A recent study of more than 150 years of U.S. bank data has concluded that weak fundamentals are the primary driver of bank failures, and that strong banks usually survive runs.
The new paper by Federal Reserve and MIT economists sought to understand what factors led to bank failures. In a New York Fed Liberty Street Economics blog post, the authors said they explored previous research on the issue and examined more than 5,000 bank failures, ultimately concluding that weak fundamentals were the primary culprit.
“Failing banks consistently exhibit declining income and capitalization, rising asset losses, and growing reliance on expensive funding in the years before failure,” they said. “A common precursor to failure is rapid asset growth, usually from aggressive lending. These patterns hold for bank failures with and without runs. They also hold across institutional regimes with and without deposit insurance or a public lender of last resort.”
Bank runs were more likely to occur at ailing institutions, but strong banks have experienced them as well, the authors said. However, strong banks can deploy several mechanisms to survive runs, such as interbank lending.
“The long-run evidence on bank failures points in one direction: Bank failures usually begin with bad assets, weak earnings and deteriorating solvency. Runs can accelerate failure and worsen the damage, but by the time depositors head for the exit, the deeper problem is usually baked into bank balance sheets,” they said.
