Principles of Macroeconomics / Unit 11 MAC 1021 worked example, 60 to 90 seconds
Why Did This Bank Fail
The idea
Given an account of a failure, name the cause: defaults, a maturity mismatch, or a failure to diversify. The test is which side of the balance sheet moved and why. Defaults and concentration destroy asset value. A mismatch destroys earnings while the assets are still sound.
In practice
A bank lending almost entirely to firms in one industry loses heavily when that industry contracts: the loans were sound individually and the portfolio was not, so this is a failure to diversify. A bank funded by deposits that can leave tomorrow, holding thirty-year loans written at low fixed rates, finds market rates rising and pays out more than it takes in: that is a maturity mismatch, and no borrower defaulted. A bank that bought securities built from loans made to borrowers nobody examined closely loses when those borrowers stop paying: that is defaults, with the twist that selling a loan onward weakens the incentive to screen the borrower in the first place.
Where people slip
The three can arrive together and often do, so naming one is the start of the analysis rather than the end of it. What the classification buys is knowing which defence would have helped, and the defences differ: diversification, matching maturities, and screening borrowers are three different disciplines.
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