Often it is the loans themselves that bring a bank into difficulty, especially when made for long terms at low interest rates. Usually there is no problem when the economy remains stable and the rates the bank pays for money received from depositors or other sources is lower than the interest on loans. But when rates paid for money climb, as they did in recent times, the bank finds itself in the position of paying out more than it is taking in.

It is even worse when those who have taken out loans cannot pay them back. This is the situation right now with many farmers in the United States. Such default is causing many smaller regional banks to fail. “Exactly one-half of the banks on the 1985 failure list were designated as farm banks, that is, at least 25% of their loans were related to agriculture,” says the financial newspaper American Banker.

Outright fraud and embezzlement is another reason for bank failure. The age of electronic transfers has made possible stealing of funds that makes old-time bank holdups look tame by comparison. “The American economy suffers an annual loss of over 500 million dollars in this way,” states the Paris daily newspaper Le Figaro. “In Europe, the big banks are much more discreet about the figures, not wishing to reveal their problems. They nevertheless admit to greater losses from computer fraud than from holdups and common burglary. Computer fraud has become the scourge of our modern economy. . . . As soon as countermoves are discovered by computer experts, new loopholes come to light that are rapidly exploited by certain individuals to their own advantage.”

As in every business, mismanagement and poor business practices can also cause failure. In fact, mismanagement is said to play a crucial role in most bank failures. It could be that the bank directors made unsecured loans to their friends or relatives. Or perhaps they overextended themselves in more prosperous times. Or greed and an effort to make a killing and get rich quick fostered some reckless investments.

In some cases, fierce competition has led banks to take extraordinary risks. Some fall victim to their own overly aggressive lending policies. In a need to cover up when problems occur and to improve reserves and cash flow, some banks seek to entice depositors by offering unusually high rates of interest or even make further investments in risky ventures.

Governmental insuring of deposits​—guaranteeing that, no matter what happens, depositors will be repaid—​has also induced some banks to throw caution to the wind. But the future is unpredictable. Some who made investments in oil and other energy fields when such were booming and prices were high, for instance, went into bankruptcy when prices plunged or ventures failed. Or if money disinflates, it can wreak havoc for those who expected to pay back borrowed money in cheaper inflated dollars.

These problems that lead to bank failures are not limited to small banks. Some of the world’s largest financial institutions also find themselves in sore straits. Many have made millions, even billions, of dollars’ worth of loans to Third World countries that cannot now pay back the interest, much less the principal.

The Debt Problem

Banks are inherently a risky business. They handle large amounts of money that is mostly not their own. Additionally, they create money and make loans far in excess of their net worth. While they may take adequate precautions, the banks know that some loans will turn bad. Therefore a certain amount is set aside as loan reserves to cover bad debts. But if an unusual number of loans turn sour, those reserves will not be sufficient to cover the large loan losses, or a run on the bank. “The more equity that’s at risk because of bad loans, the weaker the bank gets financially,” states New York magazine. “Bankruptcy (or failure) occurs when all the bank equity is used up.”

More and more banks today are finding themselves in just that position​—too many of their loans are turning sour, and there is insufficient capital to back them up. The reasons given are legion: the oil crisis, trade restrictions and deficits, downturns in the economy, unstable interest rates, capital flight, inflation, disinflation, recessions, overly aggressive lending policies, corporate bankruptcies, fierce competition, deregulation​—even ignorance and stupidity.

But there are ways to stay alive​—on paper. Rescheduling the loans, stretching the debt over a longer period, is one means used and reused. Another is to list the loans at full value, though there may be little hope of having the principal paid in full. An oft used tactic is to lend the borrowers more money so that they can make their interest payments.

All these methods are currently being used by banks in regard to Third World debt, considered by many to be the greatest threat to the stability of the international banking system. According to a World Bank survey, the external debt of over a hundred developing nations reached a combined total of some $950 billion at the end of 1985, an increase of 4.6 percent over the previous year. Although already too large, it is expected to reach $1.01 trillion by the end of 1986. Why? Because many of those nations simply cannot repay and are pressing for more time and money. Taking into account the enormity of their loans, the banks have complied. As one person puts it: “If I owe you a dollar, I am in your power; but if I owe you a million, you are in my power.”