The Implications for Risk Management and Regulation
1.Why did Continental experience a run in 1982? How did it manage to survive without recourse to official assistance?
Ans.Continental was an established organization before 1982. However it was involved in a practice where it was taking up heavy duty loans from the market. It had raised loans worth $600 million from Penn Square, an institution involved in lending practices and after meeting its lending limit, it started originating loans and then sells them in the market to other banks. Continental had bought vast sums of loans from Penn Square and in turn it had a big stake in the oil and gas industry. By 1982 Penn Square’s loan represented a total of 3% of the total loan structure of Continental. Penn Square was aggressively involved in lending out loan and lessees to the oil and gas sector especially the drilling division. The bank made its name in high-risk energy loans during the late 1970s and early 1980s Oklahoma and Texas oil boom. Between 1974 and 1982, the bank's assets increased more than 15 times to $525 million and its deposits swelled from $29 million to more than $450 million. The risky loans involving Continental and Penn Square went bad after oil and gas drilling went down significantly after 1982. Therefore the bought loans from Penn Square turned out to be faulty. This sector decline of the drilling section sent Penn Square crashing down and along with this it took down institutions involved with it. Continental was one of the bank that faced problems. These loans afterwards converted into profit cuts thus becoming a burden on the organization. The major reasons is poor risk management policies and lack of regulations surrounding the lending division.
2.After the run in 1982, what did Continental do to reduce its vulnerability to a funding shock? What else could it have done?
Ans.After the organization faced problem due to the event of 1982 it had to attain capital to restore its position. However the sources of funding had acutely dried up for the company. Continental thus based itself on the following guidelines to attract and raise required capital: •It moved to foreign markets to attain capital (Euro Markets) •It sold off and converted majority of its liquid assets
•Non-performing assets were concentrated
•Investors were attracted through flow of favorable information and an attractive dividend policy. •Meeting with fund providers and rating agencies were conducted to restore back the confidence. •Cost cutting was done through downsizing
These steps helped the firm achieve some level of sustainability. Other then these steps firing of upper managements and corrective measures regarding the loan policies were carried out. However the firm could have done the following steps: •Acquisition or Merger with another firm
This would have helped raise capital and another reputable company’s name could also have been used. The poling of resources would have dearly helped Continental.
3.Why was the run in 1984 more devastating?
Ans. Continental could never regain its position after the crash of 1982. The rundown of 1984 was more dreading then of 1982 because simply the era was carrying the backlog caused by the preceding years. The backlog which carried from the previous year posted huge burdens on profit and revenue figures. The macro economical variables such as the interest rates were low interest rate is considered as the cost of capital, means the price paid for the use of money for a period of time. From the point of view of a borrower, interest rate is the cost of borrowing money (borrowing rate). From a lender’s point of view, interest rate is the fee charged for lending money (lending rate). These interest rates were low which was an unfavorable aspect was for the corporation. This kept funding away and the market for loans was also...