All banks take on risk in one way or another. Some banks take on more risk and hold riskier assets than other banks. During financial crises, these banks are less likely to survive. When these banks cease operations, though, does their risk vanish with them? Or does the risk linger on in the banking sector?
In “How do financial crises redistribute risk?” (National Bureau of Economic Research, Working Paper 31537, August 2023), Kris James Mitchener and Angela Vossmeyer seek to map how bank mergers, acquisitions, and failures distribute risk throughout the U.S. financial system. To do so, they examine all the banks that did and did not survive the early Great Depression-era financial crisis of 1929 to 1934. Among the banks that survived, the authors measured the risk of their portfolios, as well as how connected the banks were (by measuring the number of institutions with which they had deposits) before and after the crisis. Among the banks that did not survive, the authors noted how connected they were before the crisis as well as the manner in which they went out of business. From the disappearing bank’s point of view, a merger (two banks combine balance sheets) is preferred to an acquisition (a larger bank buys the balance sheet of a smaller bank), which in turn is better than an outright failure.
Mitchener and Vossmeyer state that 38 percent of banks left the market in the 5-year span. Among the more than 9,000 banks that exited, 1,556 were acquired and another 1,552 were merged into another bank. Banks that exited had a higher level of balance-sheet risk than those that survived, but the authors find that, despite the riskiest banks leaving the market, the amount of systemic risk in the financial sector increased. By acquiring the balance sheets of high-risk banks, the larger and more connected banks inherited some of the risk of the acquired banks. This acquisition brought the associated risk closer to the core of the banking network, further destabilizing the financial system as a whole. Despite making up only 10 percent of the banks in 1934, acquirers were responsible for 25 percent of the increase in systemic risk. For the most part, the authors find that as the number of acquisitions increased, so, too, did the acquiring bank’s balance-sheet risk.
The authors also note that geography affects the odds of a merger, acquisition, or whether the only exit option is a bank failure. If a bank starts to think about being consolidated or absorbed, but a bank within the same county was acquired, then the bank will have more trouble finding a partner. Once one bank from an area is consolidated, then nearby banks that are seeking to exit are more likely to exit in a bank failure.
Mitchener and Vossmeyer’s joint model of bank survival and risk, despite being developed on almost 100-year-old data, has implications for current bankers and regulators and indeed for anyone storing money in a bank. The banking industry has changed much since the 1930s, but whether today’s banking system is different in regard to redistributing risk remains an open question.
United States Department of Labor
