There have been more than 3,500 bank failures since the early 1930s. These failures aren’t ancient history. They continue to offer insights into what can go wrong and how to avoid similar mistakes. Let’s take a look at the lessons from one of the largest failures in banking history and what this means for risk management today.
Nearly 40 years apart, two banks fail for similar reasons
In the early 1980s, $42 billion Continental Illinois National Bank & Trust was not only the best bank to invest in, but among the best companies on the stock exchange due to its rapid growth. While other banks’ stock prices barely budged during stagflation, Continental Illinois doubled its share price from $13 to $27 over five years from 1974-79.
What investors didn’t know was Continental Illinois was overexposed to oil and gas loans purchased from a “freewheeling” Oklahoma City bank, Penn Square. When OPEC imposed an oil embargo in 1973-74, American energy producers went to work. Banks like Penn Square showered money on the domestic oil and gas industry. In the following six years, the price of a barrel of oil quadrupled before experiencing a steep decline. Domestic oil users went from thriving to being unable to repay their loans by the mid-1980s.
When the FDIC seized Continental in 1984, it was the seventh-largest commercial bank in the United States. At the time, its failure was the most expensive in American banking history. The bank ultimately collapsed because its board and leaders ignored concentration risk, becoming overleveraged in oil and gas.
Think this can’t happen today? Just this last November, $66 million Citizens Bank in Sac City, Iowa failed when $14.8 million in loans to commercial trucking companies went south.
Continental’s collapse in the 1980s demonstrates the importance of maintaining a diversified lending portfolio and implementing robust risk controls. Before investing in an industry or geographic location, banks need to have a thorough understanding of the risks involved.
Seeing how Continental shuttered 40 years ago — and then seeing a similar failure last year — proves banks must closely monitor collapses throughout history, not just from within the last few years or decade. In fact, overconcentration and high-cost funding continue to challenge many banks, leading to recent failures. It seems history keeps repeating itself.
Four reasons banks fail
But how else do the failures of the past show up today? Pressure to perform, poor asset management, unforeseen events, and fraud and arrogance can all cause failures. Here’s a look at recent examples:
- Pressure to perform
$22 million Resolute Bank collapsed in 2019 due to its foray into originating and selling government-backed mortgage loans without sufficient capitalization or a sound strategic plan. Despite aiming for increased profits, the bank faltered due to insufficient oversight and controls for its new ventures. Similar to the savings and loans crisis of the 1980s, Resolute lacked the necessary risk management infrastructure to expand into a new business line.
- Poor asset management
Also in 2019, $120 million City National Bank of New Jersey failed due to poor asset quality. The bank suffered from an excess of nonperforming loans and a lack of capital to cover portfolio losses. This leads to a critical question banks must ask: Do we have the capital to suffer a negative economic shock?
- Unforeseen events
New York-based Signature Bank shuttered in March 2023 due to its overexposure to cryptocurrencies following FTX’s demise (more than 25 percent of Signature’s deposits were crypto-based). After depositors withdrew large sums of money on the heels of the collapse of SVB, regulators feared continued contagion in banking and closed the $110-billion giant to try to contain the panic. Like the sudden plunge in oil and gas prices in the early and mid-1980s, the declining value of cryptocurrencies — and Signature’s overexposure — caused it to crumble.
- Fraud and arrogance
Many bank failures are a direct result of fraud, arrogance and ineffectiveness by banking leaders. When small and mid-sized community banks fail, their insolvency may not threaten the entire financial system — but it devastates the people they serve.
The future of risk management
Banking is inherently risky, and these failures remind us that banks need to look beyond the walls of their institution and community and study failures of the past. There are numerous factors that impact an institution’s performance and ability to survive challenging times.
Looking ahead, the banks that embrace dynamic and flexible risk frameworks are the ones that will thrive. Needing longer sightlines is nothing new for the banking industry, but assessing long-term risks in any business climate presents challenges.
Robust risk management systems are necessary for banks looking to align their internal controls, IT systems and employees. But it goes beyond simple compliance. Solid risk management requires having the right tools to understand and respond to market risks, operational risks, interest rate risks, cyber risks, compliance risks, third-party risk management and other risks.
In the future, banks must seek out new opportunities and weigh the risks and rewards. The only way these initiatives will be successful is if the institution has the risk control environment to actualize their ambitions.
Rafael DeLeon is senior vice president of industry engagement for Ncontracts, which provides integrated risk management and compliance software to more than 4,000 financial institutions.
