Network Contagion and Interbank Amplification during the Great Depression

Abstract

Interbank networks amplified the contraction in lending during the Great Depression. Banking panics induced banks in the hinterland to withdraw interbank deposits from Federal Reserve member banks located in reserve and central reserve cities. These correspondent banks responded by curtailing lending to businesses. Between the peak in the summer of 1929 and the banking holiday in the winter of 1933, interbank amplification reduced aggregate lending in the U.S. economy by an estimated 15 percent.

Flight-to-Safety and the Credit Crunch: A New History of the Banking Crisis in France During the Great Depression

“…Bernanke (1983) describes an amplification mechanism in which bank failures led to nonmonetary effects because the cost of intermediation increased and some borrowers experienced costs that were too high. 4 Our argument is closer to Mitchener and Richardson's (2016), who highlight the role of interbank deposits during U.S. banking panics; deposits moved from distressed banks in less developed areas of the country to safer banks in central reserve cities such as New York and Chicago, and those reserve banks decreased corporate loans and increased government loans and central bank deposits. Economic literature on flight-to-safety (Caballero & Krishnamurthy 2008, Krishnamurthy 2010, Baele et al 2013 focuses on a shift of assets by financial institutions.…”

“…According to Feinstein, Temin, and Toniolo (1995, p.40), "French banks were generally in a strong position at the end of the 1920s and largely avoided the 1929-31 crisis." 1 Since international literature does not consider major banking problems in France during 1930France during -1931, the difficulties of French banks are assumed to have occurred later than in other countries, and to be mere consequences of France's obstinate and deflationary adherence to the gold standard until 1936, rather than the result of banking panics (Grossman 1994, Eichengreen 2004, James 2009 (Friedman andSchwartz 1963, Richardson andMitchener 2016).…”

Analysis of Stigma and Bank Credit Provision

“…Let z i reflect all covariates other than the interaction term of interest, let w † i be the case when a bank's name is not published, w ‡ i be the case when a bank's name is published in the New York Times, 7. Mitchener and Richardson (2018) show that interbank networks amplified the contraction and reduced aggregate lending by 15%. Cohen, Hachem, and Richardson (2017) show that through lending channels, suspending 10% of national banks leads to a 3.77% decline in retail sales.…”

“…Specific to this approved revealed subsample (192 banks), taking into account the total amount of RFC money disbursed, the contraction would equate to roughly $4.5 million in forgone bank lending, where total bank lending for this sample was about $110 million in 1935. The effect could be further amplified through correspondent networks (Mitchener and Richardson ) and translate to real economic effects in retail sales (Cohen, Hachem, and Richardson ) . Stigma was not the key culprit for the overall contraction of lending by banks in the Depression; however, the results show that stigma did, indeed, contribute to the breakdown in financial intermediation.…”

“…Mitchener and Richardson () show that interbank networks amplified the contraction and reduced aggregate lending by 15%. Cohen, Hachem, and Richardson () show that through lending channels, suspending 10% of national banks leads to a 3.77% decline in retail sales.…”