Bank Insolvency: Bad Luck, Bad Policy,

Bank Insolvency: Bad Luck, Bad Policy, or Bad Banking?

Gerard Caprio Jr. and Daniela Klingebiel

Since the late 1970s bank insolvencies have become increasingly common. Where these failures are systemic, they can drain a country's financial, institutional, and policy resources— resulting in large losses, misallocated resources, and slower growth. Using a new database covering some eighty-six episodes of insolvency, this article examines the causes and effects of these crises and how governments have responded. It finds that both macroeconomic and microeconomic factors have figured in bank crises and that, based on the criteria developed here, few governments have responded well to these episodes. To better manage insolvencies, policymakers must develop a regulatory framework that allows banks to respond more robustly to shocks and ensures proper management and oversight. That bankers have not regularly planned for shocks suggests that they have not had the incentive to do so. No degree of regulatory wisdom could or should have made the 1920s a profitable time for banks in [U.S.] agricultural regions affected by drastic declines in prices and land values. In the face of these shocks, some failures were inevitable. What regulation could have done, but did not do, was make the system as a whole less susceptible to shocks and more resilient in its response to failures. — Charles Calomiris (1992, p. 312)

The past ten to fifteen years have been to economists interested in banking and incentive issues what the 1840s and 1850s were to gold prospectors in California. After several decades— most of the post-World War II era— of relatively calm financial markets, in recent years there has been a profusion of banking crises in a variety of industrial and developing countries, in many cases widespread enough to qualify as systemic. In absolute terms Japan will likely suffer the largest losses, with official estimates putting nonperforming loans in 1995 at about $400...