Edited by Andrew W. Mullineux and Victor Murinde
Chapter 14: The Causes of Bank Failures
Shelagh Heﬀernan* 1 INTRODUCTION This chapter considers the causes and eﬀects of bank failures. Normally failure of a proﬁt-maximizing ﬁrm is deﬁned as insolvency, that is, the company’s assets exceed its liabilities, making its net worth negative. In the case of banks, for reasons which will become apparent, the deﬁnition is expanded to include not only insolvent banks which are closed, but banks which would have failed but for government intervention, and banks that are merged with healthy banks under central bank/government pressure and/or with state assistance. Section 2 discusses the policy controversies surrounding bank failures. There is a spectrum of academic thought ranging from the view that they should be treated the same as the failure of a ﬁrm in any industry, to the other extreme that bank failure(s) or the possibility of failure require government protection of the banking system in the form of a 100 per cent safety net, because of the potential for devastating systemic eﬀects on an economy. In between is support for varying degrees of intervention, including deposit insurance, a policy of ambiguity as to which bank should be rescued, merging failing and healthy banks and so on. The debate among academics is reﬂected in the diﬀerent government policies around the world. Governments in Japan (after a brief reversal of policy in the mid-1990s) and France believe that virtually every problem bank should be bailed out, or merged with a healthy bank. In Britain, there...
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