Continental Illinois: The Making of a Liquidity Crisis

Essay by chuddy82University, Bachelor's June 2005

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The article "Continental Illinois: The Making of a Liquidity Crisis", demonstrates the inconsistencies of the current regulatory policy in effect by the federal Reserve System, which in turn has hurt banks like Continental Illinois National Bank and Trust Co., who had problems with bad loans that they produced in the early 80's, which lowered earning drastically and decreased the market value of bank equity, undermined customer confidence, and brought about net deposits outflows. By the end of 1984, Continental's deposits had shrunk by almost 12 billion and the bank had been effectively nationalized.

The problem started in the early 70's when management's pursuit of growth through aggressive lending. The chairman of Continental, Roger Anderson, believed that Continental was one of the top three domestic lender in the U.S. Its loans where growing at an extremely fast average rate of 19.8%, while peer banks where only growing at 14.7%. However, the reported profits where disguising serious earnings and liquidity problems in funding and loan growth.

Its net reliance on "hot money" was almost double that of comparable banks, which was indicated by the liquidity measure net of these volatile liabilities.

Due to the aggressive lending in the volatile economic environment, poor quality of loans where lent out. The Continental had heavy loan exposure to problem companies like Braniff, International Harvester, Nucorp Energy, and Wickes. Lending in this area coincided nicely with the oil boom's rising prices, and profitable-looking borrowers, which included major oil companies, wildcat drillers, and old field servicing operators. Continental had serious problems when the oil prices fell. By 1981, Continental had purchased more than $600 million in loan participants from Penn Square Bank. When Penn Square failed in July 1982, Continental held more than $1 billion in loans which was originated by Penn Square.

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