Eddie Vedder once sang: “He who forgets will be destined to remember.” He was talking about love, but he could have been talking about banking.
There’s a reason economists study history. It’s renowned for repeating itself, and those who study it have an advantage when it comes to identifying pitfalls and opportunities.
This is especially true when it comes to bank failures. There have been more than 3,500 bank failures since the FDIC was founded in 1933. The greatest number of them came during the savings and loan (S&L) crisis. More than 1,600 FDIC-insured banks failed between 1980 and 1994.
Everyone has heard of the S&L crisis, but not everyone knows what happened or why. While the memory is indelible for the bankers who lived through it, newer bankers haven’t necessarily studied the crisis.
That’s unfortunate because there are many parallels between those days and the environment banks operate in today. In fact, in every bank failure, there’s a lesson for today’s bankers.
From concentration risk and commercial real estate to interest rate risk and poor risk management, the conditions that caused many of the most historic U.S. bank failures – from Continental Illinois to Silicon Valley Bank – exist today. Exploring the root causes of these failures, including both the internal and external factors that led to failure, is a valuable exercise for every banker.
Inside a historical failure
Let’s look at the $42 billion-asset Continental Illinois National Bank & Trust. In the late 1970s and early 1980s, the bank was one of the fastest-growing banks in the country. It was the seventh-largest commercial bank in the U.S. and the darling of Wall Street.
Why was the bank so successful? One word: energy. Continental Illinois’s portfolio included a huge number of loans to oil and gas. It aggressively purchased energy loans with minimal due diligence. It couldn’t get the funding it needed for this strategy solely from retail deposits, so it relied on more unstable and expensive sources of funding.
Continental Illinois’ energy concentration proved very profitable during the oil embargo in the 1970s when oil prices were sky-high. But then oil prices dropped. As word got out that oil producers couldn’t repay their loans, it created a bank run.
You can probably guess what happened from there. In 1984, the bank failed – at the time the largest bank failure in U.S. history. Regulators intervened to prop up the bank and prevent contagion (the original “too big to fail” bank).
Lessons learned
If Continental’s story sounds familiar, it’s because it is not unique. Overconcentration and high-cost funding continue to be a challenge for many banks and have led to recent failures. History keeps repeating itself.
How else do the failures of the past show up today? I’m glad you asked.
That’s the question I asked and answered in my new whitepaper, Lessons in Risk: The Surprisingly Similarities Between Historic and Contemporary Bank Failures and What They Mean for Your Institution. I look at bank failures from the 1980s through today, both large and small, looking for common threads – and I found a bunch. If you removed the years and specific details (i.e. energy vs CRE), it’s often hard to tell when the failure occurred. The results are that predictable.
The whitepaper is a quick, easy read that will arm you with fresh perspectives on managing risk – and give you the tools to prevent an unwanted repeat of past failures.
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