longer maturity than the maturity of the demandable debts. In performing the latter function, banks not only undertake maturity transformation but are also expected to screen the set of borrowing opportunities available to them using unique expertise as well as continuously monitor and obtain repayments.
Obviously, by the very nature of banking business, banks are inextricably involved in risk-taking. For instance, banks face the risk of not being able to meet their obligations to depositors to whom they have issued demandable claims. This is called liquidity risk. There is also the likelihood of borrowers failing to repay as agreed, i.e. risk of default or credit risk. Similarly, there is the possibility that the mechanism, processes and controls employed by banks to carry out its functions fail to achieve desired results i.e. operational risk. These are just a few of the risks banks face and their complexities could be astounding. Improper management of these risks is one sure cause of bank distress but this is bank-specific, i.e. endogenous factor. This is in addition to other bank specific factors which also do cause distress.
Besides the fact that individual bank’s incompetence at managing risks is a cause of bank distress, there are also some exogenous factors beyond banks’ control that could precipitate... [continues]
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