Upload
paula-powell
View
159
Download
1
Tags:
Embed Size (px)
DESCRIPTION
the research describes the causes of failure of the bank
Citation preview
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts
A Study on
The Century National Bank Ltd
University of Technology, Jamaica Western Campus
College of Business Administration
Treasury Management-FIN3010
Ms. Adian Miller
April 18, 2013
Prepared by:
Paula Powell 0908481
Ryan Wilson 0908827
Christopher Carvey 0908758
Jason Peynado 0903386
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 2
Allocation of Tasks
Member Task
Paula Powell Executive SummaryBackground
Jason Peynado IntroductionRecommended Steps
Christopher Carvey Treasury Management ConceptsChronological Timeline
Ryan Wilson Principal Causes for Failure Risk Management Objectives
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 3
Table of Contents
Content Page
Executive Summary 4
Introduction 5
Background on Century National Bank 5
Chronological Time line 6
Principal Causes for Failure 8
Literature Review 11
Risk Management Objectives 11
Treasury Management Concepts 13
Recommendations 18
References 20
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 4
Executive Summary
This research paper was compiled in order to analyze the causes of the 1990’s failure of
the Century National Bank (CNB) in Jamaica. It provides the symptoms to look out for in case of
another financial crisis and prescriptions for the prevention of further damage and contagion to
the financial sector.
Using a chronological timeline the study outlines the events which led to the failure of
Century National Bank. Researchers used this timeline to evaluate and hypothesize that the main
causes for failure were:
Failure to comply with proper internal control procedures,
Liquidity problems which came about as result of issuing high-risk loans and later having a
mismatch in maturities of the bank’s assets and liabilities,
According to Crawford, the government’s high profile and frequent audits of the bank’s
account caused depositors to lose confidence in the bank and withdraw their money,
leading to systematic risk.
The intended audience for this paper which includes students, other researchers as well as any
individual seeking information will benefit from an variety of risk management objectives and
concepts such as credit risk, liquidity risk, operation risk and systematic risk which was
experienced by Century National Bank
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 5
Introduction
The Jamaican financial sector experienced significant difficulties during the years 1993-
1997, mainly as a result of the Government's tight monetary policy, weak governance, poor
central bank regulations, supervision and deficiencies in the management of the failed
indigenous banks. Lack of confidence in the commercial banking sector produced runs on a
number of smaller commercial banks. Some of the commercial banks were not adequately
capitalized, because the regulatory authority took a proactive attitude toward supervision and the
regulatory forbearance weakened the troubled commercial banks further (Swaby, 2011). These
factors were identified as the reason for the crash of the financial sector In this paper the Century
National Bank, one of the victims, is discussed.
Background on Century National Bank
The Century National Bank Ltd. was a financial institution licensed under the Banking
Act of Jamaica. The bank’s operations were headed by Chief Executive Officer, Mr. Don
Crawford. The institution went into foreclosure in 1996 along with its counterparts Century
National Merchant Bank and Trust Company Ltd, a merchant bank licensed under the Financial
Institutions Act; and Century National Building Society, a building society licensed under the
Building Societies Act.
In the view of the Bank of Jamaica the operations of these entities were characterized by
unsafe practices. Despite attempts to correct perceived mismanagement; the position, in the view
of the Bank of Jamaica became progressively worse. Long-drawn-out negotiations with a view to
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 6
restructuring the institutions and improving their standing and placing them on a sound footing
took place between the Minister of Finance, the Bank of Jamaica and the beneficial owners and
senior management of the institutions. There was never a successful outcome to these
negotiations (Century National Merchant Bank vs. Davies, 1998)
This led to the collapse of the institutions, creating a negative effect on the banking sector.
The questionable leadings of Mr. Crawford and his team and the possible recovery of capital lost
are still being rectified in court.
Chronology of Century National Bank
Date Details
1990 The performance of the banking institutions was driven by high levels of inflation during
1990-95 and a credit boom in which many loans and investments were made with no
proper risk assessment or appropriately valued collateral. The poor portfolio management
and risk assessment bolstered profit making and disguised high levels of inefficiencies in
the banking system. The environment facilitated profit-making through the transfer of
funds between different types of institutions within a financial group.
1993 The commercial banks began to suffer the consequences of high liquid asset reserves and
excessively high interest-rate structures. The cash-reserve ratio (CRR) ranged from 22 per
cent to 25 per cent, and liquid reserve ratio (LRR) ranged from 47 per cent to 50 per cent.
The lending rates of commercial banks were excessively high, ranging from 61.3 per cent
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 7
per annum in 1993 to a low in 1997 of 44.22 per cent per annum.
1993 The commercial banks began to suffer the consequences of high central bank overdraft
penalty rates. Under such adverse banking conditions, it is unlikely that any commercial
bank would be able to assume interest rates of 120 per cent for overdraft facility by such
magnitude.
1994 There were large margins within deposit and lending rates. Deposit rates ranged from
20.79 per cent per annum to 39.8 per cent per annum, based on the amount of deposit, as
well as the maturity period. Lending rates ranged from 44.22 per cent per annum to as
much as 61.32 per cent. The interest rate spread for commercial banks was 21.52 per
cent in 1994 and then increased even further to 28.29 per cent the following year.
1993-97 The varying rates of interest offered on local deposit instruments, as well as fluctuations in
the foreign-exchange market, influenced the deposit structure of the banking system during
the period 1993-97. A widening difference in the interest rates on time and savings
deposits induced portfolio adjustments, thereby luring depositors to the more attractive
savings deposits.
The inadequate capital base and high level of non-performing loans in the commercial
banks, in addition to government macroeconomic policies, poor management, inadequate
central bank supervision, poor governance by boards of directors and shareholders, led to
liquidity and solvency problems in a number of the indigenous financial institutions
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 8
The overall health of the financial sector continued to struggle as a result of the
Government's fiscal, debt, and monetary policies. The existing policy direction of
increasing borrowing to reduce debt and fiscal deficits and to support high interest rates
continued to lead to further consolidation, mergers, and bankruptcy of the sector and the
economy.
The asset portfolio of banks became heavily skewed towards government debt instruments
and towards substantial support for other financial institutions, as opposed to productive
loans and consumer-oriented credit.
Principal Causes of Failure
Century National Bank’s failure was mostly caused by the same reasons that caused the
sector to collapse in the 90’s. One of the reasons for failure was the fact that many banks
including Century National Bank failed to comply with proper internal control procedures. It was
reported that the former head of CNB Mr. Crawford, was allegedly found to have authorized
substantial unsecured loans to companies in which he had an interest. CNB’s high risk appetite,
which was becoming very common among the local banks at that time, caused the company to
suffer the outcomes of exposing to credit risk, resulting in the company becoming illiquid. The
Century National Bank has also been allowed to run up large overdrafts at the BOJ to the tune of
$ 4 billion which was still not able to meet their obligations. The Finance Minister at the time
attempted to broker a deal with other indigenous institutions thinking that the merger would help
with their current crisis. On July 10, 1996, an accountant from the accounting firm Price Water
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 9
House was appointed the duty of managing the institutions book on the behalf of the Ministry.
The examination confirmed that there was an excess of liabilities over assets in the amount of
$2.5 billion. Additionally, it was noted that the Bank faced a big problem when it came down to
the collectability of their issued loans.
In addition, after further examination of the group’s book, other problems were shown to
be the reason for the bank failure.
i. Deposit liabilities exceeded limits prescribed by law
ii. Unsecured credit to directors exceeded limits prescribed by law
iii. Credit to persons exceeded limits prescribed by law
iv. Board of directors presented misleading financial statements
v. Depositors’ interest subordinated to owners via non-arms length transactions
vi. The board of directors and owners “have failed to conduct the business of the
respondent (CNB according to law in all respect and prudently on behalf of
the depositors”
Liquidity was also a major cause for failure. In the section of the Edward Seaga’s
biography published by the Jamaica Gleaner on June 26, 2011, he stated that CNB was a fast
growing bank. He further stated that this event made clear the need for recognition of the
fragility of the financial system, of the danger of overexpansion and the importance of careful
and confidential handling of its affairs. Factors which also contributed to the liquidity problems
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 10
were the bank was giving a lot of high- risk loans, bad loans and high interest rates, which was
common throughout most of the indigenous banks in Jamaica at the time. Also, a large amount of
money was unaccounted for.
However, Don Crawford, former head of Century National Bank told RJR News on June
07, 2011; during an interview via internet during the FINSAC enquiry, that the reason for failure
of the bank was caused by the government. Crawford informed the audience that the government
did high profile and frequent audits of the banks account, which caused a lot of depositors to lose
confidence in the bank and withdraw their money; up to $170 million in July 1996 alone. This
rapid withdrawal of cash worried the BOJ, who advice the minister at the time Omar Davis to
take control of CNB’s operations.
The reason given for the intervention by the government is that CNB outbid some of the
other financial institutions and bought foreign currency from the American embassy for more
than the exchange rate. On June 26, 2011 the Jamaica Gleaner published a section of Hon.
Edward Seaga’s biography that, the CNB bid exceeded the unofficially proclaimed 'official' rate
of exchange of J$22 to US$1 promoted by the Bank of Jamaica. CNB bid J$25.10. The
government believed that CNB was degrading the Jamaican dollar. However, Mr. Crawford
believed that the reason for the intervention was politically motivated.
Risk management objectives
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 11
Risk Management is seeking security in an increasingly volatile world. Financial institutions
assume risks in order to realize returns on their investments. There are six most common risks in
banking i.e. credit, liquidity, market, operational, strategic and compliance risks. Credit risk
arises from the potential that an obligor is either unwilling to perform on an obligation or its
ability to perform such obligation is impaired resulting in economic loss to the institution.
Secondly, Liquidity risk is the potential for loss to an institution arising from either its inability
to its obligation as they fall due or to fund increases in assets without incurring acceptable cost or
losses. Market Risk on the other hand is the risk of losses in on and off balance sheet positions
as a result of adverse changes in market prices i.e. interest rate. This exists in both trading and
banking books. Operational Risk is the current and prospective risk of earnings and capital
arising from inadequate or failed internal processes, people and systems. Moreover, Strategic
risk is the current and prospective impact on earnings. Capital, reputation or good standing of an
institution arising from poor business decisions or improper implementation of decisions. Lastly,
Compliance risk is the current or prospective risk to earnings, capital and reputation arising from
violations or non-compliance with laws, rules, regulations and agreements.
Risk management as commonly perceived does not mean minimizing risk, rather the goal of risk
management is to optimize risk-reward trade-off. Therefore one of the main objective of risk
management is to put in place an effective framework which can adequately capture and manage
all risks the financial institution are exposed to.
Risk Management entails four key processes:
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 12
Risk Identification: In order to manage risks, an institution must identify existing risks or risks
that may arise from both existing and new business initiatives for example; risks inherent in
lending activity include credit, liquidity, interest rate and operational risks. Risk identification
should be a continuing process, and should occur at both the transaction and portfolio level.
Risk Measurement: Once risks have been identified, they should be measured in order to
determine their impact on the institution’s profitability and capital. This can be done using
various techniques ranging from simple to sophisticated models. Accurate and timely
measurement of risk is essential to effective risk management systems. An institution that does
not have a risk measurement system has limited ability to control or monitor risk levels. An
institution should periodically test to make sure that the measurement tools it uses are accurate.
Good risk measurement systems assess the risks of both individual transactions and portfolios.
Risk Control: After measuring risk, an institution should establish and communicate risk limits
through policies, standards, and procedures that define responsibility and authority. Institutions
may also apply various mitigating tools in minimizing exposure to various risks. Institutions
should have a process to authorize exceptions or changes to risk limits when warranted.
Risk Monitoring: Institutions should put in place an effective management information system
(MIS) to monitor risk levels and facilitate timely review of risk positions and exceptions.
Monitoring reports should be frequent, timely, accurate, and informative and should be
distributed to appropriate individuals to ensure action, when needed.
Treasury Management Concepts
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 13
There were many treasury management concepts that could have alleviated the problems that
lead to the decline and ultimately the closure of Century National Bank. They include the
following:
1. Liquidity Management
Managing liquidity is a fundamental component in the safe sound management of all financial
institutions. Sound liquidity management involves prudently managing assets and liabilities (on
and off balance sheet), both as to cash flow and concentration, to ensure that cash inflows have
an appropriate relationship to approaching cash outflows. This needs to be supported by a
process of liquidity planning which assesses potential future liquidity needs, taking into account
changes in the economic, regulatory or other operating conditions. Such planning involves
identifying known, expected and potential cash outflows and weighing alternative asset/liability
management strategies to ensure that adequate cash inflows will be available to the institution to
meet these needs.
2. Risk Management
This is the process of identifying, analyzing and either accepting or mitigating of uncertainty in
investment decision-making. Essentially, risk management occurs anytime an investor or fund
manager analyzes and attempts to quantify the potential for losses in an investment and then
takes the appropriate action (or inaction) given their investment objectives and risk tolerance.
Inadequate risk management can result in severe consequences for companies as well as
individuals. For example, the recession that began in 2008 was largely caused by the loose credit
risk management of financial firms.
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 14
In other words, risk management is a two-step process - determining what risks exist in an
investment and then handling those risks in a way best-suited to your investment objectives. Risk
management occurs everywhere in the financial world. It occurs when an investor buys low-risk
government bonds over more risky corporate debt, when a fund manager hedges their currency
exposure with currency derivatives and when a bank performs a credit check on an individual
before issuing them a personal line of credit.
However, Century National Bank failed in its control of market risk and interest rate risk.
Market risk is the risk that the value of an on and off balance sheet position of a financial
institution will be adversely affected by movements in market rates or prices. The Bank could
have made better use of mechanisms to stem its risk profile such as an interest rate mismatch
ladder which shows interest rate balances by the time they are fixed, and gap limits which tells
the ratio of interest sensitivity on the balance sheet for a given time period.
3. Financial Regulation
Financial regulations are laws and rules that govern what financial institutions such as banks,
brokers and investment companies can do. These rules are generally promulgated by government
regulators or international groups to protect investors, maintain orderly markets and promote
financial stability. The range of regulatory activities can include setting minimum standards for
capital and conduct, making regular inspections, and investigating and prosecuting misconduct.
The Bank of Jamaica (BOJ) is one of such regulatory bodies which serve to promote a safe and
sound and an efficient and effective banking system. The newly amended Banking Act of 2002
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 15
has included in its regulation deposit- taking institutions, licensed under financial legislation
administered by the BOJ, commercial banks, licensed near banks such as merchant banks, trust
companies, finance houses and building societies. Additionally the BOJ helps the banking
system to manage its liquidity effectively. Regulation by the Financial Services Commission
brought into existence by the Financial Services Commission Act of 2001, takes a risk- based
approach to managing and enforcing strict monitoring and supervision standards for the
securities, insurance and pension schemes.
4. Capital Adequacy
A measure of the financial strength of a bank or securities firm, usually expressed as a ratio of its
capital to its assets. For banks, there is now a worldwide capital adequacy standard, drawn up by
the Basel Committee of the Bank for International Settlements. The Basel Capital Accord,
introduced from 1988, requires banks to have capital equal to a minimum of 8 per cent of their
assets. In 2004, a revised framework, known as Basel II, was issued. Among its proposals are
that those capitals requirements should be more risk sensitive and that greater use should be
made of risk assessments produced by banks' internal systems. The revisions, which have
sparked controversy, are being considered by national banking supervisors and implementation is
due at the end of 2007.
In Jamaica, the requirement of a Capital Adequacy is 10%. This requirement helps banks to have
a sufficient enough buffer to absorb any unexpected losses and helps to reduce the risk of
insolvency.
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 16
5. Management of the Banks Balance Sheet
Bank balance-sheet management entails considering competing and conflicting objectives such
as maximization of returns and minimization of risks associated with alternative portfolio
combinations. Traditional multi-objective models simply provide the decision-maker with the
entire set of non-dominated solutions; the decision-maker must then choose, unaided, the best
solution based on his subjective trade-offs, experience and judgment. This paper develops an
alternative multi-objective balance-sheet management model which allows the explicit
incorporation of the decision-maker's trade-offs between conflicting objectives, and attempts to
reduce his cognitive burden while ensuring that the solution obtained belongs to the set of non-
dominated points.
Managing a bank’s balance sheet involves attracting the proper level of equity and debt into the
bank and managing the banks liquidity. Two main tools usually used in managing liquidity
include: the liquidity worksheet which is a cash flow analysis of the major sources and uses of
funds and the liquidity summary which lists some of the common liquidity ratios used in the
banking sector. A liquidity ladder is also used to measure and keep track of all the liabilities and
assets in maturity order and by currency.
6. Cash Management
Cash Management is the corporate process of collecting, managing and investing cash (short-
term). It is a key component of ensuring a company's financial stability and solvency.
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 17
Frequently, corporate treasurers or a business manager is responsible for overall cash
management.
Successful cash management involves not only avoiding insolvency (and therefore bankruptcy),
but also reducing days in account receivables (AR), increasing collection rates, selecting
appropriate short-term investment vehicles, and increasing days cash on hand all in order to
improve a company's overall financial profitability.
Cash management has to do with the proper forecasting, control and stewardship of an
organization’s financial assets from fraud, error or loss. Forecasting helps to control finances,
manage liquidity and manage costs and can be done using any of three methods receipts and
disbursements forecast, statistical forecast or correlation and regression. Internal control involves
a series of checks and balances and monitoring transactions, cash flow and information within an
organization
Recommended Steps
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 18
The prudential regulation is regulation of deposit-taking institutions and supervision of
the conduct of these institutions and set down requirements that limit their risk-taking. The aim
of prudential regulation is to ensure the safety of depositors' funds and keep the stability of the
financial system.
To help prevent Century National Bank from failure there are prudential controls that could have
been put in place to prevent systematic risk or reduce the chances of failure.
The recommended steps according to the time line are as follows:
1. Regulation- In 1992 the government was strictly governed by the fiscal policy and free
market was highly prevalent. A free market is a market where interest rate is determined
by demand and supply and there is little or no government control. Due to the absence of
a regulator, banks act in accordance to what the board of the institution put in place as
prudential controls. The role of the Bank of Jamaica is to promote the safety and
soundness of the institution so they do not pose a threat or become a source of systematic
risk. Century National would under the regulation of the bank of Jamaica comply with all
laws and regulations including the imposing of new regulations set by BOJ. Follow the
guidelines and performance standards set. BOJ would also provide guidance through best
practice standards.
2. Low Interest Rate- In 1993 the timeline shows that Century National has a high liquid
asset reserve and high interest rates. A High Liquid asset reserve shows that Century
National is putting too much of their profits into their reserve to deal with unexpected
circumstances that may arise in the future. This high reserve is the effect of the high
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 19
interest rates as the higher the interest rates the higher the reserve. This high interest rate
and lending rate leads to default and counterparty risk. To control default and
counterparty risk Century National could to set counterparty limits and establish exposure
levels for each transaction carried out by the bank. The board should determine the
overall risk appetite and exposure limit in relation to its market risk strategy.
3. Capital- The mismatch of assets and liability was later diagnosed as an insolvency
problem. To manage insolvency Century National could have put in place regulatory
capital requirement in place. The benefit of capital is that it provides a buffer to absorb
unexpected losses, this would reduce insolvency even if management behavior does not
change. These capital requirement are known as capital requirements rules, the higher the
risk of the assets, the more capital is required. The Basel Committee on Banking
Supervision implement capital requirement standards this is necessary where there is a
institutions with high interest rates and lending rates as Century National Bank.
Running Head: The Century National Bank; Causes of failure and Treasury Management Concepts 20
Reference
Anonymous (2012) FINSAC: The Banking Sector: Why Government’s Involvement? Retrieved on April 3, 2012 from http://www.finsac.com/about/assistance/banking/aboutthebankingsector.htm
Anonymous. (2012) The Economy of Jamaica. Retrieved on March 31, 2012 from http://jamaica-guide.info/past.and.present/economy/
Seaga, Edward. (June 26, 2011) Contributor of his autobiography to the Jamaica Gleaner. Retreived on April 17, 2012 from http://jamaica-gleaner.com/gleaner/20110626/focus/focus10.html
Swaby, Neville. (June 21, 2011). Zooming in on the ‘90s Meltdown. The Sunday Gleaner, Jamaica- TheFocus. Retrieved on April 10, 2012 from http://jamaica-gleaner.com/gleaner/20110612/focus/focus5.html