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Of the 350 or so banks that have failed during the last three-year economic debacle, our firm has had the opportunity to work with, in one way or another, about a third of them. In fact, every Monday morning after the Friday night bank failures, one of our consulting and law firm staffers sends a memo around that XYZ Bank failed.

I always hope the memo adds, "... and they did not owe us any money."

Causes behind the closures

What causes a bank to fail? 

Obviously, lack of capital or lack of liquidity are the final results that lead up to the bank's failure. But what really has happened?

What has actually caused these banks to fail? 

Is it a rogue lender? 

Is it an embezzlement? 

Is it a board of directors who has not done their job? 

Is it a management who is not capable? 

Is it the economy? 

In my experience, both in the last cycle and in the current cycle, your typical failure is generally a combination of several circumstances.

Maybe management concentrated credit in one area, such as commercial real estate.

Sometimes, the cause can be darker...

"Rouges" and rouges

Maybe within that area such a commercial real estate, as mentioned, attention fell off when vigilance would have served better. Perhaps management took its eye off a couple of its lenders who, because of perverse incentives for booking of loans with little consideration about credit quality, could best be described as, or became, "rogue" lenders.

The problem is, it is often difficult to tell a rogue lender when times are good. When times are bad, however, hindsight is always 20/20 and the rogue lender sticks out like an ugly sore.

There have been banks that have had to sell prior to failure due to asset quality being destroyed by one or two lenders.

And then you have the embezzlers.

Most of the time, banks do not fail as a result of an embezzlement. But we have had a couple this year which have suffered significant embezzlements and/or fraudulent loans by insiders (a director in particular comes to mind). These thefts have had a very destructive result on the bank's year as it relates to earnings and capital augmentation such that it results in a downgrade of the bank from a 2 to a 3 or a 3 to a 4, with the resulting significant increase in FDIC insurance premiums.

Ultimately, a snowball effect

In reflecting upon the most typical bank failures, I find the cause is normally small things eroding the bank over time, or a series of cumulative events, that have resulted in the failure, as opposed to one major bet on a big loan transaction going bad.

Unfortunately, those cumulative events are still occurring.

I was recently discussing the condition of a bank with its CEO in preparation for a planning session.

He said the bank had finally taken its "big hit." He'd known it was going to take one from some direction. But even so, he was not expecting the one that socked him. It was a hotel the bank had financed four years earlier. It had that had done well until it changed its flag.

The owner, while all payments were current, simply came in, tossed the keys on the desk and indicated he could not do it anymore. Call it "borrower fatigue."

What can prevent erosion?

In any event, can the economy ruin your bank?  Sure.

Can a rogue lender ruin it?  Yes.

Can a fraudulent loan transaction bring it down?  Yes.

Can an embezzlement pile on?  Yes.

All of them can and normally cumulatively do, which result in the bank's failure.

Internal controls are a critical defensive piece. This will be addressed in a subsequent blog.

About the Author

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  Gerrish can be reached at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it , and the firm’s website, www.gerrish.com.

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