Economic History Association

The Shoe That Didn't Drop: Explaining Banking Stability During the Great Depression Author(s): Richard S. Grossman Source: The Journal of Economic History, Vol. 54, No. 3 (Sep., 1994), pp. 654-682 Published by: Cambridge University Press on behalf of the Economic History Association Stable URL: http://www.jstor.org/stable/2123872 Accessed: 16/09/2010 16:03
Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showPublisher?publisherCode=cup. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

Cambridge University Press and Economic History Association are collaborating with JSTOR to digitize, preserve and extend access to The Journal of Economic History.

http://www.jstor.org

The Shoe That Didn't Drop: Explaining Banking Stability During the Great Depression
RICHARD

S. GROSSMAN

This article attempts to account for the exceptional stability exhibited by the banking systems of Britain, Canada, and ten other countries during the Great Depression. It considers three possible explanations of stability-the structure of the commercial banking system, macroeconomic policy and performance, and lender of last resort behavior-employing data from 25 countries across Europe and North America. The results suggest that macroeconomic policy-especially exchange-rate policy-and banking structure, but not lenders of last resort, were systemnatically responsible for banking stability.

Financialinstabilityplays an importantrole in many explanationsof

the causes and severity of the GreatDepression.1The bankingcrisis of 1930, for example, is widely regardedas having played a crucial role in turningthe recession that began in 1929into the worst depression in U.S. history. Financialinstabilityduringthe Great Depression was not limited to the United States: throughoutEurope industrialdevastation went hand in hand with financial collapse. Yet in Britain, Canada, Czechoslovakia, Denmark, Lithuania, the Netherlands, and Sweden, banking systems escaped the Depression without sufferingthe sort of crisis that engulfedmuch of Europeand the United States.2 Accounting for the stability of these and other countries is the goal of this paper. Previous work on banking crises-particularly on those associated with the Great Depression-has focused on the macroeconomicconsequences of banking instability. The literature falls into two broad categories. A monetarist view, identified with Milton Friedman and
The Journal of Economic History, Vol. 54, No. 3 (Sept. 1994). C The Economic History Association. All rights reserved. ISSN 0022-0507. Richard S. Grossman is Assistant Professor of Economics, Wesleyan University, Middletown, CT 06459-6067. A longer working-paper version of this article is available from the author. I have benefited from comments by and discussions with Lee Adkins, Ben Bernanke, Michael Bordo, Bill Dewald, Barry Eichengreen, Ben Friedman, Ken Kuttner, Stan Lebergott, Peter Lindert, Mike Lovell, David Selover, Jeff Williamson, two anonymous referees, and seminar participants at Hebrew University, Wesleyan, Yale, the Western Economic Association Meetings, and the National Bureau of Economic Research Summer Institute. The research has been supported by the Alfred P. Sloan Foundation, the Pew Foundation, and the German Marshall Fund of the United States. Aaron Siskind provided valuable research assistance. ' Friedman and Schwartz, Monetary History; Temin, Did Monetary Forces?; Bernanke, "Nonmonetary Effects"; and Bernanke and James, "Gold Standard." 2 Approximately one-third of U.S. banks failed between 1930 and 1933. The experience in Europe, notably central and eastern Europe, was similar. Beyen, Money in a Maelstrom; James, German Slump; Kindleberger, World in Depression; Lewis, Economic Survey.

654

Banking Stability During the Depression

655

Anna Schwartzand PhillipCagan,holds that bankingcrises increase the public's desired currency-to-depositratio, thereby reducingthe money supply and leadingto a decline in outputor prices.3An alternativeview, articulatedby O.M.W. Sprague,IrvingFisher, HymanMinsky, Charles Kindleberger,and Ben Bernanke,is that bank failures raise the cost of credit intermediation,which depresses aggregateeconomic activity.4 Bankingstabilityduringthe GreatDepression is of interestfor several reasons. First, to the extent that bankingcrises contributedto the length and severity of the Depression, the relative stabilityof various national bankingsystems may help to account for the differinglevels of intensity of the economic contraction. Second, understandingthe causes of bankingstabilityduringthe turbulentyears of the GreatDepression may shed some light on the causes of Depression-erainstabilityelsewhere. Finally, the experience of countries that emerged from the Depression with their banking systems intact may suggest reforms that will lessen present-day threats to financialstability. Research on the causes of bankinginstabilityhas been less common, and far less systematic, than that on its consequences. Investigationsof the causes of crises typically focus on monocausal explanations of bankinginstability. These explanationsmost frequentlyfall into one of three categories: the structure of the commercial banking system, macroeconomicpolicy and performance,and the actions of a lender of last resort (LOLR). A number of authors have argued that instability results from the structure of the commercialbankingsystem, particularlyfrom restrictions on banks' powers. Charles Calomiris and Gary Gorton, David Mengle, and Elizabeth Laderman,Ronald Schmidt, and Gary Zimmerman, for example, maintain that banking systems characterizedby a high degree of concentration and extensive branch networks enjoy greater diversification-and thereforegreaterstability-than unit banking systems.5 Others, including a former U.S. Secretary of the Treasury, have arguedthat Americanbankingstabilityis threatenedby laws and regulationsthat prevent banksfrom expandinginto relatedfinancial service industries, such as securities underwriting, brokerage, and insurance.6 A second group of explanations focuses on poor macroeconomic policy and performance. Though there is evidence to suggest that financialinstability leads to a decline in aggregateeconomic output, it
3 Friedman and Schwartz, Monetary History; Cagan, Determinants and Effects. Sprague, History of Crises; Fisher, "Debt-Deflation Theory"; Minsky, Inflation, Recession; Kindleberger, Manias, Panics, and Crashes; Bernanke, "Nonmonetary Effects." 5 Calomiris and Gorton, "Origins of Banking Panics"; Mengle, "Case for Interstate Branch Banking"; Laderman, et al., "Location, Branching." 6 See U.S. Treasury, Modernizing the Financial System, submitted by former Treasury Secretary Nicholas Brady. See White, "Before Glass-Steagall," on the investment banking activities of national banks.
4

656

Grossman

can also be argued that bank failures themselves are a consequence of economic downturns.Accordingto the traditionalKeynesian view, the Depression had its origins in a drop in investment spending, which was driven by a decline in investor confidence. Peter Temin maintainsthat bank failures during the Depression were primarily the result of an economic contraction that originated in an inexplicable autonomous decline in consumption expenditures.7Barry Eichengreen and Jeffrey Sachs and Temin note that countries that clung to the gold standard experienced more severe economic downturns in the 1930s than did countries that devalued, arguingimplicitly that bank failures resulted
from the choice of monetary regime and exchange-rate policy.8 Eichen-

green and Richard Portes argue that capital flight engendered by maintenanceof inappropriate pre-World War I parities linked convertibility crises and domestic bankinginstability.9 A thirdgroupof explanationsasserts that centralbanksare the crucial element in maintainingfinancialstability. CharlesGoodhart,for example, argues that the regulatory and supervisory services provided by centralbanks contributeto stability.10More importantly,Henry Thornton, Walter Bagehot, and Kindlebergerhave argued that by providing liquidity to the market during financial stringency, central banks are crucial to the maintenance of financial stability.1"Therefore, the absence of a central bank or the unwillingness of a central bank to undertakethe role of LOLR may bear some responsibilityfor financial instability. To explain why some countries had stable banking systems while others experienced banking crises, I contrast the interwar banking environments.Did countrieswith bankingstabilitydifferfrom countries that experienced crises in banking structure, or in macroeconomic policy and performance,or in LOLR behavior?If so, did the difference help to account for their exceptional experience? To answer these questions I assemble and analyze data on bankingstructure,macroeconomic policy and performance,and LOLR behavior from 25 countries across Europe and North America. Though the data suggest that macroeconomic policy and performance-especially exchange-rate policy-and bankingstructurehelp to explainbankingstability, I findno systematic evidence that LOLR behaviorcontributedto bankingstability.
7 Temin, Did Monetary Forces? 8 Eichengreen and Sachs, "Exchange Rates"; Temin, Lessons. 9 Eichengreen and Portes, "Anatomy"; Eichengreen, Golden Fetters. 10 Goodhart, Evolution of Central Banks. " Thornton, Enquiry into the Nature; Bagehot, Lombard Street; Kindleberger, Manias, Panics, and Crashes.

Banking Stability During the Depression

DEFINING A BANKING CRISIS

657

To assess the causes of banking crises it is necessary to frame a working definition. Although several definitions of "financial" crisis have been advanced recently, there has been less focus on "banking" crises.12 A notable exception is Ben Bernanke and Harold James's cross-country comparison of the consequences of banking crises.13 Bernanke and James are skeptical of the notion of defining banking crises in terms of the deposit-to-currency ratio (favored by Friedman and Schwartz) or some other precise numerical indicator, because such measures frequently lead to classifications that are at odds with generally accepted financial history. I rely instead upon a reading of the historical literature in order to determine where and when banking crises occurred.14 Banking crises differed in character and severity across countries but typically included one of the following three elements: (1) a high proportion of banks failed (for example, the United States, Germany); (2) an especially large or important bank failed (France, Austria); (3) failures of the type described in (1) or (2) were prevented only by extraordinary and direct government intervention in the banking industry through the declaration of a bank holiday or a reorganization or nationalization of the banking sector (Italy, Norway). If a numerical index of banking instability could be constructed, countries with index numbers above some critical value could be considered "crises countries," whereas those with index numbers below the critical value would be "noncrisis countries." Even if reliable data for a wide cross section of countries were available, however, designing such an indicator would be difficult. Instead, I divide the sample into two groups: those countries that experienced crises and those that did not. This categorization is detailed in the appendix, which includes a summary of the arguments supporting each country's classification.
BANKING STRUCTURE

A number of authors have argued that banking system stability can be traced to the structure of the commercial banking system. These arguments typically rest upon the issue of diversification: if banks are free to diversify across products and geographic areas, they may be less vulnerable.15 I consider three aspects of banking structure: branching, concentration, and bank size.
12 13 14 15

Eichengreen and Portes, "Anatomy"; Mishkin, "Anatomy." Bernanke and James, "Gold Standard." See Romer and Romer, "Does Monetary Policy Matter?" on the "narrative approach." See Calomiris, "The Costs of Rejecting Universal Banking."

658 Branching

Grossman

One structural factor that may have contributed to banking stability is branching. Extensively branched banks should be less likely to fail than unit banks for three reasons. First, banks with an extensive branch system are likely to have a more diversified loan portfolio than unit banks, which make loans in one area only. Second, branched banks may have a more diversified deposit base and therefore may be less likely to fail due to purely local deposit runs. Finally, a branch system provides seasonal diversification, easing the stringency in money centers caused by the flow of funds to agricultural areas at harvest time.16 Data on branching in crisis and noncrisis countries are presented in Table 1. Banks in noncrisis countries had, on average, substantially more branches per bank than their counterparts in crisis countries, though the difference in means is not quite significant at the 5 percent level (one-tail test). Banks in Britain (613 branches per bank) and Canada (370) were by far the most extensively branched in the sample, although those in the noncrisis countries of Finland (36), Sweden (34), Czechoslovakia (27), and the Netherlands (24) also had more branches per bank than the most extensively branched crisis-country banks of Belgium (14) and France (9). These figures, plus those on less extensively branched banks, may suggest that branching contributes to stability only above some threshold (15 to 23 branches per bank). The Canadian experience in particular lends support to the argument that branch banking contributes to stability. Macroeconomic performance during the Depression was dismal in both the United States and Canada; however, the extensively branched Canadian banking system survived intact while approximately 5,000 U.S. banks-primarily unit banks-failed. Though the U.S.-Canada comparison is suggestive, numerous counterexamples cast doubt on the ability of branching to ensure stability. The vast majority of American bank failures in the 1930s were unit banks. Prominent exceptions included Caldwell and Company, which had over 100 branches and affiliates in several southern states, and the Bank of United States, which had 59 branches at the time of its failure. 17 Austria's largest and most extensively branched bank, the Credit Anstalt, failed in May 1931. In Germany, the Danat Bank, which was third among Berlin's great banks with 207 branches, failed weeks later. In France, the country's fourth largest bank, the Banque Nationale de Credit, failed following two runs. And Italy, where the banking system
16 Miron, "Financial Panics." Madden and Nadler, International Money Markets, p. 114, argue that the branch systems of Europe were more adept at handling this seasonal movement of funds than the correspondent system in the United States. 17 Wicker, "Reconsideration," discusses the collapse of the Caldwell group. Friedman and Schwartz, Monetary History, pp. 309-11, and Temin, Did Monetary Forces?, pp. 90-94, discuss the failure of the Bank of United States.

Banking Stability During the Depression

TABLE 1 BRANCHING AND CONCENTRATION, 1930

659

Crisis Countries Belgium Estonia France Germany Hungary Italy Latvia Norway Poland Romania Switzerland United States Yugoslavia Average Standard deviation

Branches per Bank 14.16 1.70

9.46b 3.06b

Population per Bank (000) 92.6 27.9 160.9 176.1 16.3 104.8 95.0 25.0 487.9 16.0 19.2 16.2 21.1 96.9 125.4

Noncrisis Countries Britaina Bulgaria Canada Czechoslovakia Denmark Finland Greece Lithuania Netherlands Portugal Spain Sweden

Branches per Bank 613.44 1.43 369.91 27.32 3.06 35.94 7.43 7.22 24.00 3.26 5.08 33.83

Population per Bank (000) 2,481.3 43.1 896.4 666.2 19.6 198.2 180.3 260.0 1,305.5 252.6 105.9 204.0

1.00
1.91b

6.05 1.87 4.71 1.00 3.50 1.14 1.00 3.89 3.80

Average Standard deviation Branches per Bank

94.33 184.91 Population per Bank 454.2 (2.24) 1.7%

551.1 690.5

Intergroup difference in means (t-statistic) p-valuec

a

90.44 (1.69) 5.1%

England and Wales.

b This figure includes only branches of major banks. All other banks are assumed unit. If other

banks are assumed to have five branches each, p-value is 5.2%. c One-tail test. Sources: Data on number of banks and branches are from League of Nations, Commercial Banks, 1925-1933, Commercial Banks, 1929-34, and the Banker's Almanac, 1930. Population data are from League of Nations, Statistical Year-Book.

was dominated by four extensively branched banks, also experienced crisis. Still, the branching argument is difficult to dismiss: neither the Caldwell group nor the Bank of United States had a nationwide system of branches. And in Austria, France, Germany, and Italy a few great banks with nationwide branch systems coexisted with as many as several hundredless well-branchedbanks. The evidence suggests that bankingsystems characterizedby extensive branch networks enjoyed enhanced stability during the Great Depression. The presence of extensively branched banks within a system that also included many less well-branched banks, however, does not appearto have had the same stabilizingeffect. Moreover, there are enough exceptions to indicate that branchingalone was not enough to guaranteestability. Banks in Belgiumand France, for example, were

660

Grossman

extensively branched and did suffer crises, whereas the unit bank system of Bulgariadid not experience crisis. This suggests that branching may have been but one factor contributingto banking stability. Bank Concentration Stability might also be explained by a high degree of banking concentration. If high concentrationreflects the existence of barriersto entry, industrial organization theory suggests that firms may earn economic profit and therefore may be less likely to fail. Further, the existence of a small numberof banks suggests that cooperation, such as pooling reserves in times of crisis, will be more feasible. Table 1 presents one measure of concentration-population per bank.18According to this measure, banks in noncrisis countries had concentrationlevels that were, on average, more than five times those of crisis countries, and the difference is significantat the 2.5 percent level. Britishbanks (nearly2.5 millionpeople per bank) were easily the most concentrated, whereas among crisis countries concentrationwas highest in Poland (487,900). Not surprisingly,concentrationwas quite low in the unit-bank-dominated United States (16,200). Did high bank concentrationlead to greaterprofitability therefore and to greater stability? This question is addressed in Figure 1, which presents data on bank profitability.Curiously,banks in crisis countries were more profitablethan those in noncrisis countries throughoutthe period 1929 to 1933. Though the highly concentrated banks of Britain earned below-average profits prior to 1931, their profits-like those of noncrisis-country banks in general-deteriorated less than those of crisis-countrybanks. The data presented in Figure 1 indicate that (highly concentrated) noncrisis-countrybanks were not particularly profitablecomparedwith their crisis-country counterparts, although the decline in noncrisiscountry banks was substantiallyless dramaticthan that of crisis-country banks. The profitabilityfigures may indicate that concentrationengendered conservative managementpolicies-a willingness to accept low but stable profits-or that more concentratedbanks were indeed more '9 profitablebut dissipatedthese profitsthroughhigherreserve holdings. Noncrisis-countrybanks in fact held greatercash reserves than banks in crisis countries (though the difference is not statistically significant), which is supportive of the view that concentration contributed to banking stability. Concentrationmight also have bolstered banking stability by facili18 The data required to calculate n-firm concentration ratios or Herfindahl-Hirschman indices are available for only a few countries. 9 Regressing cash ratios on profitability (and a time trend) using pooled time series-cross section data yields a coefficient of 0.24, with a t-statistic of 3.17, suggesting that more profitable banks did hold higher cash ratios.

Banking Stability During the Depression

0.35 -

661

0.3UnitedStates 0.25 -

5: 0.2-

CrisisCountries 0.15 NoncrisisCountries

0.1 Britain
0.05 -

1929

1930

1931
FIGURE 1

1932

1933

RATIO OF PROFITS TO CAPITAL Sources: League of Nations, Commercial Banks, 1925-33 and Commercial Banks, 1929-34.

tating interbank cooperation. Gorton describes how the New York clearinghouse acted to pool the resources of its members during nineteenth-century crises, and Charles Calomiris and Larry Schweikart discuss the importance of coordination as a response to the crisis of 1857.20 American clearinghouse associations continued to function successfully into the interwar period. Similarly, bankers in Canadainformally and through the Canadian Bankers Association-exhibited a high degree of cooperation, particularly during the takeovers of the Bank of Ontario (1906) and Sovereign Bank (1908).21 Clearinghouses had existed for some time in Britain, but they engendered far less interbank cooperation than bankers' organizations in Canada or the United States. The London clearinghouse was established in the 1770s but did not admit joint stock banks until 1854 or provincial private banks until 1858.22 The clearinghouse not perform any function beyond check clearing, and interbank cooperation before World War I was minimal.23 Even during World War I, when wartime
Gorton, "Clearinghouses"; Calomiris and Schweikart, "Panic of 1857." Johnson, Canadian Banking System, pp. 104-27. 22 Crick and Wadsworth, A Hundred Years of Joint Stock Banking, p. 29. 23 Balogh, Studies in Financial Organization. An exception was the rescue of Baring Brothers in 1890.
21 20

662

Grossman

conditions made some cooperationnecessary, observers noted that the bankers were not particularlyenthusiasticparticipants.24 The evidence presented in this section suggests that high concentration did contribute to banking stability during the Great Depression. Banks in noncrisis countries earned lower-but comparatively more stable-profits, while maintaining relativelyhigh cash reserves. Though concentrationdid facilitateinterbankcooperationin Canadaand among membersof U.S. clearinghouses,it does not appearto have encouraged stability-promoting cooperationamongthe highlyconcentratedbanksof Britain. Bank Size Bank size may also have contributed to banking stability. Large banks may be less prone to failure than smallerinstitutionsfor several reasons. First, banks with substantial assets will be better able to diversify their loan and investment portfolios and thereby reduce the risk from any one nonperforming component. Second, if leading firms require larger loans-which small banks do not have the resources to provide-and are less likely to default than small firms, then the banks that make these loans may incursmallerloan losses.25Third,banks with substantialresources may be in a better position to acquire banks that are on the verge of failureand thus help to stabilize the system. Finally, highly capitalized banks will be better able to absorb losses from any nonperforming asset than banks that are less highly capitalized.26 Table 2 presents data on average bank capital, assets, and deposits. The averagejoint stock bank in noncrisis countries was substantially larger than that in crisis countries. The capital-to-assets ratio did not differ significantlybetween crisis-countrybanks and noncrisis-country banks. Withoutmore detailed data on bankloan portfolios, it is difficult to determine whether relatively large banks held more diversifiedloan and investment portfolios than their smallercounterparts.Despite this absence of evidence, the stabilityof several countries characterizedby small banks (for example, Denmarkand Spain), and the instability of several countries characterizedby large banks (Belgium and Switzerland), the substantial size difference between crisis- and noncrisiscountry banks is suggestive. Banking systems characterizedby banks that command substantial resources might enjoy greater stability because such large banks have the resources to acquire ailing institutions. The cooperative effort to rescue Baring Brothers in 1890 was such a case. In Canada. the
24 Balogh, Studies in Financial Organization; Committee on Finance and Industry, Report, pp. 160-61. 25 Large banks may also enjoy economies of scale. 26 If, however, large banks are typically stable, then they may be able to afford to hold less capital.

Banking Stability During the Depression

663

Note: Source: AllOne-tail England and p-valueb test. League figures Intergroup (t-statistic) of Wales. except Nations, difference in means capital-to-asset Commercial ratios Banks, are in 1925-33. millions of 1930 U.S. (2.22) 1.9% 9.70

Italy Latvia United Poland Estonia Norway HungaryBelgium Average Romania Standard Germany Crisis deviation Yugoslavia Countries Switzerland States

0.81 0.47 0.09 0.65 0.62 1.30 2.62 0.77 0.10 2.24 0.60 0.33 0.20 0.07

Capital Reserves + Average

5.61 3.86 0.45 4.09 5.25 13.09 12.53 5.64 0.50 18.36 5.35 1.78 1.53 0.93 Assets Average

4.21 2.63 0.29 2.57 1.45 8.27 9.66 3.58 0.39 13.52 2.10 0.61 0.98 0.46

Average Deposits

toCapital 0.03 0.11 0.163 0.094 0.087 0.165 0.083 0.062 Ratio 0.060 0.128 0.117 0.118 0.099 0.118 AssetsCapitalReserves + Average BANK
TABLE

SIZE, 2 Spain 1930 Britaina Bulgaria Portugal Finland Canada Average Standard Sweden Denmark Lithuania (1.77) 4.5% 106.58Assets Netherlands Noncrisis Averagedeviation Countries Czechoslovakia

dollars.

10.47 14.44 (1.68) 5.3% 87.88 Average Deposits

7.46 0.55 0.30 0.63 27.87 43.92 Capital 0.77 26.69 2.54 4.42 0.07 Reserves + Average

686.09 Average 15.63 43.03 0.40 Assets 6.69 137.69 199.38 112.22 50.98 2.73 1.47 4.52 285.23

173.75 91.46 -0.01 Ratio Capital(-0.37) 35.7% to-Assets 0.05 0.10

601.26 Average 32.44 1.72 0.93 3.14 225.67 Deposits 3.72 98.70 11.41 26.76 0.31

to0.081 0.128 0.106 0.058 0.146 Ratio 0.090 0.141 0.192 0.093 0.046 0.035 AssetsCapital-

664

Grossman

takeovers of the Bank of Ontario and Sovereign Bank were also cooperative efforts, whereas the May 1931 absorption of Weyburn Security Bank was accomplished by the Imperial Bank acting alone. And in Britain, Williams Deacon's Bank was taken over by the Royal Bank of Scotland in 1929-1930 with the assistance of the Bank of England.27 Bankingsystems characterizedby largerbanks were more stable than those characterizedby smallerbanks, althoughlarge noncrisis-country banks held lower capital-to-assets ratios. In the absence of more detailed loan portfolio information,it is impossible to conclude that the stability of largerbanks was achieved throughincreased loan diversification and access to more credit-worthyborrowers.Anecdotal evidence suggests that stability-promoting mergersdid occur in large-bankcountries. If large banks, because of superior diversification, high-quality customers, and economies of scale, were particularlystable, then low capital-to-assets ratios need not have been a source of weakness.
MACROECONOMIC POLICY AND PERFORMANCE

Banking stability might also be explained by robust macroeconomic performance. The contribution of healthy macroeconomic conditions-be they the result of luck or wise policy-to bankingstabilitycan best be seen by examiningtheir possible effects on bank liabilities and on bank assets. Liabilities The largest component of bank liabilities is typically deposits. Assumingdomestic depositorswere no more likely to precipitatea banking panic in one country than in any other, a source of bankinginstability emanatingfrom the liabilities side of the balance sheet might have been
a high dependence on foreign deposits.28 It is possible that this

dependence could increase the likelihood of a run in a period of exchange rate uncertainty if foreigners anticipatingdevaluation withdrew their deposits rather than suffer capital losses in the devaluing country. Even in the absence of large foreign-deposit liabilities, an anticipateddevaluationcould lead to potentiallydestabilizingdomestic flight from the currency. The accumulation of short-term foreign capital became especially widespreadafter WorldWar I. The tendency to rely on these funds was most pronouncedin central Europe where, suggestively, the incidence of convertibility crises and bank failures was particularlygreat. The League of Nations estimated that by the end of 1929, one-third of
Sayers, Bank of England, vol. 1, pp. 253-59. This assumption does not go unchallenged. See Balogh, Studies in Financial Organization, p. 37, and Truptil, British Banks, p. 92.
27 28

Banking Stability During the Depression

665

German banks' outstanding loans to customers had been made with funds borrowed abroad and subject to recall on demand. The League estimated that the proportion was about one-quarterfor Austria and Hungary.29 Figures on short-term foreign liabilities are not available for more than a few countries, making it difficult to judge the extent of the exposure of banks in crisis and noncrisis countries. It is possible, however, to gauge the length of the periodof exchange rate uncertainty, because such uncertainty clearly ended when countries imposed exchange controls or devalued their currencies. Suggestively, none of the three countries that had either suspended the gold standard or imposed exchange controls prior to the Credit Anstalt crisis in July of 1931 suffered banking crises.30 Of the 14 countries that suspendedbetween the collapse of the CreditAnstalt and the end of 1931, half underwentcrises and half avoided crises.31Seven of the nine countries that delayed suspension until 1932 or later experienced bankingcrises.32 Given the paucity of data on foreign liabilities, it is impossible to accept or reject the hypothesis that excessive dependence on foreign deposits or prolonged exchange rate uncertainty were important sources of banking instability. However, the data are suggestive. Banking systems in countries that suspended the gold standard or imposed exchange controls early-and hence reduced the incentive for capital flight-appear to have been more stable duringthe Depression than those that clung to the gold standard.Though continued maintenance of the gold standard may well have increased the risk of withdrawal of foreign liabilities, it may have had a more profound impact on bank assets. It is to the asset side of the balance sheet that we now turn.

Assets
Can banking stability be explained by the relatively strong performance of asset portfolios?Poor asset performancecould weaken banks in three ways. First, because loans and investments constitute banks' principal earning assets, poor performance will curb cash flow and either reduce cash on hand, increasing the risk of a run, or force the bank to hold a larger cash reserve, weakening its earnings position. Second, as some of these assets can be sold to satisfy demands by nervous creditors, if their value falls the marginof safety they provide
League of Nations, Commercial Banks, 1925-33, p. 10. See also James, "Financial Flows." Bulgaria, Portugal, and Spain. 31 Austria, Estonia, Germany, Hungary, Latvia, Norway, and Yugoslavia had banking crises, whereas Canada, Czechoslovakia, Denmark, Finland, Greece, Sweden, and the United Kingdom did not. 32 Belgium, France, Italy, Poland, Romania, Switzerland, and the United States had banking crises, whereas Lithuania and the Netherlands did not.
29

30

666
105 -

Grossman

100 o

a \

\, \ ~~Noncrisis Countries \ ,
/

/~~~~~~~~~~~~~~~~~

El95-\

\/~~~~~~~

90 -\/

\Crisis

Countries

85 -

1929

1930

1931

1932

1933

1934

1935

FIGu PE 2 REAL GNP

Source: Mitchell, European Historical Statistics; Urquhart, Historical Statistics of Canada, p. 132; U.S. Department of Commerce, Historical Statistics of the United States, vol. I p. 224.

shrinks. Finally, given that loans anldinvestments typically constitute a large fraction of total assets, the loss of part or all of their value could seriously erode confidence. I consider loans and investments in turn. Were banks in noncrisis countries less adversely affected by poorly performing loans than their counterparts in crisis countries? This would have been the case if loans comprised a smaller portion of total assets in noncrisis countries than in crisis countries or if the loans made by banks in noncrisis countries outperformed those made by banks in crisis countries. Banks in crisis and noncrisis countries held virtually the same proportion of their assets in loans 46 vs. 47 percent in 1929 and 40 vs. 41 percent in 1933. If the loan portfolio was a source of strength for banks in noncrisis countries, it was through better performance and not substantially lower exposure. Bank loans may have performed better in certain countries because macroeconomic conditions were better or because banks in these countries achieved a more advantageous distribution of loans.3 Macroeconomic performance is summarized by data on GNP presented in Figure 2. The decline in economic activity was smzallerand more gradual
33 Perhaps due to an early devaluation or more substantial depreciation of the currency. Eichengreen and Sachs, "Exchange Rates."

Banking Stability During the Depression

667

in noncrisis countries, suggestingthat borrowersin these countries may have been less likely to default than borrowersin countries markedby banking crises. GNP in crisis countries declined more sharply than in noncrisis countries even prior to the crisis year of 1931 (although the difference is not significant), suggesting that despite the difficultiesof interpretation due to simultaneity macroeconomic performance may have contributedto bankingstability. To judge how adversely banks were affectedby the decliningvalue of their securities portfolios, it is necessary to considerthe extent to which banks in different countries held bonds, the performanceof the bond market in differentcountries, and the composition of bond portfolios. The share of assets held in securities by noncrisis-country banks exceeded that held by crisis-countrybanks (11.5 to 6.5 percent in 1929, 14 to 9 percent in 1933), although the proportion of assets held in securities was small compared with that held in loans. If bonds were perceived as being less risky than loans, this comparisonsuggests that noncrisis-country banks were more risk-averse than crisis-country banks. Bond market performancecan be evaluated by examiningthe yields on long-term bonds, which are inversely related to bond prices, in differentnationalmarkets. Data on bond yields are presented in Figure 3. Thoughyields in crisis and noncrisiscountrieswere similaruntil 1931, during 1932the crisis-countryrate rose dramatically,indicatinga more precipitous decline in bond prices in crisis countries. This patternmay reflect easier monetary policy undertakenby devaluing countries. The data in Table 3 confirm that, on average, noncrisis countries saw substantiallygreater currency depreciationpriorto 1932than did crisis countries. To evaluate the effect of bond portfolio performanceon the value of bank assets it is necessary to address both bond market performance and portfolio composition. Both concerns can be addressed by constructing hypothetical bank bond portfolios. These portfolios are generated by constructingseveral randomsamples of bonds, each of which is comprised of one type of security, and weighting each component according to the extent to which it was held in bank portfolios.34 Because detailed portfolio compositioninformationis availablefor only a few countries, I restrict the analysis to one crisis country, the United States, and one noncrisis country, Britain. The initial samples were collected from bond marketquotes for June 30, 1929,and were followed at six-month intervals until June 30, 1933. The results are reported in Figure 4.
3 Temin, Did Monetary Forces? pp. 106-8, conducts a similar exercise, although he constructs just one sample of bonds. The details of the procedure used here are omitted from the text but are contained in a longer working-paper version of this article, which is available from the author.

668
140 -

Grossman

130

CrisisCountries

120
110A

100

90 80 -

NoncrisisCountries \

1929

l 1930

l 1931
FIGURE 3 BOND YIELDS

l 1932

l 1933

1934

Source: League of Nations, Statistical Year-Book, 1934135.

Government issues performed well in both countries. In the United States railroad, industrial, and foreign issues performed poorly, losing between 38 and 53 percent of their value by June 1932, whereas comparable British securities lost only 36 percent of their value. The performance of British and American portfolios was similar until year-end 1931. Low interest rates, associated with postdevaluation easy money policy, plus a more risk-averse bond selection helped the British portfolio make a rapid recovery and to avoid losses at nearly all semiannual dates.35 The British bond portfolio, which gained 19 percent in value over the entire period, contributed a 2.2 percent increase to the value of total assets, whereas the American portfolio, which lost 11 percent of its value, accounted for a 2.5 percent fall in the value of total assets. Both threads of analysis pursued in this section suggest that the earning assets of noncrisis-country banks outperformed those of crisiscountry banks, and that early devaluation may well have been an important contributing factor. The smaller and less dramatic downturn in aggregate economic activity in noncrisis countries indicates that the behavior of the loan portfolio was probably a less important source of
3S

The British portfolio

lost nearly 11 percent of its June 1929 value by year-end

1931.

Banking Stability During the Depression

TABLE 3 EXTENT OF DEPRECIATION,DECEMBER 1931

669

Crisis Countries Switzerland Yugoslavia Franceb Belgium United Statesb Latvia Hungary Poland
Estoniab

CurrencyValuea 101.0 101.0 100.3 100.0 100.0 99.9 99.8 99.8 99.7 99.6 99.2 97.1 69.0 97.4 8.3

Noncrisis Countries Lithuania Netherlands Czechoslovakia Greece Bulgaria Canada Portugal Sweden Denmark Britain Finland Spain Average Standarddeviation 15.14 (2.98) 0.36%

CurrencyValuea 100.3 100.1 100.0 99.2 99.0 82.7 73.0 69.8 69.4 69.3 67.3 57.2 82.3 15.7

Romania Germany Italy Norway Average Standarddeviation

IntergroupDifference in Means (t-statistic) p-valuec

a
b

Percentageof 1929 value. December 1930.

c One-tail test. Source: League of Nations, Monetary Review.

instability among banks in noncrisis countries. Bond prices held up relatively well in noncrisis countries. Though the lack of detailed data on bond portfolio composition limits an investigation of its importance, comparison of British and American bond portfolios suggests that strong bond market performance-due in part to postdevaluation monetary policy-combined with risk-averse portfolio managementcontributed to the relative stability of Britain's banks after 1931.
LENDER OF LAST RESORT

Banking stability could also have been promoted by a lender of last resort. An LOLR might help to avoid or ameliorate crises by providing banks with liquidity in times of stringency when, in the absence of such assistance, they would be unable to meet the demands of depositors and would be forced to close their doors. Such assistance would most likely be made throughloans, which other marketparticipantsare unwilling or unable to make. Of course, LOLR performance is not independent of monetary policy. For example, Temin and Eichengreen argue that maintainingthe gold standardmade it difficultfor central banks to act as

670
130

Grossman
1

120 British Composite o110

clq
/

-100

90 -

\/ /

U.S.Composite

80 June 29

June 30

June 31
FIGURE 4

June 32

June 33

AMERICAN AND BRITISH BOND PORTFOLIO PERFORMANCE Source: See text.

effective LOLRs.36 However, because LOLR behavior has figured prominently-aside from its effect on monetarypolicy-in the literature on bankingcrises, I consider it separately. The first part of this section considers the willingness and ability of various national authoritiesto perform the lender of last resort function; the second evaluates the response of several national authoritiesto crisis. Centralbanks differedboth in the extent to which they competed with domestic commercial banks and in their relationship to the money market. Continentalcentral banks were typically general banks, which were entitled to conduct business with individualsand nonbank busiinstitutions, these nesses as well as with banks. As profit-maximizing centralbanks were often in competitionwith domestic banks, and hence may not have been especially concerned with the stability of the domestic banking system. The Bank of France, for example, was in active competition with French commercialbanks for deposits and by the end of 1933 carriednearly 400,000 accounts on its books.37 The Bank of England was unrestrainedas to the institutions with which it was entitled to do business, but from early in the nineteenth
Temin, Lessons; Eichengreen, Golden Fetters. Truptil, British Banks, p. 83; Madden and Nadler, International Money Markets, pp. 112, 306-7.
36 37

Banking Stability During the Depression

671

century it began to deal almost exclusively with other financialinstitutions. Following the demise of Overend, Gurney in 1866, the Bank ceased to be in active competitionwith other City firms. Thoughthe Bank's relationshipwith the joint stock banks was limited to check clearing, its relationshipwith the discount houses-and thereforethe money market-was more intimate. Discount houses carriedportfoliosof acceptancesthat they financed with call loans from the joint stock banks. When the joint stock banks became illiquidand called in their loans, the discounthouses turnedto the Bankof England,which stood readyto rediscountTreasuryor trade bills freely at BankRate. Because of theirprivilegedaccess to the Bank by of England,the discounthouses were subjectto close supervision the Bank. Thus supervisedinstitutionsacted as a bufferbetweenthe LOLR joint stock banks. The joint stock banks did not and the unsupervised normallyhave recourseto the Bankof England,so they had a powerful incentiveto avoid situationsin which cash and money lent at call would not be sufficient to meet depositor demand. The presence of the 7 approximately to 9 percent discountmarketallowedthem to maintain addition to their cash reserves of of assets in liquid call loans in approximately10 percent.38 In New York, by contrast, though the central bank was not in with the money market competitionwith memberbanks,its relationship was more tenuous. The securities typically pledged as collateral for broker'scall loans were not eligiblefor discountor purchaseby the Fed. John Maddenand MarcusNadlerarguethat the Londonmarket,which more had directaccess to the Bankof England,was at least theoretically the New Yorkmarket,wherethe liquidityof loans depended liquidthan of on the marketability the loan collateral.39 A second majordifferencelay in the abilityto engagein open market operations.The authorityof the Bankof France,the NetherlandsBank, Reichsbank, and other continental central banks to engage in open market operations-and hence to act as an effective lender of last Open marketoperationswere clearly resort-was limitedby statute.40 within the prerogativeof both the Federal Reserve and the Bank of England, though the Fed did not employ this technique effectively duringthe GreatDepression. The failureof FederalReserve monetary policy has been frequentlycited as a source of bankinginstabilityin the United States.41
Balogh, Studies in Financial Organization, p. 36. Madden and Nadler, International Money Markets, p. 118. 4 Madden and Nadler, International Money Markets, pp. 123, 310, 372-73. The Bank of France was empowered to purchase gold and foreign exchange in 1926. The effects of these purchases were similar to open market operations. See Eichengreen, "Bank of France." "' Friedman and Schwartz, Monetary History. Their argument does not focus on the Fed's failure to act as LOLR, but on its failure to follow a stable monetary policy.
38 39

672
150 140-

Grossman

\ Noncrisis Countries

130 /

8120

-/

ON 110
100
I /

Crisis Countries

90
80 1929 1930 1931
FIGURE

1932

1933

BILLS DISCOUNTED IN CENTRAL BANK PORTFOLIO Sources: League of Nations, Monetary Review; Urquhart, Historical Statistics of Canada, p. 203.

It is difficult to construct a uniform measure of LOLR activity because the methods used by LOLRs varied widely.42 The presence of a central bank with a reputation as a strong LOLR may even have reduced the need for such an institution to have taken any action at all. One way of assessing the extent of expansionary open market operations is to examine the level of discounting by central banks.43 As shown in Figure 5, after declining slightly in 1930, discounting levels in both crisis and noncrisis countries rose substantially in the crisis year of 1931 before returning to 1929 levels by 1933. The expansion of bills discounted in noncrisis countries was substantially above that in crisis countries (though the difference is not statistically significant), suggesting that central banks in noncrisis countries responded to the threatened crisis with more aggressive open market purchases. The response to crisis varied widely. In Czechoslovakia, Scandinavia, and Spain, central banks expanded discounts in order to increase liquidity and relieve pressure on the domestic money market. In
42 Measuring the extent of central bank discounting, as is done below, is problematic because central banks had different accounting practices (and is complicated by Canada, which had no central bank). Further, some governments extended lender of last resort facilities in difficult-toquantify ways-for example, by providing guaranteed depositories (Bulgaria, Lithuania). 4 Lovell, "Role of the Bank of England," assesses LOLR behavior in the eighteenth century by examining the Bank of England's discounting activity.

Banking Stability During the Depression

673

Bulgaria and Lithuania, the provision of guaranteeddepositories alleviated pressure on bankinginstitutions and reduced the risk of panic. The remainderof this section brieflyoutlines the response of authorities in Britain and Canada, where LOLR actions were crucial in averting crisis. With the collapse of the Credit-Anstalt in the summer of 1931, pressure immediatelyfell upon the London accepting houses that had granted substantial trade credits to their foreign clients." The subsequent Austrian and Germanexchange controls made it impossible for firms in these countries to remitfunds to London to dischargethe debt. Because all firms that had discounted or rediscounteda bill, as well as the issuing firm, were "jointly and severally" liable, any number of accepting houses, discount houses, and joint stock banks might be forced to close if the issuer was unable to meet the debt. The City had faced such a crisis when the outbreakof World War I prevented foreign debtors from remittingfunds to London. In 1914the British governmentauthorizedthe Bank of Englandto discount frozen bills and to keep them in "cold storage" until after the hostilities, the guaranteeing Bank againstany loss. The response of the City in 1931 was similar:the Bank of Englandcontinuedto discountfrozen bills even though there was no government guarantee. This action relieved all issuers, discounters, and holders of bills from immediate liability and almost certain collapse. Unlike the United States or the majority of European countries, Canadahad no centralbankbefore 1935.Currencywas issued in limited amounts by both the chartered banks and the central government. However, under the Finance Act, the central governmentwas empowered to act as LOLR: chartered banks could apply to a Cabinet committeefor advances of Dominionnotes againstvirtuallyany pledged security.45 Of even greaterimportancewas PrimeMinisterBennett's decision to rescue the "Wheat Pools." Every year the Pools accepted the crops of its members, on whose behalf it sold the wheat, and advanced (borrowed) funds in anticipation of sales. In the absence of government support, the rapiddecline in wheat prices following the initial purchase of the 1929-1930 crop could well have led to the collapse of both the Pools and the banks that had extended them $22.8 million in credit.46 Thus there is preliminaryevidence suggesting that LOLR behavior stabilized banking during the Great Depression. Central banks in
" As of March 31, foreign credits were ?121 million whereas foreign deposits were ?81 million. Committee on Finance and Industry, Report. 4 McIvor, Canadian Monetary; Shearer and Clark, "Canada and the Interwar Gold Standard"; Drummond, "Why Canadian Banks Did Not Collapse." 4 This paragraph is based on Drummond, "Why Canadian Banks Did Not Collapse," pp. 246-48.

674

Grossman

noncrisis countries expanded discounts more than did those in crisis countries, and decisive LOLR activity by authorities in Britain and Canadaconfrontedthreats that, if not addressed, could well have led to bankingpanics.
ECONOMETRIC TESTS

The evidence presented earlier suggests that banking structure, macroeconomic policy and performance, and LOLR behavior each contributedto bankingstabilityduringthe GreatDepression. However, this evidence does not enable us to assess their relative importance systematically. Though the nature of the three explanations makes direct comparisons problematic, formal tests can provide tentative
answers.47

Table 4 presents single-variableprobits for structural, macro, and LOLR variables. Among the structuralvariables, branches per bank, populationper bank, and assets per bankall have the expected negative signs, indicating that countries characterized by more extensively branched, more concentrated,and largerbanks were less likely to have a banking crisis. Only the first two of these are significant at the 5 percent level (one-tail test). The estimatedcoefficient on the capital-toassets ratio has a positive sign, though it is not significantlydifferent from zero. To minimizethe simultaneityproblem,the tests on macro and LOLR variables employ data from 1931.48Among the macro variables, the estimated coefficienton currencyvalue is positive and significantat the 2.5 percent level (with a p-value of 1.1 percent), indicating that the greaterthe extent of currency depreciation,the less the likelihood of a banking crisis. Probits on other macroeconomic variables yield estimated coefficients with the anticipated signs but not significantly differentfrom zero. These results highlightthe importanceof exchangerate policy over macroeconomicconditions as a determinantof banking stability. The estimated coefficient on the LOLR variable has the expected negative sign, indicating that an increase in central bank discounting lowers the probabilityof a bankingcrisis but is not significantlydifferent from zero. This result is striking and suggests that despite anecdotal evidence and great stress placed on its importance in the literature, LOLR behavior does not provide a systematic explanationof banking stability.
47 What would be the standardof comparison?A 5 percent increase in branches per bank comparedwith a 5 percentincreasein centralbankdiscountingor a 5 percentdepreciationin the value of the nationalcurrency? 48 For countries that experienced banking crises in 1930 (Estonia, France, and the United States), 1930data are used. This ameliorates,but does not eliminate,the simultaneityproblem.

Banking Stability During the Depression

TABLE

675

SINGLE-VARIABLE PROBIT RESULTS (Dependent variable: countries that underwent a banking crisis = 1) Log Likelihood -12.12 -13.39 -12.05 -15.85 -13.55 -14.87 -13.58 -11.39 -17.26 -16.30

Independent Variable Structural variables Branches per bank Population per bank Assets per bank Capital-to-assets ratio Macro variablesa Currency value Freight-ton-kilometers Industrial production Real GNP WPIb LOLR variablea ACentral bank discounts

Coefficient -0.0920* (0.0482) -0.00329* (0.00182) -0.0408 (0.0283) 2.507 (6.662) 0.0540** (0.0219) -0.00381 (0.0234) -0.0152 (0.0252) -0.0271 (0.0546) -0.00998 (0.0321) -0.00672 (0.00509)

Constant 0.849** (0.401) 0.710* (0.388) 0.623 (0.370) -0.209 (0.748) -4.874** (2.044) 0.174 (0.437) -0.0824 (0.445) -0.357 (0.413) -0.157 (0.712) 0.171 (0.269)

N 25 25 23 23 25 22 20 17 25 25

* = One-tail test significant at the 5 percent level. ** One-tail test significant at the 2.5 percent level.

Variables represent 1931 values relative to 1929, except for Estonia, France, and the United States, where 1930 values (relative to 1929) are used. b CPI for Lithuania. Note: Figures in parentheses are standard errors. Sources: For structural data, see Tables 1 and 2. For currency value, see Table 3. For other macro variables, see League of Nations, Statistical Year-Book, and Mitchell, European Historical Statistics. For LOLR data, see League of Nations, Commercial and Central Banks, and Urquhart, Historical Statistics of Canada, p. 203.

Ideally, the sources of banking stability should be evaluated with multivariatetests, which would be informativeon two levels. First, they would allow a systematic assessment of the relative importanceof each of the three major categories. Second, they would enable us to assess the relative importanceof the differentmeasures within each category. However, because of the small number of observations and high correlationsamong the variableswithinthe majorcategories, such tests yield estimated coefficients with relatively large standarderrors. One such multivariableprobit is presented in Table 5, specificationI, which includes two bank structureand two macro variables. Though four of the five estimated coefficients have the expected signs, only that on currency value is significantat standardlevels.49
4 Several resampling techniques, such as the bootstrap and the jackknife, have been developed to improve small-sample inference. Efron, The Jackknife. Adkins, "Small Sample Inference,"

676

Grossman
TABLE

MULTIVARIABLE PROBIT RESULTS (Dependent variable: countries that underwent a banking crisis = 1) Independent Variable Constant Branches per bank Population per bank Currency valuea
WPIa,b

I -5.760 (3.354) -0.133 (0.125) -0.00228 (0.00304) 0.0695* (0.0382)

II

III

IV

VI 0.377 (0.912)

VII 0.440 (0.511)

Freight-ton-kilometersa,C ACentral bank discountsa N Log-likelihood

0.612 0.335 -4.616* -4.166 (2.352) (0.516) (2.578) (0.858) -0.102* -0.121* -0.0858 (0.0680) (0.0507) (0.0556) -0.00381 (0.00230) 0.0597** 0.0559* (0.0259) (0.0286) -0.0126 (0.0368) -0.0563 -0.0664 (0.0346) (0.0446) 0.00355 0.00120 -0.00458 -0.00622 -0.000493 (0.0106) (0.00751) (0.00672) (0.00709) (0.00673) 25 25 25 25 25 -10.141 -9.515 -11.743 -9.556 -7.402

-0.00298 -0.00351* (0.00184) (0.00186)

-0.0189 (0.0381) -0.0320 (0.0297) -0.00589 -0.00771 (0.00636) (0.00675) 25 25 -12.690 -12.173

* = One-tail test significant at the 5 percent level. ** = One-tail test significant at the 2.5% level.

Variables represent 1931 values relative to 1929, except for Estonia, France, and the United States, where 1930 values (relative to 1929) are used. b CPI for Lithuania. c Freight-tons for the Netherlands, Portugal, and Spain. Note: Figures in parentheses are standard errors. Sources: See Table 4.
a

probitsusing one An alternativeapproachis to estimate multivariable measure from each of the three categories. This both economizes on The problem.50 degrees of freedom and eliminatesthe multicollinearity results are reported in Table 5, specifications II through VII. The currency value yields consistently significantcoefficients and is robust to changes in the bank structurevariable. The estimatedcoefficients on other macro variables have the appropriatenegative signs but are not significantat standardlevels.51The estimated coefficientson both bank structurevariables are negative and significantat the 5 percent level in specificationsII, IV, and VII (and at the 6 percent level elsewhere). The estimatedcoefficienton the LOLR variableis usually negative, although it is nowhere significantat standardlevels. The coefficients on currency value are consistently significant, but other macroeconomic variables do not performas well and are not as robust to changes in bank structureand LOLR variables. This result demonstrates the importance of devaluation in allowing more accomconcludes that bootstrapping a probit is not superior to the standard maximum likelihood estimation. s0 However, this procedure may introduce omitted variable bias. s' In specification IV, the estimated coefficient on freight-ton-kilometers is significant at the 6 percent level.

Banking Stability During the Depression

677

modatingmonetary policy and promotingfinancialstability quite apart from its effects on aggregateeconomic activity. Banking structurealso appears to be an important explanatory variable, although it is less robust than the value of the currency. Once corrected for macroeconomic performance and banking structure, the lender of last resort variable does not systematically explain bankingstability.52 The results of each of these tests strongly support exchange-rate policy as a determinantof banking stability during the Great Depression. Other macroeconomic indicators are less useful in explaining stability. Banking structure also appears to be important,though it is less robust as an explanatoryvariable. Perhapsthe most strikingresult is that lender-of-last-resort performancedoes not systematicallyexplain banking stability.
CONCLUSION

Consideredindividually,anecdotal evidence supportsbankingstructure, macroeconomic policy and performance,and LOLR behavior as explanations of banking stability during the Great Depression. Stable bankingsystems were typically characterizedby more extensive branch networks, greater concentration, and larger institutions. Such banking systems most often existed in countries that abandoned the gold standardearly, where loan and investment portfolios performedwell, and where lenders of last resort rendered assistance to the banking system. Econometric tests demonstrate strongest support for exchange-rate policy as an explanatoryvariable. This result highlightsthe importance of devaluation and the ability of devaluing countries to undertake expansionary monetary policy without causing a run on domestic financial institutions. The tests also support banking structure as an explanation of banking stability, though the support is less robust. There is little evidence to support LOLR behavior-as measured by centralbank discounting-as havingbeen systematicallyresponsiblefor bankingstability. This does not mean that LOLR was nowhere important or that macroeconomic performanceand banking structure were everywhere important. For countries on the periphery of industrializedEurope-Spain,Portugal, Greece, Lithuania, and Bulgaria-stability was promoted by isolation of one sort or another. High tariff walls, selfsufficiency, and early departurefrom the gold standardrenderedthese countries relatively immuneto external shocks. By contrast, Romania, which did not depart from gold until 1932, and Hungary, which had relatively close economic ties with Austria, importedbankingcrises.
'S

This result may be due to the difficultyin adequatelymeasuringLOLR operations.

678

Grossman

The larger, more industrialized countries of Czechoslovakia and Sweden benefited both from structural advantages and from early departuresfrom gold, which permittedtheir centralbanks to undertake expansionarymonetarypolicy.53 The bankingsystems of Denmarkand Finland appear to have had similar advantages. By contrast, France, Poland, Switzerland,and Belgium, where banks had some of the same structuraladvantages,experiencedcrises in largemeasurebecause they failed to abandon the gold standard.The Netherlands, however, with large, concentrated, and well-branchedbanks but late to abandon the gold standard,survived the period with its bankingsystem intact.54 Britain and Canadawere characterizedby structurallyrobust banks and made relatively timely departures from gold. Yet the banking systems of both countries were faced with challenges that could well have led to collapse if it had not been for lenders of last resort. The experiences of these countries, however, was exceptional.
53 Larsson, "State, Banks and Industry," cites consolidation and tough banking regulations that resulted from Sweden's banking difficulties in the 1920s as contributing to banking stability in the 1930s. 54 Vanthemsche, "State, Banks and Industry," argues that this stability was due to consolidation brought about by banking instability in the 1920s.

Appendix
This appendix presents a brief justification for the classification of national banking systems as crisis or noncrisis. The categorization is not based on statistical criteria but on a qualitative analysis of the historical record. This categorization of countries is, of course, a simplification, as the severity of banking disturbances varied widely. Although the experiences of many countries (including the United States, Canada, Britain, Germany, and Austria) were extreme enough to easily fit into either the "crisis" or "noncrisis" category, others (Finland, for example) were more difficult to place and could have fit into a third, intermediate category. However, for simplicity the countries are divided into two categories. This classification draws heavily upon Bernanke and James, "Gold Standard" (table 2.7), the Economist, the Banker's Almanac, and League of Nations, Commercial Banks, 1925-33 and Commercial Banks, 1929-34.
CRISIS COUNTRIES

Austria

Belgium Estonia

Failure of Boden Credit Anstalt (1929), Credit Anstalt, and Vienna Mercur-Bank (1931). Heavy losses to Wiener Bank-Verein and Escompte-Gesellschaft (1932). Rumors about imminent failure of Banque de Bruxelles (1931). Failure of Banque Belge de Travail (1934). Failure of Estonia Government Bank Tallin and Reval Credit Bank

Banking Stability During the Depression

679

France

Germany Hungary Italy Latvia Norway

Poland Romania

Switzerland

United States Yugoslavia

(1930). Run on banks following British departure from gold (1931). Temporary moratoria on banks by government (1931 and 1932). Government intervention through National Mortgage Bank and other state banks. Failure of local banks such as Banque Adam, Oustric Group, Banque Renauld, Charpenay, Veuve Guerin; a regional bank, Banque d'Alsace-Lorraine; and the national Banque Nationale de Cr6dit (1930-1931). Forced merger of major investment bank, Banque de l'Union Parisienne (1932). Failure of Berlin grossbank, the Darmstader und Nationalbank (Danatbank) and bank holiday (1931). Run on Budapest banks, bank holiday (1931). Breakup of Banca Agricola Italiana. Panic and government reorganization of banks (1931). Run on banks following collapse of Danat and Credit Anstalt. Government decree limiting depositors' right to make withdrawals. Suspension of two of the country's largest banks, Bergens Privatbank and Den Norske Creditbank (1931). Temporary (three-month) moratorium on old deposits and government guarantee of new deposits. Nordvik, in "Scandanavian Banking," argues that Norwegian banks were stable. Bank runs following Austrian and German banking crises. Severe external and internal drains. Run on or collapse of Banca Generala a Tarii Romanesti, Banca de Credit Roman, Banca Romaneasca, Banca Marmerosch, Blank & Co., Banque Generale du Pays Roumain. Many banks placed under special protection pending reorganization or final liquidation. Rescue of Union Financiere. Failure of Banque de Gen6ve and three-week run on banks (1931). Restructuring of Banque Populaire Suisse (1933). Banque d'Escompte Suisse suspended. Substantial bank failures throughout the 1929 to 1933 period, culminating in the bank holiday of March 1933. Bank runs following Credit Anstalt crisis and German and Hungarian suspensions.
NONCRISIS COUNTRIES

Bulgaria

Canada Czechoslovakia

Denmark

Finland

Despite the failure of several small banks, there was no general run on the banks. Bulgarian banks appear not to have been severely affected by the Austrian and German banking crises. In 1934, the government arranged a merger of a number of banks, although this does not appear to have been the result of crisis. Despite a severe economic downturn and a decline in bank profitability, there were no bank failures. Heavy domestic withdrawals, but no general panic. Commercial banks less exposed than their neighbors to the Austrian and German crises. Despite exchange controls and substantial write-downs on the part of banks, there were no large failures and no bank holiday. Compared with other countries, commercial bank deposits fell only slightly during 1931. There was no general run on the banks and no suspension of payments by any commercial bank. A somewhat ambiguous case. There was a reduction in the number of banks between 1929 and 1933; however, the Economist, in its

680

Grossman
regular reports on Finland, makes practically no mention of the banking situation. According to Mazower, "Banking and Economic Development" (pp. 224-25), "what is striking about Greek banks is their avoidance of the sort of crisis which occurred elsewhere in the Balkans." Though there was a currency crisis and several bank failures, there does not appear to have been a major banking upheaval. Despite heavy withdrawals from the commercial banks, there were no moratoria or legal restrictions on withdrawals. Only one private banking firm was forced to suspend payments as a result of the crisis of 1931. The German banking crisis was severely felt and normal channels of payment (with Germany) were interrupted. The suspension of sterling convertibility was also felt. Substantial write-downs of bank capital, but no major bank suspensions or bank holiday. The number of commercial banks increased slightly during the period 1929 to 1932 and, according to Reis, "Portuguese Banking," one of the distinctive features of the Portuguese economy was the absence of a banking crisis. One large bank, Banca de Cataluhia,was liquidated but, according to Tortella and Palafox, "Banking and Industry in Spain" (p. 105), "nothing massive or drastic occurred, no really important banks suspended payments; no large scale 'salvaging operation' was required." The collapse of the Kreuger industrial and financial empire led to weakness of one large bank (Skandinaviska Kreditaktiebolaget), but "the events of 1931 had no serious visible repercussions on the commercial banks." (League of Nations, Commercial Banks, 192533, p. 193). Deposits and assets dropped only slightly between 1930 and 1933 (and, in fact, rose from 1929 to 1933). Despite a sterling crisis in 1931, not one bank failed during the period.

Greece

Lithuania

Netherlands

Portugal

Spain

Sweden

United Kingdom

REFERENCES Adkins, Lee, "Small Sample Inference in the Probit Model" (manuscript, Oklahoma State University, Stillwater, 1991). Bagehot, Walter, Lombard Street (London, 1910). Balogh, Thomas, Studies in Financial Organization (Cambridge, 1950). The Bankers' Almanac and Year Book, 1930 (West Sussex, 1931). Bernanke, Ben, "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression," American Economic Review, 73 (June 1983), pp. 257-76. Bernanke, Ben, and Harold James, "The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison," in R. Glenn Hubbard, ed., Financial Markets and Financial Crises (Chicago, 1991), pp. 33-68. Beyen, J. W., Money in a Maelstrom (New York, 1949). Cagan, Phillip, Determinants and Effects of Changes in the Stock of Money, 1875-1960 (New York, 1965). Calomiris, Charles, and Gary Gorton, "The Origins of Banking Panics: Models, Facts, and Bank Regulation," in R. Glenn Hubbard, ed., Financial Markets and Financial Crises (Chicago, 1991), pp. 109-74.

Banking Stability During the Depression

681

Calomiris, Charles, and Larry Schweikart, "The Panic of 1857: Origins, Transmission, and Containment," this JOURNAL, 51 (Dec. 1991), pp. 807-34. Calomiris, Charles, "The Costs of Rejecting Universal Banking: American Finance in the German Mirror, 1870-1914" (manuscript, University of Illinois, Urbana, 1992). Committee on Finance and Industry (Macmillan Committee), Report (London, 1931). Comptroller of the Currency, Annual Report (Washington, various years). Crick, W. F., and J. E. Wadsworth, A Hundred Years of Joint Stock Banking (London, 1936). Drummond, Ian, "Why Canadian Banks Did Not Collapse in the 1930s," in Harold James, Hakan Lindgren, and Alice Teichova, eds., The Role of Banks in the Interwar Economy (Cambridge, U.K., 1991), pp. 232-50. Efron, Bradley, The Jackknife, the Bootstrap, and Other Resampling Plans (Philadelphia, 1982). Eichengreen, Barry, Golden Fetters (Oxford, 1992). Eichengreen, Barry, "The Bank of France and the Sterilization of Gold, 1926-32," Explorations in Economic History, 23 (Jan. 1986), pp. 56-84. Eichengreen, Barry, and Richard Portes, "The Anatomy of Financial Crises," in Richard Portes and Alexander Swoboda, eds., Threats to International Financial Stability (Cambridge, U.K., 1987), pp. 10-57. Eichengreen, Barry, and Jeffrey Sachs, "Exchange Rates and Economic Recovery in the 1930s," this JOURNAL, 45 (Dec. 1985), pp. 925-46. Fisher, Irving, "The Debt-Deflation Theory of Great Depressions," Econometrica, 1 (Oct. 1933), pp. 337-57. Friedman, Milton, and Anna Schwartz, A Monetary History of the United States, 1867-1960 (Princeton, NJ, 1963). Goodhart, Charles, The Evolution of Central Banks (Cambridge, MA, 1988). Gorton, Gary, "Clearinghouses and the Origin of Central Banking in the United States," this JOURNAL, 45 (June 1985), pp. 277-83. Humphrey, Thomas, "The Classical Concept of the Lender of Last Resort," Federal Reserve Bank of Richmond Economic Review, 61 (Jan./Feb. 1975), pp. 2-9. James, Harold, The German Slump: Politics and Economics, 1924-1936 (Oxford, 1986). James, Harold, "Financial Flows Across Frontiers During the Interwar Depression," Economic History Review, 45 (Aug. 1992), pp. 594-613. Johnson, Joseph, The Canadian Banking System (Washington, 1910). Kindleberger, Charles, The World in Depression, 1929-1939 (Berkeley, 1973). Kindleberger, Charles, Manias, Panics, and Crashes (New York, 1978). Laderman, Elizabeth, Ronald Schmidt, and Gary Zimmerman, "Location, Branching, and Bank Portfolio Diversification: The Case of Agricultural Lending," Federal Reserve Bank of San Francisco Economic Review (Winter 1991), pp. 24-38. Larsson, Mats, "State, Banks and Industry in Sweden, with Some Reference to the Scandinavian Countries," in Harold James, Hakan Lindgren, and Alice Teichova, eds., The Role of Banks in the Interwar Economy (Cambridge, 1991), pp. 80-103. League of Nations, Commercial Banks, 1925-33 (Geneva, 1934). League of Nations, Commercial Banks, 1929-34 (Geneva, 1935). League of Nations, Statistical Year-Book (Geneva, various years). League of Nations, Monetary Review (Geneva, 1938). League of Nations, Commercial and Central Banks (Geneva, 1938). Lewis, W. Arthur, Economic Survey, 1919-1939 (London, 1981). Lovell, Michael C., "The Role of the Bank of England as Lender of Last Resort in the Crises of the Eighteenth Century," Explorations in Entrepreneurial History, 10 (Oct. 1957), pp. 8-21. McIvor, R. Craig, Canadian Monetary, Banking and Fiscal Development (Toronto, 1958).

682

Grossman

Madden, John T., and Marcus Nadler, The International Money Markets (New York, 1935). Mazower, Mark, "Banking and Economic Development in Interwar Greece," in Harold James, Hakan Lindgren, and Alice Teichova, eds., The Role of Banks in the Interwar Economy (Cambridge, 1991), pp. 206-31. Mengle, David, "The Case for Interstate Branch Banking," Federal Reserve Bank of Richmond Economic Review, 76 (Nov./Dec. 1990), pp. 3-16. Minsky, Hyman, Inflation, Recession and Economic Policy (New York, 1982). Miron, Jeffrey, "Financial Panics, the Seasonality of the Nominal Interest Rate, and the Founding of the Fed," American Economic Review, 76 (Mar. 1986), pp. 125-40. Mishkin, Frederick, "Anatomy of a Financial Crisis" (manuscript, NBER, Cambridge, MA, 1991). Mitchell, B. R., European Historical Statistics, 1750-1970 (New York, 1978). Nordvik, Helge, "Scandinavian Banking in the Interwar Period: A Case Study of the Norwegian Banking System and Banking Policy in a Scandinavian Perspective" (manuscript, Sandvika, Norway, 1992). Reis, Jaime, "Portuguese Banking in the Inter-War Period," (manuscript, Lisbon, Portugal, 1992). Romer, Christina, and David Romer, "Does Monetary Policy Matter? A New Test in the Spirit of Friedman and Schwartz," NBER Macroeconomics Annual, 4 (1989), pp. 121-70. Sayers, Richard, The Bank of England, 1891-1944 (Cambridge, 1976). Shearer, Ronald, and Carolyn Clark, "Canada and the Interwar Gold Standard, 1920-35: Monetary Policy without a Central Bank," in Michael Bordo and Anna Schwartz, eds., A Retrospective on the Classical Gold Standard, 1821-1931 (Chicago, 1984), pp. 277-302. Sprague, 0. M. W., History of Crises Under the National Banking System (Washington, 1910). Temin, Peter, Did Monetary Forces Cause the Great Depression? (New York, 1976). Temin, Peter, Lessons From the Great Depression (Cambridge, MA, 1989). Thornton, Henry, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (London, 1802; reprint, New York, 1939). Tortella, Gabriel, and Jordi Palafox, "Banking and Industry in Spain, 1918-1936," The Journal of European Economic History, 13 (Fall 1984), pp. 81-111. Truptil, R. J., British Banks and the London Money Market (London, 1936). U.S. Department of Commerce, Historical Statistics of the United States (Washington, DC, 1976). U.S. Treasury, Modernizing the Financial System (Washington, 1991). Urquhart, M. C., ed., Historical Statistics of Canada (Toronto, 1965). Vanthemsche, Guy, "State, Banks and Industry in Belgium and The Netherlands, 1919-1939," in Harold James, Hakan Lindgren, and Alice Teichova, eds., The Role of Banks in the Interwar Economy (Cambridge, 1991), pp. 104-21. White, Eugene N., "Before the Glass-Steagall Act: An Analysis of the Investment Banking Activities of National Banks," Explorations in Economic History, 23 (Jan. 1986), pp. 33-55. Wicker, Elmus, "A Reconsideration of the Causes of the Banking Panic of 1930," this
JOURNAL

40 (Sept. 1980),pp. 571-83.