Failing Banks

2025-06-06

AI Summary

This study challenges the prevailing “panic-driven failure” narrative regarding U.S. bank failures by investigating their fundamental causes. Method: Leveraging a comprehensive panel dataset of U.S. commercial banks spanning 1863–2024, the paper employs panel regressions, event-study analysis, and dynamic accounting metrics—including asset loss rates, capital adequacy ratios, and reliance on non-core funding—to systematically identify pre-failure indicators. Contribution/Results: Findings reveal that bank failures are almost invariably preceded by persistent deterioration in fundamentals: declining asset quality, eroding solvency, and sharply rising funding costs. Even prior to federal deposit insurance, runs were strongly associated with weak fundamentals—not with irrational, fundamentals-agnostic panic. Low asset recovery rates further corroborate insolvency. This study provides the first ultra-long-run panel evidence refuting the “non-fundamentals-driven run” hypothesis and demonstrates that publicly available financial indicators alone enable high-accuracy prediction of failure risk.

Technology Category

• Reasoning under Uncertainty: Other Foundations of Reasoning under Uncertainty
• Game Theory and Economic Paradigms: Other Foundations of Game Theory & Economic Paradigms
• Search and Optimization: Other Foundations of Search & Optimization

Application Category

• Web Mining and Content Analysis: Web data provenance, reliability, and authenticity
• Social Networks and Social Media: Social media analysis through the lenses of networks
• Economics, Online Markets and Human Computation: Sustainability of Web economics

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.

Problem

• Identify common factors leading to US bank failures from 1863-2024
• Assess predictability of bank failures using public financial metrics
• Determine if bank failures stem from fundamental insolvency or external runs

Innovation

• Analyzing bank failures using historical panel data
• Predicting failures with simple accounting metrics
• Linking failures to deteriorating bank fundamentals