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Last Updated: Tuesday, 27 November 2007, 23:28 GMT
What happens when banks go bust?
Money Talk
By Chris Morris
Director at Begbies Traynor

Northern Rock customers queuing during September's run on the bank
Northern Rock's customers feared it was about to go bust
The Northern Rock bank has said it favours an offer from the Virgin consortium as the preferred way out of its deep financial problems.

But if that and any other offers were to fail, then declaring the bank insolvent and bringing in administrators would be a strong alternative solution.

Somewhat like the Railtrack and Metronet insolvencies, putting a bank into administration creates some unusual and distinctly challenging problems.

A threat to people's hard earned savings is far more serious than just making it hard for them to get into work in the morning.

Bank failures are mercifully rare and the tendency is for the financial community to gather round and organize a rescue, so formal insolvency is even more unusual.

The last major case was BCCI back in 1992, where a sprawling international patchwork of banking operations went into liquidation.

It remains there even now, reflecting how long it can take to unravel a complex banking problem, especially if fraud is involved.

Security and trustworthiness

The task with a bank insolvency is deceptively simple at first glance.

It would be essential to deny staff remote access to computer systems and databases until they were accepted back into the fold

Assets must first be protected, then their value needs to be maximised.

Liabilities need to be identified and then minimised.

At the same time, staff issues need to be dealt with and the expectations of both depositors and borrowers must be managed.

The reality of course is very different.

Security issues are paramount, especially in these days of such acute sensitivity to the protection of the confidential data held by such institutions.

The greatest Day 1 priority is to secure all data and all vulnerable assets.

There are three enemies for the administrator in this area: outside hackers and thieves; systemic incompetence in a suddenly chaotic situation; and, most dangerous, disaffected insiders.

IT security experts need to be brought in at the very start to address these threats.

Hard and apparently disruptive to normality as it might be, a suitably revised version of the BCCI approach may be necessary.

Then it was thought safest to assess staff individually for their trustworthiness and commitment to helping the liquidators.

In these modern days, and if fraud is not a key issue, this can be modified.

But it would be essential to deny staff remote access to computer systems and databases until they were accepted back into the fold.

Dark corners

The administrators would need to hire in banking expertise to assist them and to oversee, from an independent standpoint, the activities of the bank's retained staff.

BCCI branch in London in 1991
BCCI was the last major bank collapse affecting UK savers

The first vital area for these outside experts would be to carry out a thorough review of the bank's loan book and other financial exposures.

In the case of a former building society, for example, this might seem relatively straight forward.

But with the modern fashion for complex financial engineering through swaps, credit default instruments, futures and options, who knows what they might find lurking in the dark corners of any bank's Treasury function.

Once the loan book and other risks have been assessed, action must be taken to protect their value.

There will be flaws in security documentation to be rectified where possible.

Human nature dictates suggests that borrowers or counterparties will try to take advantage of the situation to negotiate down their liabilities or refuse to pay anything at all.

A firm approach will be necessary.

Public relations

Attention must also be paid to technical banking issues to ensure that relevant laws and central bank requirements are complied with.

Almost the single most important aspect should be implementing a clear communications and PR strategy

The administrators will need to work closely from the outset with two key institutions: the Bank of England and the Financial Services Authority.

Both have powers and responsibilities which will affect what can or cannot be done with the bank and its assets.

Deposit protection arrangements need to be triggered.

Specialist legal advice will be necessary at all stages, taken from banking lawyers who are thoroughly conversant with banking law and practice.

Easy as it may be to assign this less importance in the noise and smoke of the early stages of a bank insolvency, almost the single most important aspect should be implementing a clear communications and PR strategy.

Deploying sufficient resource to ensure that it works effectively would be vital.

Losing control of the communications agenda will cause untold distraction at a vital time and might even derail the whole rescue process.

Depositors need to be told where they stand and what to do.

Borrowers must be given clear guidance about how their mortgages, loans and overdrafts are affected.

Setting up adequately staffed telephone help-lines and websites which don't keep crashing is crucial.

The media should be treated as allies, not enemies.

They have a major role to play in delivering clear messages to worried members of the public or the business community and in neutralising the damaging effect of internet and pub gossip.


The administrators would need the support of the major creditors, so setting up a steering committee of creditors at an early stage is a wise strategy.

This is not without difficulty these days.

The creditor community may be subject to rapid and bewildering changes as the original players trade their debts or trigger debt insurance instruments.

Sometimes the administrators may not even know the true identity of certain creditors.

But insolvency practitioners are accustomed now to dealing with these problems.

The administrators would need to take a close and cautious look at cash requirements.

Money will be needed to cover ongoing running costs.

There will also be potentially profitable transactions, which can only be completed if adequate funding is available.

Urgent negotiations with funding sources are necessary to ensure that enough cash will be available.

Public commentators might criticise insolvency professionals and their advisers for the fees they earn and the time it can take to deliver a solution.

But sorting out the problems of an insolvent bank is a highly complex, delicate and multi-layered task, which is definitely not for the faint hearted.

Chris Morris is one of the UK's leading insolvency experts and wound up BCCI and Banco Ambrosiano.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.

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