Bank failures and rescues

Many of the numerous bank failures that have occurred over the years have not proved harmful to their national economies. Governments have found it necessary, however, to guard against the danger of "systemic failure" resulting from a general loss of confidence in the banking system and have, from time to time, rescued a failing bank in order to avert that danger. There have nevertheless been several instances of banking crises that have done serious damage to national economies.

For definitions of the terms shown in italics in this article, see the glossary.

For a detailed list of failures and rescues in their historical sequence, see the timelines subpage.

Background

The vulnerability of banks

The fact that banks often lend as much as twenty times the value of their share capital makes their continued solvency sensitive to defaults on those loans. "Retail banks", that obtain funds from depositors, are also vulnerable to the risk that fears of insolvency can result in "bank runs". They are also vulnerable to the "contagion" that can occur when depositor "herding" converts the news of a run on one of their number into runs on the others. "Wholesale" or "investment" banks, that obtain their funds by borrowing on the "money markets" and the "interbank markets", can also suffer from contagion resulting from herding by market operators. Before the adoption by central banks of the roles of "lenders of last resort", herding and contagion were believed to have led to the failure of many otherwise solvent banks. The pre-war creation of the Federal Reserve Bank as lender of last resort did not eliminate contagion in US banking in the inter-war years, but there is evidence to suggest that it was no longer common . However, the development in the latter years of the twentieth century of complex systems of "securitisation", added progressively to their vulnerability to contagion by making the banks a component of a complex, tightly-coupled interactive, financial system; and by adding to the difficulty of assessing risks. That development led to the word-wide incidence of over 100 bank crises that have been termed "systemic" on a World Bank database because they were so extensive that they threatened the integrity of their national financial systems , a growing number of which had been contagious in the sense of spreading into neighbouring countries. The culmination of that trend was the world-wide crash of 2008.

The case for rescues

lender of the last resort

In England, the need for regulation of the financial intermediaries became evident in 1866 when contagion from the collapse of the Gurney-Overend bank led to the collapse of over 200 companies . The influential commentator Walter Bagehot urged that in a future panic it should "advance freely and vigorously to the public out of its reserves" in order to avoid another "run on the banks", and in 1890 the Bank rescued the failing Barings bank by guaranteeing loans to it by other banks </ref>

The inter-war years

The United States

In the immediate post-war years there was a rapid growth in the number of United States banks, and there were relatively few failures. In 1921, however, there was a surge in the number of bank failures, especially in farming areas, and the number of banks started to decline. In 1930, a massive further increase in failures occurred in response to the Great Recession, and failures continued at a high level until the "banking holiday" of 1933. The introduction in that year of the Federal Deposit Insurance scheme restored investors' confidence, and there were few failures during the remainder of the inter-war period.