A bank insolvency simply refers to the scenario when a bank is unable to meet its obligation to its depositors or other creditors, because it has become insolvent or too liquid to meet its liabilities. Specially a bank usually fails economically when its market value that is less than the market value of liabilities. The insolvent Bank either borrows from other solvent banks or sells its assets at a lower price then its market values to generate liquid money . The insolvent Bank creates a bank panic among the depositors as more depositors try to take out cash deposits from the bank . As such, the bank is unable to fulfill the demands of all of its depositors on time. Also, a bank may be taken over by the regulating government agency if shareholders equity are below the regulatory minimum .
The failure of bank is generally considered to be of more importance than the failure of other types of business forms because of the interconnected nature or trajectory of banking. Research has shown that the market value of customers of field banks is adversely affected at the date of a failure announcement. It often feared that the spill over effects 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 Bank swear solvent at the time as the marginal depositors try to take out cash deposits from those banks to avoid from suffering losses. Thereby, the spillover effect of bankpan Accord systemic risk has a multiplier effect on all banks and financial institutions leading to a greater effect of bank failure in the economy.
In other words, For a bank, bankruptcy means that it cannot repay its depositors, because its liabilities exceed its assets. The effect of bank insolvency depends on the availability of deposit insurance.
For example* , A bank may value its loan book at £ 1 billion. However, it can only receive £ 800 million if it is forced to sell quickly. If the shareholder’s equity is less than £ 200 million, the bank will go bankrupt.
After analyzing the empirical evidence for a large panel of countries for 1980–97, this study shows that clear deposit insurance is detrimental to bank stability, and therefore where the bank interest rate has been reduced and Where the institutional environment is weak. We interpret the latter result, meaning that where institutions are good, it is more likely that an effective system of prudential regulation and supervision is to overcome the lack of market discipline created by deposit insurance.
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