Federal Deposit InsuranceCorporation• Center for Financial Researchh
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
June 2005
Carlos D. Ramirez
Philip A. Shively
Do Bank Failures Affect Real Economic Activity?
State-Level Evidence from the Pre-Depression Era
FDIC Center for Financial Research
Working Paper
No. 2005-06
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
June 2005
Carlos D. Ramirez
Philip A. Shively
Do Bank Failures Affect Real Economic Activity?
State-Level Evidence from the Pre-Depression Era
FDIC Center for Financial Research
Working Paper
No. 2005-06
Do Bank Failures Affect Real Economic Activity?
State-Level Evidence from the Pre-Depression Era
Carlos D. Ramirez and Philip A. Shively∗
FDIC Center for Financial Research Working Paper No. 2005-06
Abstract
This paper provides empirical evidence documenting the existence of a credit
channel during the pre-Depression era using a newly constructed, state-level
quarterly time series from 1900Q1 through 1931Q2 for the 48 contiguous states.
It also investigates the source and size of the credit channel, and it examines the
dynamic effects of bank failures on business failures. Granger-causality tests
find evidence that bank failures cause commercial failures at the aggregate U.S.
level and over half of the 48 states. The cross-sectional variation allows us to
test two explanations of the credit channel discussed in the literature: (i) a
reduction in consumption spending from the slow liquidation of failed-bank de-
posits, and (ii) a decrease in investment spending from a disruption of credit
to bank-dependent firms. Our results support both theories, but the evidence
in favor of the first is stronger statistically. Branch banking restrictions, state-
sponsored deposit insurance, and differences in the agricultural-manufacturing
share of commerce do not affect the empirical importance of an independent
credit channel. Using aggregate U.S. level data, our structural model indicates
that bank failures account for about 25% of commercial failures, and that bank
failures have only minor subsequent effects within the banking sector.
Key words: Credit channel, Bank runs, Deposit insurance, Granger causal-
ity
JEL classifications: E32, E51, G21
CFR Research Program: Banking and the Economy
∗Department of Economics, George Mason University,Fairfax, VA 22030-4444, Phone: 703-993-
1145, Email: cramire2@gmu.edu; and Division of Insurance and Research, Federal Deposit Insurance
Corporation, 550 17th Street, NW, Room 4206, Washington, DC 20429, Phone: 202-898-8545,
Email: pshively@fdic.gov. We are especially grateful to Paul Kupiec for detailed comments and
suggestions. This paper has benefited greatly from the comments of Arthur Murton, Fred Carns,
Mark Flannery, Haluk Unal, Dan Nuxoll, Jesse Weiher, Graham Elliot, Matthew Spiegel and other
seminar participants at the Federal Deposit Insurance Corporation as well as the Washington Area
Finance Association meetings. Ramirez gratefully acknowledges financial support and hospitality
from the Center for Financial Research at the Federal Deposit Insurance Corporation. The views
expressed in this paper do not necessarily reflect those of the Federal Deposit Insurance Corporation.
1
State-Level Evidence from the Pre-Depression Era
Carlos D. Ramirez and Philip A. Shively∗
FDIC Center for Financial Research Working Paper No. 2005-06
Abstract
This paper provides empirical evidence documenting the existence of a credit
channel during the pre-Depression era using a newly constructed, state-level
quarterly time series from 1900Q1 through 1931Q2 for the 48 contiguous states.
It also investigates the source and size of the credit channel, and it examines the
dynamic effects of bank failures on business failures. Granger-causality tests
find evidence that bank failures cause commercial failures at the aggregate U.S.
level and over half of the 48 states. The cross-sectional variation allows us to
test two explanations of the credit channel discussed in the literature: (i) a
reduction in consumption spending from the slow liquidation of failed-bank de-
posits, and (ii) a decrease in investment spending from a disruption of credit
to bank-dependent firms. Our results support both theories, but the evidence
in favor of the first is stronger statistically. Branch banking restrictions, state-
sponsored deposit insurance, and differences in the agricultural-manufacturing
share of commerce do not affect the empirical importance of an independent
credit channel. Using aggregate U.S. level data, our structural model indicates
that bank failures account for about 25% of commercial failures, and that bank
failures have only minor subsequent effects within the banking sector.
Key words: Credit channel, Bank runs, Deposit insurance, Granger causal-
ity
JEL classifications: E32, E51, G21
CFR Research Program: Banking and the Economy
∗Department of Economics, George Mason University,Fairfax, VA 22030-4444, Phone: 703-993-
1145, Email: cramire2@gmu.edu; and Division of Insurance and Research, Federal Deposit Insurance
Corporation, 550 17th Street, NW, Room 4206, Washington, DC 20429, Phone: 202-898-8545,
Email: pshively@fdic.gov. We are especially grateful to Paul Kupiec for detailed comments and
suggestions. This paper has benefited greatly from the comments of Arthur Murton, Fred Carns,
Mark Flannery, Haluk Unal, Dan Nuxoll, Jesse Weiher, Graham Elliot, Matthew Spiegel and other
seminar participants at the Federal Deposit Insurance Corporation as well as the Washington Area
Finance Association meetings. Ramirez gratefully acknowledges financial support and hospitality
from the Center for Financial Research at the Federal Deposit Insurance Corporation. The views
expressed in this paper do not necessarily reflect those of the Federal Deposit Insurance Corporation.
1