Failing Banks

TL;DR

This study analyzes over a century of US bank failures, showing they are highly predictable from financial metrics and primarily caused by deteriorating fundamentals, with implications for banking stability and policy.

Contribution

It provides a comprehensive historical analysis demonstrating that bank failures are mainly driven by fundamental weaknesses, challenging the role of non-fundamental runs and emphasizing predictability.

Findings

Bank failures are highly predictable from financial statements.

Failures are mainly due to deteriorating bank fundamentals.

Most failed banks were fundamentally insolvent, with low asset recovery rates.

Abstract

Why do banks fail? We create a panel covering most commercial banks from 1863 through 2024 to study the history of failing banks in the United States. Failing banks are characterized by rising asset losses, deteriorating solvency, and an increasing reliance on expensive noncore funding. These commonalities imply that bank failures are highly predictable using simple accounting metrics from publicly available financial statements. Failures with runs were common before deposit insurance, but these failures are strongly related to weak fundamentals, casting doubt on the importance of non-fundamental runs. Furthermore, low recovery rates on failed banks' assets suggest that most failed banks were fundamentally insolvent, barring strong assumptions about the value destruction of receiverships. Altogether, our evidence suggests that the primary cause of bank failures and banking crises is almost always and everywhere a deterioration of bank fundamentals.