Modern banking development during natural disasters: Evidence from the early 20th century China

Abstract

How do commercial banks react to natural disasters? Using data for 375 droughts in 262 prefectures in China during 1906–1927, we find that drought-affected prefectures have more private bank inceptions than unaffected ones. The results remain robust to socioeconomic characteristics, foreign market exposure, and conditions of neighboring prefectures. This effect is driven by the prefectures with more agriculture-dependent enterprises, suggesting that banks meet local financial demand. On the other hand, new banks would enter less when the prefecture has more incumbent banks connected to drought-free areas. We argue that capital size and the network of capital reallocation are two advantages of banks coping with natural disasters over alternative financing vehicles such as pawn shops and foreign banks. In addition, the effect is greater among the prefectures practicing common law and with greater social capital, consistent with existing studies that bank credit supply depends on creditor rights protection. Finally, we show that drought-affected regions with more private bank inceptions have better development in agricultural businesses and social stability.