Glamor Economics

Chapter 117

Chapter 15 Section 8 Banks Are Not Safes—Credit Risk

When you receive your cash salary, if there is a part of it that you don’t need urgently, you may immediately think of depositing the money in the bank, because you are worried that it is not safe to carry the cash with you or hide it at home.In fact, banks are not absolutely safe "safety boxes", and they also face many risks.The bankruptcy of Barings Bank is a good example.

On February 1995, 2, the Bank of England suddenly announced that Barings Bank could not continue to engage in trading activities and would apply for bankruptcy liquidation.This news shocked the whole world, because Barings Bank is a world-renowned old commercial bank in the UK. It has a long history of 26 years and manages more than 233 billion pounds of assets around the world. It has created countless enviable brilliance. Performance is regarded as a dazzling pyramid in the financial market, and even Queen Elizabeth II and Prince William are its customers.How could this prestigious "pyramid" suddenly collapse overnight?Speaking of the reasons for the bankruptcy of Barings Bank, it is even more unbelievable: it was buried in the hands of an ordinary employee of the Singapore branch of Barings Bank!
The one who brought down this "pyramid" was a man named Nick?Leeson's trader. In 28, Leeson joined Barings Bank and was sent to the Singapore branch.Due to his hard work and alertness, Leeson was quickly promoted to a trader, responsible for the financial derivatives trading of the Singapore branch.Leeson's main job is to carry out arbitrage activities of Nikkei futures in Osaka, Japan and Singapore.However, Leeson, who was too conceited, did not strictly follow the rules. He judged that the Nikkei futures would rise, forged documents, set up private accounts and misappropriated a large amount of funds to buy Nikkei futures. In 1992, the Great Kansai Earthquake in Japan shattered Leeson's dream. The Nikkei Index fell sharply, and the futures positions held by Leeson suffered huge losses.At this moment, if Leeson closes the position immediately, the loss is still within a controllable range.However, the conceited Leeson chose to put all his eggs in one basket and continued to buy a large number of futures contracts, resulting in further losses.

1995年2月23日，里森突然失踪，他失败的投机活动导致巴林银行的损失逾10亿美元之巨，已经远远超过了巴林银行5.41亿美元的全部净资产。英国中央银行束手无策，于2月26日正式宣告巴林银行破产。3月6日，这家拥有200多年辉煌历史的老牌银行被荷兰商业银行以1英镑的象征性价格收购。

The reasons for the bankruptcy of Barings Bank are intriguing.On the surface, Barings Bank was directly caused by Leeson's personal speculation failure.In fact, the deep-seated reason is that Barings Bank's system of controlling internal risks, especially operational risks, is quite weak.

Bank risks mainly include the following aspects:
1. Credit risk.The risk that commercial banks cannot recover the principal and interest of loans on schedule is the most important risk for commercial banks.Issuing loans is the most traditional and main business of commercial banks, but the loans may not be recovered due to various reasons, for example, bad debts are formed due to the malicious default of the lender or the inability of the lender to repay.Once bad debts are formed, commercial banks can only make up for them with capital or accumulated surplus.When the scale of bad debts is too large, leading to the exhaustion of capital and insolvency of commercial banks, commercial banks can only go bankrupt. In the summer of 1982, Ambercino Bank, Italy's largest private bank, was unable to recover its US$14 billion loan in Latin America, resulting in a serious deficit in the bank's capital. In the end, the bank with US$60 billion in deposits had to close down.

2. Market risk.Refers to the risk of loss to commercial banks due to fluctuations in interest rates, exchange rates, securities prices and other asset and commodity prices.The interest rate difference between deposits and loans is the main source of income for commercial banks, and fluctuations in interest rates will naturally cause fluctuations in income.For some commercial banks, especially those with cross-border business, exchange rate fluctuations will also bring the risk of devaluation of their foreign currency assets.In addition, the price fluctuations of some real assets will also bring risks to commercial banks.For example, if the price of a house used as collateral for a loan falls, it will also indirectly bring losses to the bank.

3. Operational risk.This refers to the risk of loss caused by inadequate or problematic internal procedures, people and systems or external events.For example, because the bank's internal control is not strict enough, a certain employee may violate the regulations and operate incorrectly or simply abscond with the money, causing huge losses to the bank.

In addition, commercial banks also face country risks, policy risks, etc.Supervision requires the authorities to strengthen the prevention and control of bank risks, which not only protects the interests of banks, but also protects the interests of depositors.The supervisory authority must first implement the market access supervision of financial institutions.Market access regulation is to review and determine who can open a bank under what circumstances and who cannot open a bank under what circumstances.Market access regulation excludes those who are likely to endanger the interests of depositors or the healthy functioning of the banking industry.

In the daily operation of commercial banks, supervisory authorities need to strictly supervise the risks of banks, mainly including capital adequacy ratio supervision, loss reserve supervision, liquidity supervision, etc.Liquidity is a bank's ability to turn over funds, and regulatory authorities also require banks to maintain necessary liquidity to ensure healthy operations.

Regulatory authorities also shoulder the mission of punishing violations of laws and regulations and maintaining normal financial order.When commercial banks or other financial institutions operate in violation of regulations, supervisory authorities need to make corrections in a timely manner and impose appropriate penalties on relevant responsible persons and institutions.

[links to related words]

Credit risk Credit refers to the credit that the credit giver promises to the trustee (or the credit agreed by both parties).Credit risk, also known as default risk, refers to the risk of economic loss caused by the failure of the counterparty to perform the obligations in the contract, that is, the failure of the creditee to fulfill the responsibility of repaying the principal and interest, which causes the credit giver's expected income to deviate from the actual income. Likelihood, which is the main type of financial risk.

(End of this chapter)