Not all banking crises involve panics | MIT News
A banking crisis is often seen as a self-fulfilling prophecy: the wait for bank failure makes it possible. Imagine people lining up to withdraw their money during the Great Depression or customers shopping for UK bank Northern Rock in 2007.
But a new article co-authored by an MIT professor suggests we’ve missed the big picture of banking crises. Yes, sometimes there are panics about banks creating self-reinforcing problems. But many banking crises are calmer: Even without customers panicking, banks can suffer losses large enough to cause subsequent economic downturns.
“Panic is not necessary for banking crises to have serious economic consequences,” said Emil Verner, the MIT professor who helped lead the study. “But when panics do occur, it’s usually the most severe episodes. Panics are an important amplifying mechanism of banking crises, but not a necessary condition.
Indeed, in an ambitious research, covering 46 countries and dating back to 1870, the study identifies banking crises that have occurred with and without panic. In the event of panic and bank panic, according to the study, a 30% drop in equity in the banking sector predicts a 3.4% drop in real GDP (inflation-adjusted gross domestic product) after three years. But even without creditors’ panic, a 30% drop in bank equity predicts a 2.7% drop in real GDP after three years.
So virtually all banking crises, and not just the biggest blows in history, create long-term macroeconomic damage as banks are less able to provide the credit used for business expansion.
“Banking crises are often accompanied by very severe recessions,” says Verner, a career development professor in the Class of 1957 and assistant professor of finance at the MIT Sloan School of Management.
The newspaper, “Bank Crises Without Panic,” appears in the February issue of Quarterly economic review. The authors are Matthew Baron, assistant professor of finance at Cornell University; Verner; and Wei Xiong, professor of finance and economics at Princeton University.
A rigorous and quantitative approach
To conduct the study, the researchers constructed a new dataset on bank stock prices and dividends in 46 countries from 1870 to 2016, using existing databases and adding information from newspaper archives. historical. They also collected non-bank stock prices, monthly information on credit spreads, and macroeconomic information such as GDP and inflation.
“People have historically sought to define and identify different episodes of banking crises, but there really wasn’t a rigorous quantitative approach to defining these episodes,” says Verner. “There was a little more of a ‘know it when you see it’ approach.”
Researchers examining past banking crises fall roughly into two camps. One group focused on panics, suggesting that if bank runs could be avoided, bank crises would not be so severe. Another group looked more at bank assets and focused on the circumstances in which bank decisions result in heavy losses, for example through bad debts.
“We’re in the middle, in a sense,” says Verner. Panics worsen banking problems, but nonetheless, “There are a number of examples of banking crises where banks have suffered losses and reduced their loans, and businesses and households have found it more difficult to access credit. , but there was no leak or panic from the banks. creditors. These episodes again led to poor economic results. “
More precisely, the careful examination by the study of the monthly dynamics of banking crises shows how often these circumstances are in fact foreshadowed by an erosion of the bank’s portfolio, and the recognition of this fact by its investors.
“Panics don’t come out of nowhere. They tend to be preceded by a drop in bank stocks, ”says Verner. “Investors in the bank’s shares recognize that the bank will suffer losses on the loans it has available. And so what this suggests is that panics are really often the consequence, rather than the root cause, of problems that have already built up in the banking system due to bad debts.
The study also quantifies how impaired banking activity becomes in these situations. After banking crises accompanied by visible panics, the average bank credit / GDP ratio was 5.7 lower after three years; that is, there were less bank loans as the basis of economic activity. When a “silent” banking crisis struck, with no visible panic, the average bank credit-to-GDP ratio was 3.5% lower after three years.
Historical detective work
Verner says the researchers are happy they were able to “do historical detective work and find episodes that had been forgotten.” The study’s expanded set of seizures, he notes, includes “new information that other researchers are already using.”
Banking crises formerly overlooked in this study include a multitude of episodes from the 1970s, Canada’s struggles during the Great Depression, and various 19th-century bank failures. The researchers presented versions of this study to a range of policymakers, including some regional councils of the U.S. Federal Reserve and the Bank for International Settlements, and Verner also says he hopes those officials keep the work in mind. .
“I think it’s valuable for the future, and not just for a historical perspective,” he says. “Having a large sample in many countries is important to recognize the lessons to be learned when new crises arise. “
Researchers are continuing their research in this area with further studies on trends in loans that banks grant before they lose value – for example, identifying the types of businesses that are less likely to repay bank loans. When banks start lending more heavily to certain types of businesses, possibly including restaurant, construction and real estate companies, it can be a sign of the beginning of a problem.
Research support has been provided, in part, by the Cornell Center for Social Sciences and the Institute for New Economic Thinking.