Prevention

In order to address the issues that Continental Illinois ran into we must first understand the banking climate during the 1970’s. An article by Randall Krosner and Philip Strahan depict a national banking system after the new deal that was highly regulated until the 1970’s when national and state policies moved to become more lenient. “Since the early 1970s, however all but one of these states have relaxed restrictions on intrastate branching” (Kroszner and Strahan, pg 1440). This statement depicts a climate in which banks were increasingly able to merge and collude. These banks are able to expand and have many branches of a single bank. Banks in one state were also able to purchase banks that existed in other states. This type of deregulation officially began 1975 when the state government of Maine passed a statute permit out of state holding companies to acquire Maine banks.

The idea that banks from different localities could join together and become more efficient on the surface is very attractive. When one looks deeper into the connection between bank size and unrestrained politic clout that one bank may hold, this deregulation process can be crippling to the banking system as a whole. In one study by Strahan and Wetson, it was found that the availability of credit to small businesses increases in the years following a small scale bank being taken over by a large bank (Kroszner and Strahan, 1444). Therefore, if large banks become more prevalent, more risky loans will be given out and the risk of the borrowing defaulting becomes greater, making the banking system less solvent.

Contential Illinois attempted to expand in the late 1970s and early 1980s. Contential’s adverse selection process loosened during this period because of deregulation making it very easy for the bank to expand. This expansion occurred in an unstable way, where the bank gave out loans to high risk borrowers. High risk borrowers are appealing to banks in that they are able to charge high rates of interest on loans they give out. These higher rates of interest occur because the individual or more likely small businesses probability of defaulting is greater and that is what crippled Continental in the mid-1980s.