Large losses and failures of large banks : a study of the contributing factors

Abstract

Over the past decade, banks have been experiencing losses through trading in the capital markets, such as, LTCM, Barings Bank, Daiwa Bank and Allied Irish Bank. Several institutions have collapsed over the years, sometimes causing a crisis. Such phenomenon gave rise to new regulations to be implemented. Financial innovation has been a key factor that stimulated growth of financial institutions, derivative trading being one of the fundamentals of financial innovation. Such activities were carried out by banks in order to increase funding through the capital markets. The aim of this dissertation was to understand the problems with large banks, more precisely why they fail. The reason is that many of them were considered as too big to fail. Seven major factors were found to contribute to large bank losses which involve themselves in derivative trading. These are: unauthorised concealed trading; failure of internal controls and risk management; inadequate culture; inadequate supervision and monitoring; moral hazard; failure of understanding the duties and responsibilities; and inadequate segregation of duties. It was concluded that although regulatory reforms were put into place, this alone was not sufficient to stop banks from experiencing losses. The need for efficient and effective controls is substantial, and the need to change corporate culture is essential for banks to be successful. Through such tools, banks can limit the risk of default and minimise losses. Applying such tools, financial markets would become more efficient and effective, thus, establishing confidence in financial markets.