Bank failure

Bank failure refers to a situation where a bank becomes insolvent or unable to meet its obligations to its depositors or other creditors because it has become bankrupt or has been liquidated.

Causes of Bank Failure

Bank failures are typically caused by exposure to credit risk, market risk, liquidity risk, operational risk, and solvency risk. These risks can arise from a variety of factors, such as poor management, economic downturns, or irregularities in a bank's operations.

Credit Risk

Credit risk is the risk that a borrower will default on any type of debt by failing to make required payments. If a bank's borrowers fail to repay their loans, the bank's assets can quickly deplete, leading to failure.

Market Risk

Market risk is the risk of losses in positions arising from movements in market prices. Banks that are heavily invested in certain markets may face significant losses if those markets perform poorly.

Liquidity Risk

Liquidity risk is the risk that a bank will not be able to meet its financial obligations as they come due. If a bank cannot meet its obligations, it may be forced to sell its assets at a loss, leading to failure.

Operational Risk

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. This includes legal risk, but excludes strategic and reputational risk.

Solvency Risk

Solvency risk is the risk that a bank will not be able to continue to operate because its liabilities exceed its assets. If a bank becomes insolvent, it may be forced to declare bankruptcy and liquidate its assets.

Consequences of Bank Failure

When a bank fails, it can have significant impacts on the economy, including a decrease in lending, a decrease in consumer confidence, and a potential financial crisis. In many countries, a system of deposit insurance has been established to protect depositors from bank failure.

Prevention of Bank Failure

Preventing bank failure is a key concern of banking regulation, and is often overseen by a country's central bank. This can involve regular inspections of the bank's financial health, as well as regulations to ensure that the bank is not taking on too much risk.

See Also

• Bankruptcy
• Financial crisis
• Deposit insurance
• Bank regulation