Banking Crises Without Panics*

Abstract

We examine historical banking crises through the lens of bank equity declines, which cover a broad sample of episodes of banking distress both with and without banking panics. To do this, we construct a new dataset on bank equity returns and narrative information on banking panics for 46 countries over the period of 1870–2016. We find that even in the absence of panics, large bank equity declines are associated with substantial credit contractions and output gaps. While panics are an important amplification mechanism, our results indicate that panics are not necessary for banking crises to have severe economic consequences. Furthermore, panics tend to be preceded by large bank equity declines, suggesting that panics are the result, rather than the cause, of earlier bank losses. We also use bank equity returns to uncover a number of forgotten historical banking crises and to create a banking crisis chronology that distinguishes between bank equity losses and panics.

Credit Supply Shocks and Household Defaults

“…Importantly, our empirical results provide a micro foundation to the well-established link at the aggregate level from a rise of household debt to subsequent financial crises and recessions (Jorda et al, 2016;Nakajima and Rios-Rull, 2019). We emphasize that the increased level of household defaults may be a bridge from household credit expansion to future losses on bank capital and associated credit crunch, which deepen recessions (Reinhart and Rogoff, 2009) and financial crises (Baron et al, 2021).…”

Can Policy Tame the Credit Cycle?

“…This is the "leveraged losses" mechanism presciently highlighted by Greenlaw et al (2008) in the early stages of the GFC. Baron et al (2020) provide evidence for this mechanism, using a long cross-country panel to document that sharp declines in the market value of bank equity tend to lead to significant contractions in economic activity, even absent banking panics.…”

Fiscal Deficits, Bank Credit Risk, and Loan-Loss Provisions

“…Bank-specific fundamentals come from Bankscope, and macroeconomic and country-level variables are coalesced from multiple sources, including the World Bank database, the International Monetary Fund (IMF) Cross-Country Macroeconomic Statistics data set, the Stockholm International Peace Research Institute (SIPRI), and databases of documented banking crises (Laeven and Valencia (2014), ( 2018), Baron, Verner, and Xiong (2020)), among others.…”

“…Following the same intuition of the analysis of aggregate credit risk, it is also crucially important to investigate potential heterogeneous effects during periods of expansions and contractions and to distinguish between normal periods versus financial crises. Notwithstanding the credit-risk analysis of Table 3 failing to provide evidence that contemporaneous business-cycle conditions modulate the effect of deficits, banking crises, in particular, are also shown to predict persistent credit contractions and output gaps (Baron et al (2020)). To investigate whether the main effect of fiscal deficits is significantly different in periods of economic crisis, I include i) %ΔPCGDP c,t  DEFICIT c,t , as in equation ( 4); ii) RET BVX c,t , the absolute value of the drop in bank equity prices documented by Baron et al (2020); and iii) I LV c,t , a dummy variable coded as 1 if the country-year in question has experienced either a banking, currency, or sovereign-debt crisis, as documented by Valencia (2014, 2018), and 0 otherwise.…”

“…throughout the business cycle (i.e., during booms and busts). Although an important literature emphasizes a handful of variables with predictive power for businesscycle fluctuations and financial crises (e.g., Demirgüç-Kunt and Detragiache (1998), Gilchrist and Zakrajšek (2012), Schularick and Taylor (2012), and Baron et al (2020)), as argued by Reinhart and Rogoff (2011) it is typically much easier to identify when an economy is vulnerable to a financial crisis than to gauge the probability or the timing of the debacle. Multiple equilibria models provide a theoretical justification for the so-called "this-time-is-different" syndrome that underlies the Gordian task of anticipating financial crashes.…”