Abstract
Hundreds of banks failed during the financial crisis of 2008 to 2010 causing significant social cost and enfeebling economic growth for years following. In the aftermath of the crisis, regulators responded, as always, with new regulations, the efficacy of which is debatable. For policy makers to enact effective regulation, they must understand the true cause of bank failures during crisis periods. We study the effects of 31 variables using univariate t-tests and probit regression to determine their influence on the probability of bank failure. We find that banks failed during the 2008 to 2010 financial crisis because of choices management made to accept more risk, specifically by having higher financial leverage, investing in higher risk loans in real estate and construction and by holding less liquid assets and fewer low risk loans like single family real estate loans. That is, the cause of US bank failures during the finance crisis was poor management.
Highlights
Waves of bank failures occurred in the United States in 1907, the Great Depression, the savings and loan (S&L) crisis of the 1980’s and early 1990’s (2,320 banks and S&Ls failed), and the financial crisis of 2008 to 2010 (322 banks failed with 25, 140, and 157 failing in the years 2008, 2009, and 2010 respectively)
We find that banks failed during the 2008 to 2010 financial crisis because of choices management made to accept more risk, by having higher financial leverage, investing in higher risk loans in real estate and construction and by holding less liquid assets and fewer low risk loans like single family real estate loans
We report the Akaike information criterion (AIC) and the Bayesian information criterion (BIC) from the maximum likelihood estimation to aid in comparing model fit
Summary
Waves of bank failures occurred in the United States in 1907, the Great Depression (approximately 9,000 banks failed), the savings and loan (S&L) crisis of the 1980’s and early 1990’s (2,320 banks and S&Ls failed), and the financial crisis of 2008 to 2010 (322 banks failed with 25, 140, and 157 failing in the years 2008, 2009, and 2010 respectively). The complete list of failed banks from the Federal Deposit Insurance Corporation is at the website: https://www.fdic.gov/bank/individual/failed/banklist.html. Policy makers have responded with waves of regulation: the Federal Reserve Act of 1913, the Banking Act of 1933 (Glass-Steagall), the Basel accords, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. There have be countervailing waves of deregulation: the Bank Holding Company Act of 1956, the Depository Institutions Deregulation and Monetary Control Act of 1980, the Garn–St. Germain Depository Institutions Act of 1982, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, and the Gramm–Leach–Bliley Act of 1999. The failure of regulators to prevent banking crises and the huge social cost associated with them points to the need for an improved understanding of why banks fail
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