Are Banks Really Special? New Evidence from the FDIC-Induced Failure of Healthy Banks

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractThe FDIC used cross-guarantees to close thirty-eight subsidiaries of First RepublicBank Corporation in 1988 and eighteen subsidiaries of First City Bancorporation in 1992 when lead banks from each of these Texas-based bank holding companies were declared insolvent. I use this exogenous failure of otherwise healthy subsidiary banks as a natural experiment for studying the impact of bank failure on local-area real economic activity. I find that the closings of the subsidiaries were associated with a significant decline in bank lending that led to a permanent reduction in real county income of about 3 percent.

Are Bank Holding Companies a Source of Strength to Their Banking Subsidiaries?

“…In contrast, the source‐of‐strength doctrine involves the transfer of capital to a distressed subsidiary to prevent failure. This latter point is important given recent evidence that even healthy bank failures are followed by significant and permanent declines in real economic activity (Ashcraft 2005) Moreover, since the largest commercial banks in the United States are controlled by financial holding companies, which in turn own the largest investment banks, the equity that a parent holding company has invested in non‐bank subsidiaries has important consequences for the real default risk of the affiliated banking subsidiaries and potential liability of the FDIC in the event of failure.…”

“…1 1 The FDIC used the cross‐guarantee provision during the failure of First City Bancorporation in 1992, when the failure of lead banks in Dallas and Houston precipitated the failure of 18 non‐lead subsidiaries. As the FDIC expected losses of more than $500 million and these other subsidiaries held less than $300 million in equity capital, they were closed by the insurer (Ashcraft 2005). …”

Bank Structure and Lending: What We Do and Do Not Know

“…In the second study, Ashcraft (2005) finds an equally clever way to isolate loan supply changes by studying lending by healthy subsidiaries of bank holding companies that were closed by the FDIC. Under the so-called source-of-strength doctrine, one bank's liabilities to the FDIC become the liability of other banks held by the same BHC.…”

The Economics of Interfirm Networks

“…Second, Ashcraft (2005) examined the effects of bank failures on local economic activity by identifying bank failures that occurred for reasons that have little to do with local economic activity. Specifically, using a county-level dataset from the United States, he studied two similar incidents that occurred when the healthy subsidiaries of two multi-bank holding companies collapsed after the failure of their unhealthy lead banks.…”