This essay is based on the paper “Failing Banks” by Sergio Correia, Stephan Luck, and Emil Verner.
What are the causes of bank failures? In a new working paper, we analyze around five thousand bank failures in the United States from 1865 to the present and find a set of strikingly consistent patterns. We find that failing banks tend to experience rising losses, deteriorating solvency, and increasing reliance on costly, unstable funding sources. Moreover, deteriorating bank fundamentals that result in failure often follow a period of rapid growth.
A New Long-Run View of Bank Failures
Bank failures have been a recurrent feature of the US financial landscape for more than a century and a half. To better understand the root causes of these failures, we assembled a new and unusually comprehensive dataset. It includes balance sheet data for most US banks from 1865 to 1941 (covering all national banks) and for all commercial banks from 1959 to 2023. This long-run dataset allows us to study more than 37,000 banks—of which about 5,000 ultimately failed.
Two advantages set this historical approach apart. First, we can examine a far larger sample of failures than most studies, which tend to focus on data from the 1980s onward. Second, we can observe bank behavior in periods without government interventions like deposit insurance or emergency central bank lending.
Three Consistent Patterns in Failing Banks
1. Rising Losses and Falling Solvency
One of the clearest signals of impending failure is a gradual but steady deterioration in a bank’s balance sheet. In the years leading up to failure, banks tend to accumulate more nonperforming loans , which drags down income and depresses profits. As losses mount, capital erodes. In the modern era, this often shows up as a decline of about 10 percentage points in the equity-to-assets ratio and a large fall in return on assets in the 5 years before a bank fails.
Strikingly, these patterns are not just a feature of the contemporary US banking system but were also common in the pre-FDIC period, which featured no deposit insurance, frequent bank runs, and much weaker accounting standards. Failing banks in earlier eras also saw rising loan losses and eroding capital buffers. Moreover, when failure happened, whatever assets failing banks still held were often subject to large losses. On average, failing banks only recovered around 54 cents per dollar of assets held at the time of failure. These patterns indicate that many failing banks were deeply insolvent, even when the failure involved a run on the bank.
2. Increasing reliance on noncore funding
As solvency weakens, we document that banks shift towards more expensive and less stable funding sources. In modern failures, we see a growing reliance on time deposits, brokered deposits, and non-deposit wholesale funding—sources of funding that carry higher interest costs and are more sensitive to perceptions of bank risk.
In the historical sample, similar shifts occurred. Banks that failed before deposit insurance also moved away from traditional deposit funding in their final years, turning instead to wholesale sources that usually carried higher costs and thus reduced bank profitability. In both eras, this shift toward noncore funding appears to be a symptom—and possibly a catalyst—of growing stress.
3. Boom Before Bust
Why do some banks end up on this path? A common precursor to failure is rapid asset growth. In both the historical and modern samples, we find that failing banks often expand aggressively in the years before failure—growing faster than their peers, particularly through increased lending. This growth phase is typically followed by a sharp contraction, as losses mount and funding dries up.
In the modern era, the boom-and-bust pattern is especially pronounced, often driven by surges in real estate lending. But this pattern is not new: banks that failed in earlier periods also tended to grow quickly before faltering. This suggests that unsustainable growth strategies have long been a leading indicator of future trouble.
The Bottom Line
Bank failures display striking commonalities throughout the past 160 years in the United States. The typical failing bank goes through a boom before entering a bust. As failing banks boom, they increasingly finance themselves with expensive forms of noncore funding. As failure approaches, these banks experience rising losses and deteriorating solvency. All three patterns point to the central role of deteriorating fundamentals and rising insolvency risk for bank failures. This holds even for failures that were triggered by bank runs. Thus, the key to understanding bank failures and banking crises is to understand the realization of solvency risk that is at their root.
Read the full paper here.
Stephan Luck serves as financial research advisor at the Federal Reserve Bank of New York.
This essay is part of the Financial Regulation Research Brief Series. Research briefs in this series highlight the policy-relevant research on financial systems, including the impact of financial regulations on economic growth and stability.
