The causes of free bank failures

Rolnick, Arthur J.; Weber, Warren E.

doi:10.1016/0304-3932(84)90044-8

Cited by 135 publications

(40 citation statements)

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“…This is consistent with empirical evidence, which indicates that banking panics are explicable responses to bad states of the world (Rolnick and Weber 1984;Gorton 1988;Economopoulos 1990;Dwyer and Hasan 2006. ) A number of papers have focused on the incentive properties of demand deposits.…”

supporting

confidence: 77%

Why do banks promise to pay par on demand?

Dwyer

Samartín

2009

Journal of Financial Stability

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We survey the theories of why banks promise to pay par on demand and examine evidence about the conditions under which banks have promised to pay the par value of deposits and banknotes on demand when holding only fractional reserves. The theoretical literature can be broadly divided into four strands: liquidity provision, asymmetric information, legal restrictions, and a medium of exchange. We assume that it is not zero cost to make a promise to redeem a liability at par value on demand. If so, then the conditions in the theories that result in par redemption are possible explanations of why banks promise to pay par on demand. If the explanation based on customers' demand for liquidity is correct, payment of deposits at par will be promised when banks hold assets that are illiquid in the short run. If the asymmetric-information explanation based on the difficulty of valuing assets is correct, the marketability of banks' assets determines whether banks promise to pay par. If the legal restrictions explanation of par redemption is correct, banks will not promise to pay par if they are not required to do so. If the transaction explanation is correct, banks will promise to pay par value only if the deposits are used in transactions. After the survey of the theoretical literature, we examine the history of banking in several countries in different eras: fourth-century Athens, medieval Italy, Japan, and free banking and money market mutual funds in the United States. We find that all of the theories can explain some of the observed banking arrangements, and none explain all of them. JEL classification: G21, E5

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confidence: 77%

Why do banks promise to pay par on demand?

Dwyer

Samartín

2009

Journal of Financial Stability

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“…It is possible that a suspension of payment is merely a device to lower the transition costs to a new equilibrium after a banking panic and all bank failures are due 1 In an earlier paper, we (Hasan and Dwyer 1994) show that free bank failures concentrated in short periods generally were precipitated by episodic events, with an implication that falling bond prices are not a general explanation for these failures. Nonetheless, dramatic decreases in bond prices are associated with the large number of banks closing in Illinois and Wisconsin at the start of the Civil War (Rolnick and Weber 1984;Economopolous 1988;Hasan and Dwyer 1994; and the earlier work referenced in these papers).…”

Section: Introductionmentioning

confidence: 99%

Suspension of payments, bank failures, and the nonbank public's losses

Dwyer

Hasan

2007

Journal of Monetary Economics

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Suspensions of payments are an important part of many explanations of the rise of the Federal Reserve, theories of banking panics and even counter-factual evaluations of the Great Depression. To date though, there is no evidence on suspensions' effects. We present evidence about suspensions of payments from an episode that is close to a controlled experiment for examining their effects. In 1861, about 44 percent of the banks in Wisconsin closed, 87 percent of the banks in Illinois closed, and noteholders suffered substantial losses. The historical record suggests that an effective suspension of payments in Wisconsin but not in Illinois may be the explanation. Historical and statistical evidence indicate that the suspension of payments decreased the number of banks that closed as well as noteholders' losses. Our statistical evidence indicates a 20 percent increase in the probability that an average bank in the two states remains open with the suspension of payments. The suspension of payments decreases noteholders' losses by about 15 cents per dollar of notes.

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“…Two seminal papers deserve mentioning. Meyer and Pifer (1970) find that financial ratios are good predictors of the likelihood of bank failures, and Rolnick and Weber (1984) report that markets discipline banks with weak fundamentals as they fail when market conditions deteriorate and asset prices fall. After US regulators introduced CAMELS ratings to assess bank conditions, a number of scholars used traditional proxies for capital adequacy, asset quality, management quality, earnings, liquidity, and sensitivity as a basis for early warning systems.…”

Section: Literature Reviewmentioning

confidence: 99%

A methodology to assess the financial soundness of regional banking system

Chetverikova¹,

Bibikova²,

Valinurova³

2017

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We formulate the "High Liquidity Creation Hypothesis" (HLCH) that a proliferation in the core activity of bank liquidity creation increases failure probability. We test the HLCH in the context of Russian banking, which provides a natural field experiment due to numerous failures experienced over the past decade. Using Berger and Bouwman's (2009) liquidity creation measures as a comprehensive proxy for overall bank output, we find that high liquidity creation significantly increases the probability of bank failure; this finding survives multiple robustness checks. Our results suggest that regulatory authorities can mitigate systemic distress and reduce the costs of bank failures to society through early identification of high liquidity creators and enhanced monitoring of their funding and investment activities. JEL Classification Numbers:G21; G28

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The causes of free bank failures

Cited by 135 publications

References 1 publication

Why do banks promise to pay par on demand?

Why do banks promise to pay par on demand?

Suspension of payments, bank failures, and the nonbank public's losses

A methodology to assess the financial soundness of regional banking system

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