Some Notorious TBTF Cases

Abstract

In May 1984 the eighth largest bank in the U.S. at that time, Continental Illinois, found itself deep in trouble as a result of a faulty funding model (similar to the messy funding model that led to the collapse of the British bank, Northern Rock, in 2007). Beyond using funds from FDIC-insured small depositors and other stable long-term lenders such as bondholders, Continental relied more than most banks on short-term, uninsured lenders worldwide (particularly large short-term depositors and foreign money markets, which are typically more risk averse than the average retail depositor). This left the bank exposed to the risk of changes in attitude towards risk. On the assets side (the uses of funds), things were just as bad. Tight money, Mexico’s default and plunging oil prices followed a period when the bank had aggressively pursued a commercial lending business, a Latin American syndicated loans business, and loan participations in the energy sector. The bank held a significant stake in the highly-speculative oil and gas loans of Oklahoma’s Penn Square Bank. In a nutshell, Continental had two fundamental problems in its risk management system: (i) its appraisal of credit risk was faulty, and (ii) it had almost no core deposits to tide itself over if it got into trouble (Gup, 2004a).