Credit Loss Liability of Bank Director Case 6

Background information Finnish banking crisis (1990-1993): In the 1980s, the financial market was deregulated resulted in private people and companies taking foreign debt banks took too big risks and participating in risky investments and providing loans at a fast rate In the beginning of 1990s financial situation got worse the debtors started defaulting on their loans and banks suffered huge losses Several banks couldn’t handle the crisis without governmental help Government intervention firstly the government granted loan for the banks Bad debt was transferred to the established bad bank, Arsenal the banks had little experience in unregulated markets and therefore they took too big risks

Introduction of the case ( I.) Three parties: Arsenal SSP - a company founded on the basis of a special legislation to administer the assets and credits of the savings banks The Savings Bank Managing director and the board members

Introduction of the case ( II.) The bank had granted credit to overindebted customers for completing a building project. However, the firms became bankrupt, mainly because of the difficulty to predict the depth and long duration of the economic depression which caused a collapse in real estate prices. The products were no longer marketable, and also their values as securities were ruined.

Legal Document: Act on Savings Bank Any credit given to a client by a savings bank should as a rule be accompanied by a sufficient security. Giving credit to the same person or the same cluster of clients may not exceed an upper limit of 10 per cent of the bank's own capital, imposed by the supervising authority to the bank. Giving credit to the same cluster of clients may not amount to a volume that would endanger the solvency of the bank.

Bank director’s situation (I.) Problem: credit granting to overindebted customers Alternative: close the credit faucet immediately and let the firm go into bankruptcy and accept the realization of credit risks Alternative: continue credit giving and accept the risk of increased credit losses with a (slight) hope of the recovery of the firm in the future.

Bank director’s situation (II.) Rational policy of the bank: in building project crediting, it may often consist of trying to prevent the project from remaining incomplete, because of the poor marketability of such a project and high completion costs accruing from the use of another contractor. Plus,the director and the board members were granted exemption from liability by the board of managers. The credit losses were disclosed in annual reports. An adequate apprehension of the crediting of client clusters and the risks assumed therein may not have been possible to acquire on the basis of the material given. Some managers, however, had obtained the relevant information on their own initiative.

Can the bank director be liable for the bank’s loss? Preconditions of liability: existence of a damage a causal relationship between the acts of the responsible person and the damage as a rule negligence of that person. Each one of these preconditions must be considered thoroughly

Court decision The supreme court decided that some board members and bank directors were liable for damages. Those persons were responsible for giving credit to overindebted customers without sufficient security. The bank in question was already in a bad economical situation in 1989, but board members and bank director continued risky credit giving as had been the bank’s policy. So with their actions, they endangered the solvency of the bank.

Court decision The court also saw that the board members and bank director were negligent in investigating their customers and in disclosing important information about previous loans and securities for new credits. Court found the board members liable for damages in cases where credit was given without sufficient securities or to a customer that was overindebted and starting a new project. However, in cases where credit was given to finish a certain building project the charges were dropped.