The Impact of Extended Liability on Bank Runs: Evidence from the Panic of 1893

Abstract

Prior to the Great Depression, regulators used extended liability to encourage conservative banking and enhance depositor protection. Using a difference-in-difference setup, we study how extended liability affected deposit withdrawals during the panic of 1893. We compare the capital and portfolio management of national banks that were subject to double liability (limited liability) to that of state banks that were subject to unlimited liability. We find that banks with stricter shareholder liability targeted a lower level of default risk and experienced smaller liquidity shocks. State banks held more secured loans and used less leverage than national banks. State banks also experienced less deposit withdrawals during the panic. Our findings show that extended liability contributed to financial stability by discouraging risky activities and mitigating runs.