This essay is based on the working paper “Survival of the Biggest: Large Banks and Financial Crises” by Matthew Baron, Moritz Schularick, and Kaspar Zimmermann.

The recent collapse of Silicon Valley Bank in March 2023 was a powerful reminder of the recurrent nature of banking crises throughout modern economic history. Understanding the origins and consequences of these crises remains an urgent priority for economists.

Our understanding of historical banking crises has been hindered by the scarcity of comprehensive data on individual banks in many countries, especially beyond the United States and the United Kingdom. While recent research has made important strides in combining macrofinance and financial history, prior studies rely on either aggregate country data, lacking individual-bank granularity, or on bank-level data but only focused on a single crisis or country. Our paper is able, for the first time, to bridge this gap by integrating both approaches.

Our analysis is built around a newly constructed dataset encompassing the annual balance sheets and stock returns of more than 11,000 individual commercial banks spanning seventeen advanced economies, comprising more than 216,000 bank-year observations. This dataset, meticulously built over eight years from primary sources in financial archives, enables us to comprehensively examine banking industry dynamics across historical banking crises.

Using this dataset, we delve into bank-level behavior and the structural evolution of the banking sector before, during, and after banking crises. What types of banks tend to drive bank lending booms and subsequent banking crises? And how is the banking sector reorganized in the aftermath of banking crises?

Our research is particularly focused on role of the five largest banks in each of the seventeen countries, which we henceforth simply term the “large banks.” We discern a notable surge in their size over time, both relative to the rest of the banking system and relative to GDP in each country. We show that the five largest banks in each country account for nearly all the growth of assets in that economy’s entire banking sector over the last 150 years.

Using our new bank-level dataset, we then study banking crises and analyze the two-way feedback loops between banking crises and concentration of the banking sector: the role that large banks play in driving banking crises and, conversely, how banking crises reshape banking-sector structure.

Our paper is broadly motivated by a debate on the connection between bank size and financial stability. On one side of this debate, several potential reasons are often given as to why one might be concerned about a concentrated banking sector dominated by a small number of large banks. A primary concern is that large banks might be perceived as “too big to fail” by regulators and creditors, allowing these banks to take excessive risks, which may make banking crises both more likely and more severe. Additionally, the size and complexity of large banks as organizations can make them more difficult to regulate or make effective risk management practices and corporate governance harder to implement. Their greater interconnectedness with other financial institutions could add to risk and amplify contagion effects. Moreover, relative to smaller banks, they may have greater access to risk-taking opportunities, such as risky trading activities and risky international lending.

On the other side of this debate, some theoretical arguments suggest that large banks could be more financially stable than smaller banks. Proponents of large banks argue that they are a source of stability by diversifying risks and better absorbing shocks. In other words, their size and scale can allow them to spread risks across different markets, reducing the potential for a single market or industry shock to endanger the bank. On the asset side, large banks may be better diversified across geographies and loan types, while on the liability side, their funding sources may also be better diversified across different types of depositors and alternative money market sources, making them less prone to runs. Furthermore, large banks, which have often been around for decades or centuries, might have more established business relationships or a higher reputational value, which these banks would not want to lose if they were to fail. Their so-called charter value might thus reduce large banks’ incentives for excessive risk-taking. Moreover, a small number of large entities might be easier for supervisors to focus on than a large number of small entities. In support of these arguments, financial historians have often argued that the United States’ highly fragmented financial system has historically been less stable and has experienced more frequent depositor panics than has Canada’s concentrated banking system.

Using our new bank-level dataset, our analysis yields four key findings:

  1. Large banks are substantially less likely than smaller banks to fail in banking crises. Smaller banks also experience a high rate of absorption by large banks. As a consequence, the asset share of large banks tends to grow in the aftermath of crises, making them even more dominant going forward. We call this repeated pattern during crises the “survival of the biggest.”
  2. We find that the “survival of the biggest” is not due to more prudent behavior of large banks around crises. In fact, large banks typically take more risks than smaller banks in the run-up to a banking crisis. Then, in the aftermath of a banking crisis, large banks suffer bigger equity losses and contract their lending more.
  3. The “survival of the biggest” around crises can be mainly attributed to two interrelated forces: a) government interventions during crises that have disproportionately favored the largest banks across history; and b) greater funding stability of large banks, enabling them to avoid runs even amid significant equity losses during crises.
  4. Contrary to the US-Canada comparison mentioned above, concentrated banking systems are not measurably safer than more fragmented banking systems, when studied across our larger sample of countries and over history. The frequency of banking crises between fragmented versus concentrated banking systems is similar. Conditional on experiencing a crisis, the resulting business cycle downturns are more severe in more concentrated banking systems.

Our work has several implications for financial stability. First, our results highlight that aggregate bank lending booms and busts are, in the majority of cases, driven by a handful of large banks. Prior research has established that the acceleration of bank credit growth is the single best predictor of future banking crises. An important policy consequence is that macroprudential policy objectives focused on restraining risk-taking and excessive credit growth should primarily target the very largest banks. Supplemental capital requirements for the largest and most systemic banks are, in our view, key.

Second, even though policymakers may need, in severe crises, to design emergency interventions that rescue large banks—in order to prevent a collapse of the entire financial system or a severe credit contraction that could be devastating to the macroeconomy—they should make sure to appropriately discipline banks in conjunction with these emergency interventions, in order to prevent moral hazard. Such punishments may include wiping out existing shareholdings, replacing management, and forcing certain types of creditors (though not necessarily ordinary depositors) to take losses. Such actions would help to restrain future excessive credit growth and risk-taking of the largest banks.

Finally, policymakers should promote new entry into the banking sector and otherwise foster competition in financial services. While competition by itself does not necessary prevent financial instability—in fact, excessive competition in banking can potentially lead to excessive risk-taking, for example, if banks, pushed by competition, make too many risky loans at too-low yields—a healthy level of competition is important for financial stability, consumer welfare, and economic growth.

Read the full paper here.

Matthew Baron is assistant professor of finance at Cornell University’s Johnson Graduate School of Management.

This essay is part of the Financial Regulation Research Brief Series. Research briefs highlight the policy-relevant features of research on financial systems, including the impact of financial regulations on economic growth, stability, and other factors shaping living standards.

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