IntroductionWhat is Bankruptcy?Bankruptcyis a legal status of aninsolventperson or an organisation, that is, one who cannot repay the debts they owe tocreditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor. The word bankruptcy is derived from Italianbanca rotta, meaning "broken bench". It may allude to a literal custom of breaking a moneychanger's bench or counter to signify his insolvency.

What is bankruptcy of banks or bank failures?Banks are financial institutions that act as payment agents for customers in addition to borrowing and lending money. In some countries, banks are the primary owners of industrial corporations while in others they are prohibited. Banks act as payment agents by conducting check or current accounts for customers, paying cheques and collecting deposited cheques. Banks provide various payment services and a bank account is considered indispensable by most individuals and governments.Abank failureor bankruptcy of a bank occurs when abankis unable to meet its obligations to itsdepositorsor othercreditorsbecause it has become insolvent or too illiquid to meet its liabilities. More specifically, a bank usually fails economically when the marketof itsassetsdeclines to a value that is less than the market value of itsliabilities. Theinsolventbank either borrows from othersolventbanks or sells its assets at a lower price than its market value to generate liquid money to pay its depositors on demand.There are a number of reasons due to which banks go bankrupt. Bank runs are the most common amongst them. Following bank runs are frauds and dishonest practices, not enough liquidity, etc. The effects of bankruptcy of such institutions cause a panic in the economy hence it also impacts the stock market and the capital market. And it goes without mention that individual depositors are worst hit in such a scenario. Many a times the banks that we least expect to fail are the ones which sink first. So before predicting the financial soundness of a bank we must completely understand how it functions, what are its strategies and if it fails what will be the effects.

Causes of bankruptcy / Ways in which banks can get bankruptA well-organized and efficient banking system is an essential pre-requisite for overall economic growth of country. Banks play an important role in the functioning of organized money market. They act as a conduit for mobilizing funds and channelizing them for productive purposes. In order to meet the banking needs of various sections of the society, a large network of bank branches is established in all highly developed countries. But it has been observed during the past 30 years that even the sophisticated markets and long functioning banking systems have had significant bank failures and bank crisis. Bank failures are a direct threat to the economy of any country and hence regulatory changes are required to be designed to decrease the probability of future bank failures and lessen the cost of bank failures.A number of recent official working groups and academic studies have analyzed the causes to bank failures across the world. The working paper presented by the Basel Committee is the analysis carried out by the experts on the same issue.

Major causes of Bank Failures1. Foreign Exchange Risk:Banks may get into trouble if they undertake large and risky foreign exchange business. Losses may result if the bank has incurred liability in terms of a foreign currency and there is an unanticipated appreciation in that specific currency. The risk is higher especially in the environment of floating exchange rates. If the transactions are entered into with a fixed currency exchange rate the future liability is known in advance.For example:A bank has a future obligation to pay $10,000 say 3 months later.Present rate of exchange =Rs45=$1Present liability= Rs 4,50,000Rate of exchange 3 months hence =Rs47=$1Liability after 3 months:-Fixed rate of exchange Floating rate of exchangeRs 4,50,000 Rs 4,70,000The banks should therefore hedge their risks in foreign exchange through forward contracts both for their pay ins and pay outs in the environment of floating exchange rates. Also the management should periodically review the open foreign exchange positions and close or hedge them accordingly. Similar were the circumstances in case of Herstatt bank in Germany. They got into trouble because of their large and risky foreign exchange business In the environment of floating rates of exchange Herstatt became over indebted as the bank suffered exchange losses of around DM 470 Million.

2. Excessive exposure to real estate industry:One of the types of securities banks accept is the Immovable Property. Once the property is mortgaged in the banks name, the bank enjoys an exclusive control over it in case the borrower defaults in repayment of the loan. But real estate in itself has limitations such as the liquidity problem and risk of decline in the prices. Banks tend to give more and more loans against real estate when the market is at boom. Over a period of time the market stabilizes, real estate prices fall thereby reducing the value of collaterals in banks commercial loan portfolios. In case of Sweeden banking crisis, around 1990 the period of strong economic growth ended. Significant problems developed in the housing market and rents started to fall.Decreasing demand for premises resulted in substantial fall in real estate by about 50%. It caused large credit losses for financial institutions They had typically provided loans against the upper range of the value of assets pledged as collateral. As the banks were heavily exposed to real estate related industry declining real estate prices created significant amount of Non Performing Assets after the burst of bubble economy.

3. Improper credit evaluation, poor selection of borrowers:If the credit evaluation is poor, loans are given to borrowers not having enough repayment capacity. As a result the volume of loans disbursed increases which may initially strengthen the asset portfolio of the bank. But at the same time it carries with itself the risk of Non Performing Assets. If there are no stringent regulations regarding specific provisioning of NPAs, provisioning made is insufficient. Hence the impact is that banks do not address the problem of NPAs until it is reached an alarming level. One of the major aspects of Japans banking crisis also was the length of time it took to address the problems of Non Performing Assets and later faced liquidity problems

4. Deterioration in banks capital position:Although it is recognized that banks capital position should be improved:a) in order to resolve the problem of NPAs andb) to increase banks capacity to extend new loans,it is not always possible. The reason being inadequate retained earnings, which actually should be the primary source for strengthening banks capital position. A faulty dividend policy and insufficient provisioning for bad debts results into reduced retained earnings.

5. Heavy expenditure on banks fixed assets:Heavy expenditure on assets especially on the office building requires huge investment. This may endanger the liquidity of bank funds.

6. Huge operating costs:Sometimes banks open deposit counters which are a Cost Unit but not definitely a profit center. Due to excessive number of branches not only the time and demand liabilities of the bank increase, but also operating costs like staff salaries. Maintenance are pushed up.

7. Management Frauds:Managerial personnel are in whole charge of the banks funds and are responsible for proper channelization of the same. But in cases managers divert bank funds from banks to businesses owned by them or the main shareholders. Also in cases the latter acquires assets of the banks for less than true value or sells assets to banks at excessive prices. In addition finance extended by the banks is used for speculative real estate or industrial projects by the firms of the banks own groups.A Classic example of this is found in Bank crisis in Spain. On occasions some banks had more than 50% of their balance sheet invested in loans to their own group. The lending criteria in these cases were always much more relaxed than for other borrowers. As a result NPAs increased deteriorating the banks profitability and hence the capital position.8. Importance of Supervision:In July 1991 the Bank of Credit and Commerce International failed because of wide spread fraud. BCCI had a very complex structure involving branches over 70 countries. Its complex group structure made it difficult to conduct effective supervision and audit. It is believed that BCCIs financial statements had Indiaforensic Foundation been falsified from its establishment in 1972. A scheme of deception was developed to conceal lending losses. To achieve this BCCI failed to record deposit liabilities and created fictitious loans that generated substantial but fictitious profits. Frauds also took place in BCCIs treasury position. BCCIs failure was attributable to wide spread fraud that was at least initially undertaken to conceal loan losses. In circumstances such as this where financial statements do not reflect true financial health, reporting capital ratios will also be misleading to investors. Hence in such cases the process of ongoing supervision may encourage banks to assess and improve their systems and controls.

9. Inadequate regulatory capital:The regulatory capital should be in line with the economic capital. It will help to strengthen the solvency of banks. The correct measurement of risk would enable it to be better managed. It is also important that capital requirements should cover operational risks including fraudulent operations. This risk is nearly always present in banking crisis of some size and its coverage with capital should help reduce it. The banks should be required to maintain sufficient control over the risks associated with their business such that their survival is not jeopardized.

10. Capital Adequacy Ratio:Basel committee has recommended that the banks should maintain a ratio of equity to total assets of 8% minimum. Also capital requirements should be based on capital adequacy ratio defined as the ratio between own funds and borrowed funds. In fact it is a leverage ratio bearing little relation to the risk incurred by the institutions.

11. Bank Run/Bank Panic:Abanking panicorbank panicis afinancial crisisthat occurs when many banks suffer runs at the same time, as people suddenly try to convert their threatened deposits into cash or try to get out of their domestic banking system altogether. A systemic banking crisisis one where all or almost all of the banking capital in a country is wiped out. The resulting chain of bankruptcies can cause a longeconomic recessionas domestic businesses and consumers are starved of capital as the domestic banking system shuts down.Much of theGreat Depression's economic damage was caused directly by bank runs. The cost of cleaning up a systemic banking crisis can be huge.

Effects of bankruptcy of banks

The failure of a bank is generally considered to be of more importance than the failure of other types of business firms because of the interconnectedness and fragility of banking institutions. It is often feared that thespillovereffects of a failure of one bank can quickly spread throughout the economy and possibly result in the failure of other banks, whether or not those banks weresolventat the time as themarginaldepositors try to take out cash deposits from these banks to avoid from suffering losses. Thereby, the spillover effect of bank panic has amultipliereffect on all banks andfinancial institutionsleading to a greater effect of bank failure in the economy. As a result, banking institutions are typically subjected to rigorousregulation, and bank failures are of majorpublic policyconcern in countries across the world. Losses accrue to shareholders and most likely also to depositors, unsecured creditors, and the deposit insurer.Global Failure:As aforementioned, the failure of a bank is relevant not only to the country in which it is headquartered, but for all other nations that it conducts business with. This dynamic was highlighted quite dramatically in the 2008 financial crisis, during which the failures of major bulge bracket investment banks held dire consequences for local economies throughout the global market. The high degree to which markets are integrated in global economy made this a near inevitability. This interconnectedness was manifested on a high level, with respect to deals negotiated between major companies from different parts of the world, but also to the global nature of any one companys make up. Outsourcing is a key example of this make up. As major banks such as Lehman Brothers and Bear Stearns failed, the employees from countries other than the United States suffered in turn.

How Bank Failures Impact ConsumersBank failures have two major impacts on consumers. The customers are directly impacted, and all banking customers are affected on a macro level. It is important to understand what happens when a bank fails.1. Micro Level Bank CustomersIf you have a loan with a bank that fails, you will start making payments elsewhere. If you have assets (checking, savings, CDs) with the bank, you will receive a check from the FDIC that covers your insured assets. My check came within two weeks.It is a hassle to change banks, but it is something that people do all the time.

2. Macro Level Economy Wide ImpactsFewer banks results in less competition. Less competition means higher prices for consumers. That is simple economics. We keep reading about increased fees for credit card rewards programs and bank services. This is partially a result of the end of automatic overdrafts. This is also, however, a result of less competition. It is bad for the country, economy, and consumers when a bank fails.Measures to prevent bankruptcy of banksSeveral techniques have been used to try to prevent or mitigate the effects of bank failures. They have included governmentbailoutsof banks,supervision and regulationof commercial banks, the organization ofcentral banksthat act as alender of last resort, the protection ofdeposit insurancesystems such as the U.S.Federal Deposit Insurance Corporation and Indian DICGC and after a run has started, a temporary suspension of withdrawals. These techniques do not always work: for example, even with deposit insurance, depositors may still be motivated by beliefs they may lack immediate access to deposits during bank reorganization.

Prevention and Mitigation:Several techniques have been used to help prevent or mitigate bank failures:Individual banksSome prevention techniques apply to individual banks, independently of the rest of the economy. Banks often project an appearance of stability, with solid architecture and conservative dress. A bank may try to hide information that might spark a run. For example, in the days before deposit insurance, it made sense for a bank to have a large lobby and fast service, to prevent the formation of a line of depositors extending out into the street which might cause passers-by to infer a bank run.

A bank may try to slow down the bank run by artificially slowing the process. One technique is to get a large number of friends and family of bank employees to stand in line and make a large number of small, slow transactions.

Scheduling prominent deliveries of cash can convince participants in a bank run that there is no need to withdraw deposits hastily.

Banks can encourage customers to maketerm depositsthat cannot be withdrawn on demand. If term deposits form a high enough percentage of a bank's liabilities its vulnerability to bank runs will be reduced considerably. The drawback is that banks have to pay a higher interest rate on term deposits.

A bank can temporarily suspend withdrawals to stop a run; this is calledsuspension of convertibility. In many cases the threat of suspension prevents the run, which means the threat need not be carried out.

Emergency acquisition of a vulnerable bank by another institution with stronger capital reserves. This technique is commonly used by the U.S.Federal Deposit Insurance Corporationto dispose of insolvent banks, rather than paying depositors directly from its own funds.

To clean up after a bank failure, the government may set up a "bad bank", which is a new government-run asset management corporation that buys individual nonperforming assets from one or more private banks, reducing the proportion of junk bonds in their asset pools, and then acts as the creditor in the insolvency cases that follow. This, however, creates amoral hazardproblem, essentially subsidizing bankruptcy: temporarily underperforming debtors can be forced to file for bankruptcy in order to make them eligible to be sold to the bad bank.

Systemic techniquesSome prevention techniques apply across the whole economy, though they may still allow individual institutions to fail. Deposit insurancesystems insure each depositor up to a certain amount, so that depositors' savings are protected even if the bank fails. This removes the incentive to withdraw one's deposits simply because others are withdrawing theirs.However, depositors may still be motivated by fears they may lack immediate access to deposits during a bank reorganization. To avoid such fears triggering a run, the U.S. FDIC keeps its takeover operations secret, and re-opens branches under new ownership on the next business day. Government deposit insurance programs can be ineffective if the government itself is perceived to be running short of cash.

Bankcapital requirementsreduce the possibility that a bank becomes insolvent. The Basel III agreement strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage.

1. Full-reserve bankingis the hypothetical case where the reserve ratio is set to 100%, and funds deposited are not lent out by the bank as long as the depositor retains the legal right to withdraw the funds on demand. Under this approach, banks would be forced to match maturities of loans and deposits, thus greatly reducing the risk of bank runs.2. A less severe alternative to full-reserve banking is areserve ratiorequirement, which limits the proportion of deposits which a bank can lend out, making it less likely for a bank run to start, as more reserves will be available to satisfy the demands of depositors. This practice sets a limit on the fraction infractional-reserve banking.

Transparencymay help prevent crises spreading through the banking system. In the context of the recent crisis, the extreme complexity of certain types of assets made it difficult for market participants to assess which financial institutions would survive, which amplified the crisis by making most institutions very reluctant to lend to one another.

Central banksact as alender of last resort. To prevent a bank run, the central bank guarantees that it will make short-term loans to banks, to ensure that, if they remain economically viable, they will always have enough liquidity to honor their deposits. Walter Bagehot's bookLombard Streetprovides influential early analysis of the role of the lender of last resort. The role of the lender of last resort, and the existence of deposit insurance, both createmoral hazard, since they reduce banks' incentive to avoid making risky loans. They are nonetheless standard practice, as the benefits of collective prevention are commonly believed to outweigh the costs of excessive risk-taking.

Techniques to deal with a banking panic when prevention have failed: Declaring a emergencybank holidayGovernment or central bank announcements of increased lines of credit, loans, or bailouts for vulnerable banks

Deposit insurance corporation in India (DICGC):The Banks that are insured by the DICGC:Commercial Banks:All commercial banks including branches of foreign banks functioning in India, local area banks and regional rural banks are insured by the DICGC.

Cooperative Banks:All State, Central and Primary cooperative banks, also called urban cooperative banks, functioning in States / Union Territories which have amended the local Cooperative Societies Act empowering the Reserve Bank of India (RBI) to order the Registrar of Cooperative Societies of the State / Union Territory to wind up a cooperative bank or to supersede its committee of management and requiring the Registrar not to take any action regarding winding up, amalgamation or reconstruction of a co-operative bank without prior sanction in writing from the Reserve Bank are covered under the Deposit Insurance System. At present all co-operative banks other than those from the States of Meghalaya, and the Union Territories of Chandigarh, Lakshadweep and Dadra and Nagar Haveli are covered under the deposit insurance system of DICGC.

What does the DICGC insure?

In the event of a bank failure, DICGC protects bank deposits that are payable in India.The DICGC insures all deposits such as savings, fixed, current, recurring, etc except the following types of deposits:1. Deposits of foreign governments.2. Deposits of Central/State Governments3. Interbank deposits.4. Deposits of the State Land Development Banks with the State co-operative banks.5. Any amount due on account of any deposit received outside India.6. Any amount, which has been specifically exempted by the corporation with the previous approval of Reserve Bank of India.

Maximum deposit amount insured by the DICGC

Each depositor in a bank is insured up to a maximum of Rs.1,00,000 (Rupees One Lakh) for both principal and interest amount held by him in the same capacity and same right as on the date of liquidation/cancellation of banks license or the date on which the scheme of amalgamation/merger/reconstruction comes into force.

Suggestion:The least that the Government and the Reserve Bank of India could do is revise upwards the current Rs 1 lakh insurance limit on retail deposits, which was fixed in 1993. The Damodaran Committee on Customer Service in Banks had recommended that this be raised to Rs 5 lakh. Banks may not be happy because they would have to fork out higher premia. And the fact that these would go largely to compensate depositors of cooperatives - the only ones to fail so far - will also bother the regular commercial banks. Yet, despite the higher costs and moral hazard issues, it makes sense to guarantee adequate protection. You can never say when you'll need it.

Major bank failures around the world10 Biggest Bank Failures in the WorldThe distress and chaos caused by bank failures has been a feature of the economy for centuries. The ongoing turmoil in the financial world, however, has seen a depressing surge in bank collapses around the globe (it'sa weekly occurrencein the States). In this article we take a look back over the last few decades at some of the more notable cases in the ever-growing list of failed banks.IndyMacThe IndyMac Federal Bank happened to be one of the largestsavingsandloanassociations in the US shortly before its collapse in 2008. Its primary reason for failure stemmed from its specialization in products like Alt-Amortgages, which allowed the company to experience rapid growth at the cost of generating a "high concentration of risky assets" so that when the mortgagemarket failed in 2007, IndyMac was left with many a problem, leading to the seizure of its assets (around $30-32 billion) by theFDIC.Barings BankBarings had been around for over 230 years, surviving many troubling times, including two World Wars, but all it took to bring this mighty giant down was one man,Nick Leeson. Leeson managed to incur losses totaling around 827 million ($1.3 billion) viarogue trading, making unsupervised and unauthorized trades and deals on behalf of Barings. Sadly, due to poor management, supervision, outside events and his own judgment, Leeson successfully bankrupted his employer.NetBankPrimarily recognized as being one of the first internet-only banks and launched during the Dot-Com Boom of the late 90s, it specialized in retail and mortgage banking, as well as business finance. However, due to "significant operating deficiencies" such as poor underwriting, difficulties withloansand the collapse of the subprime mortgage industry, NetBank was shut down by the OTS.Northern RockNorthern Rock is another famous one, due to the sheer amount of press coverage it has received in the past two years. The failure and subsequent nationalization of Northern Rock occurred thanks largely to the subprime mortgage failure that was happening in the US at the time. After seeking liquidity support from the Bank of England and receiving billions of pounds as a loan, stock prices fell, many of its customers queued outside branches of the bank in order to rescue their savings, disaster followed and the bank was nationalized in February 2008.Long-Term Credit Bank of JapanNow restructured as the Shinsei Bank, the LTCB encountered a whole host of bed debt issues following the bursting of theJapanese asset price bubble. With debts being as high as 2.4 trillion yen ($19.2 billion), their bubble had most definitely been burst and the LTCB was nationalized in 1998, only to be sold to a consortium of foreign banks who then proceeded with a restructuring.Bank of Credit and Commerce InternationalBCCI was - at its peak - the seventh largest private bank in the world, with assets of well over $20 billion. The bank came under scrutiny from regulators, however, and in 1991 was at the centre of a huge legal battle in which lawsuits were thrown in every which direction, leading to the bank's eventual collapse. This battle would later be described as a "$20 billion dollar heist".Washington MutualIt was an impressive bank run to the tune of $16 billion dollars that ended this giant's career. During the subprime failure and fearing its collapse, customers withdraw billions of dollars from the bank, leading to its eventual seizure by the FDIC, all in the space of one month in 2008. TheWal-Mart, Starbucks and Costcoof the banking industry was doomed to failure by the very people it was created to serve.CreditanstaltBased in Vienna and founded by the Rothschild family in 1855, the Creditanstalt was a very successful bank and eventually became one the largest banks in Austria-Hungary. The bank hit rocky waters during the time of the Great Depression, declaring itself bankrupt and having to be rescued by the central Bank of Austria as well as the Rothschilds, who then merged it with another bank, being rebranded as the Creditanstalt-Bankverein.

Hokkaido Takushoku BankFounded as a "special bank" in order to help promote development and growth on the island of Hokkaido, the bank enjoyed many a successful year and grew steadily. Initially specialising in debtinsuranceand low-interest loans, the bank branched out into real estate investments only to suffer huge losses (over a trillion yen - $10 billion) as a result of Japan's bubble bursting in the 90s. The bank could no longer continue to do business and was declared bankrupt in 1997.Herstatt BankThis German bank was declared bankrupt in 1974, but the big deal here was that the failure of this bank actually resulted in a change in legislature, specifically that coveringsettlement risk, which then led to the eventual formation of theCLSprocess. Essentially, payments in Deutsch Marks had been made to Herstatt on the very day it was due to be liquidated. These DM were to be exchanged into USD and then sent on to New York. However, before this could happen (but after the payments had been made) the bank was seized and because of the rules at the time, the banks never received their payments.

Bank Failures in India:

A recent press report said that an average 40 banks failed in India during each year between 1947 and 1955. Reports said that in the year 1951, there were 566 private commercial banks in India with 4,151 branches. Bank failures in India were out of control before Independence in the absence of comprehensive banking legislation and structured supervision mechanism for the banks.Reports added saying that during 1913 to 1936, 481 banks had failed in the country and the situation did not improve in the post-Independence period even after the spread of the Banking Regulation Act in 1949. Almost 106 banks were liquidated during the period 1954 to 1959 among which 73 banks went into voluntary liquidation and 33 into compulsory liquidation. To protect public savings, it was considered better to wind up insolvent banks or amalgamate them with stronger banks.But it must be noted that access to credit in the form of Agriculturalloan, jewel loans,personal loanetc could be affected for retail customers as many of them depend on these commercial banks for credit.In 1960, after RBI received formal powers to amalgamate banks, 217 banks were amalgamated. Further, some of the bigger private banks were nationalized in two tranches in 1969 and 1980 to promote inclusive banking. Thus, the number of private banks has significantly reduced over time. Currently there are 14 old private banks operating in the country.

Indian bankThe RBI was criticized in a similar situation when a fully government-owned banknamely Indian Bank went bust about a decade back. Indian Banks Chairman and Managing Director brazenly violated all discretion and sanctioned millions and millions of rupeesloans and advancesto corporate bodies with doubtful integrity. The RBI had its representative in the board of Indian Bank but its representative probably wassleeping duringboard meetings because the RBI did not question any of the decision of the CMD of Indian Bank. Not only that, the RBI even extended the tenure of the CMD several times so that he created a history in the banking industry in India to have worked as a CMD for a long period of seven years. A multi-crore scam was exposed in 1992, where then chairman M. Gopalakrishnan lent loan to small corporates and exporters from the south amounting to 1,300 crore. The amount was never paid back by the borrowers.

Global Financial Disaster Looms: European Banks Face Bankruptcy

Right now, the entire world is in denial about the trouble that European banks are in. The situation is a replay of 2007 and 2008 when the extent of eventual write-downs from sub-prime mortgages in the US was known and specialists knew that in the event of such write-downs, US banks would be potentially bankrupt and the entire financial world could be thrown into crisis.Today, European banks are in considerably worse shape than their US counterparts were in 2008. And the consequences of a European bank crisis for the global financial and economic systems could be just as severe as and even more so than they were when the US financial system experienced its crisis in 2008-2009.

The State of European BanksFirst, the capitalization levels of European banks are much lower than they were in the US and the potential write-downs are at least as severe. As can be seen in the table below, the tangible common equity to assets (TCE) ratio is less than 3.0% for most of the largest European banks, including Barclays, Deutsche Bank and Credit Suisse.

For all intents and purposes, European banks face a serious threat of bankruptcy, since write-downs on total assets are ultimately quite likely to exceed the value of common equity capital perhaps by a very substantial amount.It is important to clarify that operating with negative net worth is not a problem in and of itself for banks. As long as they have access to sufficient funding via deposits and central bank facilities, banks can operate with negative equity on a marked-to-market basis and still have value to equity shareholders. That is because bank profitability normally exceeds the cost of capital. For this reason, the intrinsic value of a bank generally exceeds its book value and is reflected in normalized P/BV ratios that typically exceed 1.0x.The problem is that there is a very serious possibility that the eventual write-downs that European banks face could be so severe that the banks have negative net present value to equity shareholders. In other words, all of the projected future profitability of the current banking franchise (into perpetuity) discounted to the present may not exceed the value of the write downs that the banks may have to make on their assets. In this event, equity shareholders would face a total loss and the banks would likely have to be taken into receivership by the state and restructured.

European banks face two main potential sources of losses that could wipe out all equity value:

1.Sovereign bonds:

Less than one month ago, Dexia had passed the European stress test with flying colors and could brag that it was one of the best capitalized banks in Europe. Today, Dexia is on the verge of insolvency merely due to its exposure to the sovereign debt of a country as tiny and relatively insignificant as Greece. Reflect on this for a moment. If one of the best capitalized banks in Europe is on the verge of bankruptcy due to its exposure to Greek sovereign debt, what happens to the other European banks if the sovereign debt of Portugal, Ireland, Spain or Italy exposures that are many magnitudes larger -- have to be written down to any substantial degree? The answer is clear general insolvency.

2.Real estate bust:

Real estate in Europe is way more overvalued than it was in the US at the height of the US property bubble. The trouble is, nobody has even begun to talk about the massive write-downs that European banks are going to have to take on their mortgage portfolios and their loans to property developers. Until now, property values in countries such as Spain have held remarkably steady at bubble levels in large measure due to aggressive policies by banks designed to prevent foreclosures. However, this could change at any moment, and a melt-down could begin, particularly if European economies begin to contract.

There are several important consequences that could flow from a general insolvency crisis amongst European banks:

Importance of European Banks to Europes economies.Bank assets as a percent of the GDP of European countries are magnitudes higher than they were at their peak in the US. Furthermore, finance represents a much larger percentage of GDP in Europe than it ever did in the US. Thus, banking sector troubles could cause greater damage to European economies than they did to the US economy.

Importance of European Banks to Europes equity markets. European banks generally constitute a larger portion of European equity indices than was the case with US banks in 2008. Thus, the effect of a major decline or even bankruptcy in European banks on European equity markets could be even more dramatic than in the US.

Credit contraction and economic depression.A banking crisis would cause an immediate and deep contraction of credit to European businesses and households. The result of the concomitant liquidity crisis would be general economic collapse and depression throughout the European continent.

Spiraling sovereign debt crisis.Collapsing tax revenues and the cost associated with bank rescues would provoke either general sovereign defaults, a chaotic break-up of the EU and/or a massive inflation engineered by the ECB.

Dexia as Europes Bear Stearns

Dexia is Europes Bear Stearns. Right now, European officials seem more in denial than US officials were leading up to and immediately after the Bear Stearns crisis.In 2008, US officials were publicly fretting about theoretical future risks such as moral hazard rather than focusing on the proximate problem, which was no less than an imminent collapse of the financial and economic system. Today, the dithering and penny-pinching of European leaders is even more pronounced.As I stated in a recentarticle, European leaders seem to be whistling past the graveyard, hoping that some miracle will occur that will enable them to avoid taking drastic and expensive action to contain the evolving crisis.Unfortunately, there is no alternative to drastic and costly action to save the European financial system and prevent the collapse of Europes economies and perhaps the entire EU system.If dramatic and decisive actions are not taken within the next month, I believe that Europe will face a Lehman Moment. At that point, there may be no turning back for Europe.What actions must be taken? Contrary to the approach currently favored by European officials, the most urgent need isnotintervention to capitalize the banking system; it is to place a credible backstop on the sovereign debt of European countries.As Josef Ackermann, the CEO of Deutsche Bankhas said,It is not the capital funding of banks that is the problem, but rather the fact that government bonds have lost their status as risk-free assets.Banks can operate with low and even negative levels of equity capital. However, no amount of equity capitalization can withstand the fallout from sovereign defaults of several European states.Thus, as I have stated previously, the default of all European nations with the possible exception of Greece must be taken off the table credibly through authorization of an unlimited commitment by the ECB to purchase and/or finance the purchase of European sovereign debt of member states when and if interest rates on European sovereign bonds exceeds predetermined levels.

Conclusion

Unfortunately, European leaders have shown no signs of rising to the challenges that face them. For this reason, while European leaders may succeed in jawboning global markets higher one or several more times as prices fall to critical support levels and nervous traders cover shorts, the prognosis for Europe and the global economy is quite bleak.I believe that there is currently at least a 50% probability of a severe financial crisis in Europe triggered by a combination of skyrocketing sovereign bond yields and insolvencies on the part of systemically important European banks.As a consequence, in addition to selling and/or shorting European banks, investors should steer clear of US financials such as Citigroup, Bank of America, Morgan Stanley and JP Morgan.

Indian banks having the last laugh?

The pace of development for the Indian banking industry has been tremendous over the past decade. As the world reels from the global financial meltdown, Indias banking sector has been one of the very few to actually maintain resilience while continuing to provide growth opportunities, a feat unlikely to be matched by other developed markets around the world.

Can private banks go bankrupt in India?

Because of US Recession and Global Economic Slowdown so many retail investors and small depositors of India have a same query. And that Query is Can private banks go bankrupt in India?

These types of queries arise because of past derivatives exposure of ICICI bank into bankrupt firm Lehman Brothers. Once there were rumors coming into the market that "ICICI Bank will go Bankrupt". So depositors in panic started withdrawing their money and Investments with ICICI Bank.

So back to the main question: Can private banks go bankrupt in India?Very short and clear cut answer is -"Yes. Any Bank of India, weather it is private or nationalized can go Bankrupt"

Not to get disappointed. Lets discuss a few things about Indian banks

1. Fundamentals of Indian Banks:

See, Fundamentals of Indian Banks (Both Nationalized & Private) are extremely sound. You will than think that if largest firms of USA are going bankrupt than how can you say that fundamentals of Indian banks are sounder than the US financial firms.Well, the reason is very simple. Today USA is in housing, credit & stock market crisis because it has practiced very liberal borrowing and lending practice since past two decades.In USA, once upon a time, Banks were used to give 120% loan on Property Value....Can you believe that 120% loan on property value. It means that if the Valuation of property is Rs.1 Crore than banks of USA will give you Rs.1.20 crore loan to buy that property.You will think that how this can be possible? Well, see this is how it was possible.These banks take no Down payments at all to buy that property where as in India you have to put Minimum 20-40% Down payment. And not only this but they will lend you a 20% more amount of check to buy a luxurious furniture for that home. So in this way they were used to give people 120% loan of property value.Now I have never seen any Indian banks doing this kind of practice.Not only this but i have gone through financial statements of Indian banks on various credit rating agencies of India such as CARE, CRISIL & ICRA and I come to know that various statistical ratios of Indian banks are very sound.So it is almost impossible that an Indian bank gets bankrupt.

2. What happens to your investments (Stocks/RBI bonds/MF units/ULIPS) if Indian banks go bankrupt?

Even in worst case scenario of your bank going bankrupt all your investments would be 100% safe.i. Stocks in demat account.ii. RBI banks brought through your banks.iii. NSC and KVP brought through your banks.iv. ULIPSv. MF unitsvi. Insurance cum investment products.

All of your above Investments are absolutely safe even if your Bank files Bankruptcy. Because all of the above are your Assets and creditors of that Bank has no right to liquidate it. More over your investments such as stocks are in custody with SEBI via your Demat account so they are also absolutely safe.Your mutual fund units are in custody with your fund house and your bank does not have any access over that so any MF investment done through your bank is also safe.Any government security that you have bought from your Bank and is in possession of your Bank are also safe such as RBI Bond, KVP, NSC, etc.

Only your savings account balance and fixed deposit are the two things which are not safer if your bank goes bankrupt. If your Bank goes bankrupt than according to Indian Government rules all the depositors will be given back up to Maximum Rs.1 lakh of amount irrespective of how many bank accounts they hold with the same bank.

Conclusion:

According to the above stated facts, the possibility of an Indian bank going bankrupt is quite less except if there is a huge scam. And even in the worst case scenario, which is your bank going bankrupt, all your investments are protected. Also you receive a compensation of up to Rs.1 lakh. Hence in this global financial slowdown, the conditions of Indian banks are better than the banks of the rest of the world.Where we here news of a lot of banks going bankrupt in US and the European banks facing major problems and seeking bailouts, Indian banks are comparatively safe and secure.

Articles

The Financial Express

For every 5 US bank failures, 2 Indian banks shut in FY09Posted: Wednesday, Apr 08, 2009 at 2217 hrs ISTNew Delhi:When banks were falling like ninepins in the US, India too was not far behind with two Indian lenders going belly up for every five in the worlds largest economy during fiscal 2008-09. As many 19 Indian co-operative banks collapsed for the 12 months ended March 31, 2009, against 44 American entities failing during the same period.Consequently, the Reserve Banks credit insurance arm had to pay over Rs 142 crore to depositors to cover the liabilities of 19 banks. Under the Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly-owned subsidiary of the RBI, insurance norms, a maximum of Rs 1 lakh is paid to a depositor in case the bank goes bust. From April 2008 till March 2009, a whopping 44 lenders in America were shut down by the authorities as the country continued to grapple with the worsening financial meltdown. Most of the bank failures happened after Lehman Brothers filed for bankruptcy on September 15 last year, with 35 entities going bust. Meanwhile, this year, seven US banks are collapsing on an average every month, taking the total to 21 entities so far.As far as India was concerned, the 19 co-operative banks, including six from Karnataka, have failed to repay deposits to customers during the last fiscal. The DICGC paid the maximum amount of Rs 45.4 crore to District Cooperative Bank Ltd of Gonda in UP. This was followed by The Maratha Co-operative Bank of Karnataka (Rs 17.7 cr), Parivartan Co-operative Bank of Maharashtra (Rs 16.7 cr), Ravi Co-operative Bank (Rs 16.2 crore) and Indira Priyadarshini Mahila Nagrik Sahakari Bank of Chhattishgarh (Rs 13.1 cr).The other five lenders from Karnataka are Varda Co-operative Bank (Rs 2.4 crore), Harugeri Urban Co-operative Bank (Rs 3.1 crore), Kittur Rani Channamma Mahila Pattana Sahakari Bank (Rs 2.2 crore), Challakere Urban Co-operative Bank (Rs 3.2 crore) and Basavakalyan Pattana Sahakari Bank (Rs 0.24 crore).Four banks each in Maharashtra and Gujarat went bankrupt, while two cases were reported in Uttar Pradesh. During 2007-08, as many as 22 cooperative banks closed operations.

Co-operative bank failures tally hits 32 in 2009Zeenews.com Sunday, February 14, 2010New Delhi: As many as 32 co-operative banks in the country folded up last year forcing the depositors to invoke insurance guarantee to recover part of their losses. Deposit Insurance and Credit Guarantee Corporation (DICGC), the Reserve Bank's credit insurance arm, paid nearly Rs 482 crore to these 32 cooperative banks in the period between January and December, 2009, to settle the dues of the depositors. A maximum of Rs 1 lakh is paid to a depositor in case of failure of banks under the DICGC insurance norms.Maharashtra-based banks-- Vasantdada Shetkari of Sangli was paid the maximum of Rs 159.93 crore, followed by Shri PK Anna Patil Janata Bank (Rs 56.48 crore), The South Indian Co-operative Bank Ltd of Mumbai (Rs 35.40 crore) and Rohe Ashtami Sahakari Bank Ltd (Rs 34.94 crore).

Other banks which closed down during the year were, Ajit Sahkari Bank for which the DICGC paid Rs 25.72 crore as claim, Bhavnagar Mercantile Co-operative Bank (Rs 24.52 crore), Chalisgaoan Cooperative Bank (Rs 14.97 crore) and Hirekerur Bank (Rs 13.73 crore), according to the DICGC data.

Out of 32 banks that closed counters, most (15) were from Maharashtra, which was followed by Karnataka (7). Gujarat's tally was at 5, while Uttar Pradeshs 3 banks downed shutters. In 2008, the number of co-operative bank collapses was 17. Out of this, 4 banks of Gujarat and Maharashtra failed to pay back the depositors money. Last month, RBI Deputy Governor Subir Gokarn said that premium charged from banks for deposit insurance should be linked to the quality of the loans. "One way of encouraging overall efficiency is to differentiate insurance premiums between institutions based on some objective measure of the riskiness of their loan and asset portfolios. This will help to bring about a better alignment between the cost of funds and the portfolio risks across the deposit taking financial sector, Gokam had said. By simply making it compulsory for banks to buy insurance, would impact their operating expenses as they have to service a large number of small accounts, and the depositors also have to bear it to some extent, he had said.

The Hindu : Business LineRBI needs more powers to help banks overcome insolvency: ChakrabartyMUMBAI, NOV. 16:The Reserve Bank of India should have powers to set the affairs of a bank in order before it becomes insolvent, according to RBI Deputy Governor, Dr K. C. Chakrabarty.Banks can face insolvency due to erosion in net worth, insufficient capital backing assets, and high default rate on the debt issued by them.The Deputy Governor, in his address at an international conference on the role of deposit insurance in bank resolution framework in Jodhpur, said, a special legislation is needed to expand the resolution powers of the RBI. Further, a legislation is needed for the appointment of a temporary administrator to resolve the problems facing banks.Emphasising the importance of making sweeping reforms to the deposit insurance system, Dr Chakrabarty said, it is necessary to broaden the mandate of the Deposit Insurance and Credit Guarantee Corporation from pay-box (to pay claims of depositors to the extent and in the manner stipulated by law) to resolving the problems of a troubled bank.The DICGC should play a proactive role in early identification of bank failures and their effective resolution with the aim of protecting their funds and maintaining public confidence.Monitoring of banks, taking prompt corrective action and finding and implementing the least-cost method of resolution of troubled banks would lead to faster settlement of claims to depositors.The ultimate way out is to put in place a clearly defined bank solvency regime and a properly designed resolution process, said the Deputy Governor.For depositors of failed banks to maintain confidence in the banking system, it is essential to provide depositors quick access to their funds. This will require technology upgradation, including the adoption of core banking solution by all urban co-operative banks (UCBs) and an effective interface between the DICGC and banks' CBS to access depositor databases.Pointing out that there are delays in appointment of liquidators (by State Governments) for UCBs, Dr Chakrabarty said it will be beneficial to grant the Corporation the power to appoint and monitor liquidators so that depositor information can be obtained within a shorter timeframe.IT EXEMPTIONAbout half of the Corporation's premium income, which is its main source of funds, is paid as income-tax to the Government.In this regard, Dr Chakrabarty observed that since DICGC is a non-profit organisation serving social obligations of protection of small depositors, it should be exempted from payment of tax, as is done globally.The tax exemption would enable the DICGC build up its fund base, provide higher coverage to depositors and even pass on the benefits to insured banks by reducing the rate of premium.The Deputy Governor said it is surprising that in India, there is inadequate awareness about deposit insurance.One reason for this could be that in India banks are perceived to be either too-big-to-fail or impossible to fail on account of the Government or RBI backing.While this may be true for the public sector banks, it certainly does not hold good in the case of private sector banks, foreign banks operating in India and the large number of cooperative banks, added Dr Chakrabarty.

Business StandardRemedy against bankrupt banksJehangir Gai / Dec 08, 2011, 00:33 ISTTo protect small and marginal account holders, it has been made mandatory for banks to insure each account up to Rs 1 lakh. The rider is: The insurance amount becomes payable only when the bank goes into liquidation. The Reserve Bank of India (RBI) tries to prevent the liquidation and winding up of the bank, and instead attempts to revive it by granting protection, which often runs into years. So, the account holder is left high and dry, in a catch-22 situation where he can neither access his money nor avail the insured amount. This is not justified, according to a ruling by the National Consumer Disputes Redressal Comm-ission in 2008 in the case of Reserve Bank of India v/s Eshwarappa & Anr in revision petition number 2528 of 2006 and other connected matters.The Maratha Co-operative Bank Ltd (MCB), Hubli, had run into problems. The RBI granted protection to it by issuing a prohibitory order under section 35A of the Banking Regulation Act 1949. The order stated that from the close of business on 3.2.2004, MCB shall not, without prior approval in writing from the RBI, grant or renew any loans and advances, make any investment, incur liability, including borrowing of funds and acceptance of fresh deposits, disburse or agree to disburse any payment whether in discharge of its liabilities and obligations or otherwise, enter into any compromise or arrangement and sell, transfer or otherwise dispose of any of its properties or assets. Consequently, the account holders were not allowed to withdraw money from their own accounts. Feeling frustrated, several account holders filed complaints before the consumer fora against the MCB and the RBI.Both MCB and RBI opposed the complaints, contending that the consumer fora would not have the jurisdiction in view of the prohibitory order issued by the RBI. Rejecting this objection, the National Commission observed that the Consumer Protection Act (CPA) provides an additional remedy and its provisions must be construed liberally, so as to bring the many cases under it for their speedy disposal. It held that the prohibitory order of the RBI would not prevent a depositor from filing a suit or a complaint under the CPA.The Commission noted that the Deposit Insurance and Credit Guarantee Corporation Act (DICGC) provides insurance cover to small depositors, but this Act remains on paper because the it is framed in such a way that such insurance cover would come into operation only when there is a winding up or liquidation order. Since the RBI neither permitted the bank to operate nor it passed the order for liquidation, the purpose of extending insurance cover to the small depositors was frustrated in the hope of reviving the bank.The Commission observed that bureaucracy attempts to delay proceedings at every stage and lamented that the authorities were trying to even stonewall the Commission's attempts to arrive at a reasonable solution to the problems faced by persons whose money was blocked.The Commission noted that while the RBI's prohibitory order was binding on the bank, the pertinent question is whether it would be justifiable to continue the prohibitory order beyond reasonable time to the detriment of the depositors having small or limited means, thereby putting them to hardship. The Commission observed that the established law is that administrative powers are required to be exercised within a reasonable time in order that they are not abused. The RBI has a duty to act as a watchdog of the finance and economy of the nation. It has to act in public interest and prevent the affairs of any bank being conducted in a manner detrimental to the interests of the depositors. A failure to do so would constitute a deficiency in service. Relying on various decisions of the apex court, the Commission held that where the law does not prescribe limitation, the court would import the concept of "reasonable time". If a bank cannot be revived within a reasonable time, the banking licence should be cancelled and the bank ordered to be wound up. The DICGC must pay the amount covered by the insurance as soon as such liquidation order is passed, without waiting for further orders from the liquidator. Otherwise, it would be torturous to the poor depositors who may have to wait for years for the cumbersome procedure whereby the liquidator crystallizes the amounts due to each depositor. The Commission, which had impleaded the DICGC as a party, directed it to pay the insured amount to the account holders. However, in case the bank was revived later, the amount paid by the DICGC could be recovered from the bank. This landmark judgment will help the small depositor to approach the consumer forum for recovering claims up to Rs 1 lakh from the insurance coverage provided by DICGC. It is also hoped that the RBI will do its duty, so that depositors do not suffer.Case StudyThe Collapse of Lehman Brothers

On September 15, 2008, Lehman Brothers filed forbankruptcy. With $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such asWorldComandEnron. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide. Lehman's demise also made it the largest victim, of the U.S.subprime mortgage-induced financial crisis that swept through global financial markets in 2008. Lehman's collapse was a seminal event that greatly intensified the 2008 crisis and contributed to the erosion of close to $10 trillion in market capitalizationfrom global equity markets in October 2008, the biggest monthly decline on record at the time.

The History of Lehman Brothers Lehman brothers had humble origins, tracing its roots back to a small general store that was founded by German immigrant Henry Lehman in Montgomery, Alabama, in 1844. In 1850, Henry Lehman and his brothers, Emanuel and Mayer founded Lehman Brothers. While the firm prospered over the following decades as the U.S. economy grew into an international powerhouse, Lehman had to contend with plenty of challenges over the years. Lehman survived them all the railroad bankruptcies of the 1800s, theGreat Depressionof the 1930s, two world wars, a capital shortage when it was spun off by American Express in 1994, and theLong Term Capital Managementcollapse and Russian debt default of 1998. However, despite its ability to survive past disasters, the collapse of the U.S. housing market ultimately brought Lehman Brothers to its knees, as its headlong rush into the subprime mortgage market proved to be a disastrous step.

The Prime CulpritIn 2003 and 2004, with the U.S. housing boom well under way, Lehmanacquiredfive mortgage lenders, includingsubprimelender BNC Mortgage and Aurora Loan Services, which specialized inAlt-Aloans (made to borrowers without full documentation). Lehman's acquisitions at first seemed prescient; record revenues from Lehman's real estate businesses enabled revenues in the capital markets unit to surge 56% from 2004 to 2006, a faster rate of growth than other businesses in investment banking or asset management. The firm securitized $146 billion of mortgages in 2006, a 10% increase from 2005. Lehman reported record profits every year from 2005 to 2007. In 2007, the firm reported net income of a record $4.2 billion onrevenueof $19.3 billion.

Lehmans Colossal MiscalculationIn February 2007, the stock reached a record $86.18, giving Lehman amarket capitalizationof close to $60 billion. However, by the first quarter of 2007, cracks in the U.S. housing market were already becoming apparent as defaults on subprime mortgages rose to a seven-year high. On March 14, 2007, a day after the stock had its biggest one-day drop in five years on concerns that rising defaults would affect Lehman's profitability; the firm reported record revenues and profit for its fiscal first quarter. In the post-earningsconference call, Lehman'schief financial officer(CFO) said that the risks posed by rising home delinquencies were well contained and would have little impact on the firm's earnings. He also said that he did not foresee problems in the subprime market spreading to the rest of the housing market or hurting the U.S. economy.

The Beginning of the End:As the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds, Lehman's stock fell sharply. During that month, the company eliminated 2,500 mortgage-related jobs and shut down its BNC unit. In addition, it also closed offices of Alt-A lender Aurora in three states. Even as the correction in the U.S. housing market gained momentum, Lehman continued to be a major player in the mortgage market. In 2007, Lehman underwrote moremortgage-backed securitiesthan any other firm, accumulating an $85-billion portfolio, or four times its shareholders' equity. In the fourth quarter of 2007, Lehman's stock rebounded, as global equity markets reached new highs and prices for fixed-income assets staged a temporary rebound. However, the firm did not take the opportunity to trim its massive mortgage portfolio, which in retrospect, would turn out to be its last chance.

Hurtling toward Failure:Lehman's high degree ofleverage- the ratio of total assets to shareholders equity - was 31 in 2007, and its huge portfolio of mortgage securities made it increasingly vulnerable to deteriorating market conditions. On March 17, 2008, following the near-collapse of Bear Stearns - the second-largest underwriter of mortgage-backed securities - Lehman shares fell as much as 48% on concern it would be the nextWall Streetfirm to fail. Confidence in the company returned to some extent in April, after it raised $4 billion through an issue ofpreferred stockthat was convertible into Lehman shares at a 32% premium to its price at the time. However, the stock resumed its decline as hedge fund managers began questioning the valuation of Lehmans mortgage portfolio.On June 9, Lehman announced a second-quarter loss of $2.8 billion, its first loss since being spun off by American Express, and reported that it had raised another $6 billion from investors. The firm also said that it had boosted itsliquiditypool to an estimated $45 billion, decreased gross assets by $147 billion, reduced its exposure to residential and commercial mortgages by 20%, and cut down leverage from a factor of 32 to about 25.

Too Little, Too Late:However, these measures were perceived as being too little, too late. Over the summer, Lehman's management made unsuccessful overtures to a number of potential partners. The stock plunged 77% in the first week of September 2008, amid plummeting equity markets worldwide, as investors questioned CEO Richard Fuld's plan to keep the firm independent by selling part of its asset management unit and spinning off commercial real estate assets. Hopes that the Korea Development Bank would take a stake in Lehman were dashed on September 9, as the state-owned South Korean bank put talks on hold.The news was a deathblow to Lehman, leading to a 45% plunge in the stock and a 66% spike incredit-default swapson the company's debt. The company's hedge fund clients began pulling out, while its short-term creditors cut credit lines. On September 10, Lehman pre-announced dismal fiscal third-quarter results that underscored the fragility of its financial position. The firm reported a loss of $3.9 billion, including awrite-downof $5.6 billion, and also announced a sweeping strategic restructuring of its businesses. The same day, Moody's Investor Service announced that it was reviewing Lehman's credit ratings, and also said that Lehman would have to sell a majority stake to a strategic partner in order to avoid a ratingdowngrade. These developments led to a 42% plunge in the stock on September 11. With only $1 billion left in cash by the end of that week, Lehman was quickly running out of time. Last-ditch efforts over the weekend of September 13 between Lehman, Barclays PLC and Bank of America, aimed at facilitating atakeoverof Lehman, were unsuccessful. On Monday September 15, Lehman declared bankruptcy, resulting in the stock plunging 93% from its previous close on September 12.

Conclusion

Lehman's collapse roiled global financial markets for weeks, given the size of the company and its status as a major player in the U.S. and internationally. Many questioned the U.S. government's decision to let Lehman fail, as compared to its tacit support for Bear Stearns (which was acquired by JPMorgan Chase) in March 2008. Lehman's bankruptcy led to more than $46 billion of its market value being wiped out. Its collapse also served as the catalyst for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also announced on September 15.

The Rise and Fall of Global Trust BankAbstract:The case describes the growth and collapse of Global Trust Bank, a leading private sector bank in India. Since 2001, GTB's name was associated with scams and controversies, thereby casting shadows over the credibility of the bank and its management.Due to the overexposure to capital markets and huge NPAs, the bank was in a financial mess. When GTB tried to cover up its monumental NPAs through under provisioning, RBI - the Central bank and the regulatory authority for banks in India, appointed an independent team to review the finances of the bank. The review revealed various financial discrepancies kept covered by the bank.RBI imposed a three month moratorium on GTB on the ground of "wrong financial disclosures" and within two days the bank was merged with Oriental Bank of Commerce (OBC), a public sector bank. With the merger becoming effective, GTB's identity came to an end and it became a part of OBC.The MoratoriumOn July 24, 2004, the Government of India imposed a moratorium on Global Trust Bank (GTB), a leading private sector bank, on the grounds of 'wrong financial disclosures.'The moratorium was for three months from close of business on July 24, 2004 till October 23, 2004. Earlier, the Reserve Bank of India (RBI) had announced that GTB's net worth had turned negative as it had incurred huge losses and accumulated a significant number of non-performing assets (NPAs).RBI stated that the numbers reported in GTB's balance sheet did not match its audited figures. Moreover, GTB failed to provide satisfactory explanations to most of RBI's queries regarding its capital market exposures and why prudent lending norms were not observed in disbursing huge amounts for investments in the stock market. RBI said the moratorium was imposed in public interest and to protect the interests of depositors.All operations of GTB were frozen and it was ordered not to give loans without RBI permission. It was allowed only to make payments for day-to-day operations or for meeting obligations entered into before the order.

Background NoteThe liberalization process initiated by the Government of India, during the early 1990's witnessed the entry of several private players in the Indian banking sector. GTB was one of the earliest private sector banks to be incorporated on October 30, 1994, in Hyderabad. GTB was promoted by Jayant Madhab (Madhab), Ramesh Gelli (Gelli) and Sridhar Subasri (Subasri). Madhab, a development banker, was employed with the Asian Development Bank, Manila. Gelli who was Chairman of Vysya Bank for10 years had played a major role in transforming that bank into one of India's top private sector banks. Subasri was a former bank executive and a close friend of Gelli.Though the licence to GTB was given in the name of Jayant Madhab and Associates, Madhab's involvement with GTB was affected by the loss of his only son.The bank's operations were managed by Gelli. Apart from the three promoters, the International Finance Corporation (IFC) and the Asian Development Bank (ADB) were the bank's major shareholders. GTB offered an array of products and services in retail, wholesale, corporate, treasury and investment banking and products for non-resident Indians, apart from depository and advisory services. The bank specialized in lending to the software, energy, telecom, textiles, pharmaceuticals and gems and jewellery sectors. Since its inception, GTB had been in the news several times. The three promoters raised Rs 400 mn, considered a substantial amount for individual promoters.With two international financial institutions IFC and ADB- as shareholders, GTB became the first Indian private sector bank to attract equity participation from international investment banks.The initial public offer (IPO) in late 1994 was oversubscribed 60 times. Subscription worth Rs 62.40 bn from over one mn investors was received as against the original size of Rs.1.04bn. On opening day, the bank reportedly received deposits worth Rs one bn, which increased to Rs 10 bn by the end of the first year; and Rs 27.06 bn in three years.

In three years of operations, the total business exceeded Rs 43.02 bn, making it one of the fastest growing banks in India. It was also the first among Indian banks to raise Tier II capital from multilateral institutions. In five years, GTB's deposits were worth Rs 40 bn out of which 70 per cent were from retail investors.

The FallThe collapse of GTB resulted from many mistakes committed by the bank's management. GTB's problems started in 2000 and the imposition of the moratorium finally ended its independent existence.RBI's probe into GTB's accounts revealed a significant erosion of the bank's net worth and huge number of NPAs reflected its weak financials. Moreover, GTB's attempts to strengthen its capital base through investments from overseas failed due to regulatory problems, resulting in the total collapse of the bank. The major factors that led to the fall of GTB included:NEXUS WITH KETAN PAREKHIn mid-2000, GTB disbursed loans of Rs 1.4 bn to Ketan Parekh (KP), a leading stockbroker at the Bombay Stock Exchange (BSE). He used the money to purchase GTB shares from the BSE and the National Stock Exchange (NSE).

The MergerAll these factors resulted in the imposition of moratorium by RBI on GTB. On July 26, 2004, RBI announced that GTB would be merged with the Oriental Bank of Commerce (OBC).As per the scheme, OBC took over all the assets and liabilities of GTB on its books. It acquired all 104 branches of GTB, 275 ATMs, a workforce of 1400 employees and one million customers at an estimated merger cost of Rs. 8 bn. OBC's total business volume was expected to reach Rs 65 bn and the total branch network to cross 1,100. All corporate accounts including salary accounts were transferred to OBC. The entire amount of paid-up equity capital of GTB was adjusted towards its liabilities. There was no share swap between GTB and OBC, which meant that GTB shareholders were the ultimate losers, as they did not get any shares of OBC. Moreover, OBC enjoyed a huge tax break by acquiring GTB's NPAs worth Rs 1.2 bn and impaired assets of Rs. 3 bn.

The AftermathThough RBI's decision to merge GTB with OBC came as a relief for the former's depositors, analysts and industry experts raised concerns about the way RBI handled the entire issue. They said RBI had announced the merger of GTB and OBC, in less than 48 hours of the imposition of the moratorium.If the deal was already in process, they wondered why RBI took the extreme measure of imposing a moratorium instead of announcing the mandatory merger straight away. This step would have prevented panic and anxiety among GTB's depositors. Analysts also wondered why RBI rejected the proposal of equity injection from NewBridge, which would have solved the re-capitalization problem of GTB easily and could have prevented the bank's eventual collapse. They wondered why RBI favored the merger with OBC and did not try for competitive bidding to acquire GTB. Moreover, though the interests of GTB's depositors were protected, its shareholders lost their total investments in the bank overnight.

ConclusionTo control occurrence of bank failures, it is necessary on the part of Banks to follow guidelines of the Central bank or other monetary authorities with regards to reserve ratios, employing employees, dealing with customers and timely reporting the appropriate authorities.Bank failures have the capacity to wreak havoc in the global financial scenario. The contagion effect is too dangerous for any economy. Thus, the monetary authority of the country must make sure that banks are liquid enough to pay off its debts and see to it that there are no flaws in terms of banks management and functioning.The total number of bank failures so far in U.S 2012 is 38, following 92 in 2011, 157 in 2010, and 140 in 2009 and 25 in 2008. News says that U.S. bank failures through 2014 will drain $60 billion from the Federal Deposit Insurance Corporation fund that protects customer accounts in the event of a collapse. Such staggering amounts of money have to be infused into the banks to save them from bankruptcy which in turn hampers economic progress. European banks are too in major crisis with Spanish, Greek and Italian banks seeking bailouts.While the financials of a few large banks continue to stabilize on the back of an economic recovery and increasing dependence on noninterest revenue sources, the industry is still on shaky ground. The sector presents a picture similar to that of 2011, with nagging issues like depressed home prices along with still-high loan defaults and unemployment levels troubling such institutions. The lingering economic uncertainty and its effects also weigh on many banks. The need to absorb bad loans offered during the credit explosion has made these banks susceptible to severe problems.Hence greater measures have to be taken to safeguard banks in order to avoid triggering another global depression which will plunge the already problem-ridden world economy into further darkness.

Bibliography

BooksBusiness Ethics: An Indian Perspective by A. C. FernandoBank Regulation by S.K. Singh

Websites:www.investopedia.comwww.totalbankruptcy.comwww.indianforensic.comwww.rbi.orgwww.icmrindia.orgwww.bankbazaar.com

Newspapers:The Times of IndiaThe Economic TimesFinancial ExpressThe Hindu: BusinesslineBusiness Standard1