Bank Capital and Portfolio Management: The 1930's Capital Crunch and Scramble to Shed Risk / Charles W. Calormiris, Berry Wilson.

By:

Calormiris, Charles W

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w6649.Publication details: Cambridge, Mass. National Bureau of Economic Research 1998.Description: 1 online resource: illustrations (black and white)Subject(s):

G21 - Banks • Depository Institutions • Micro Finance Institutions • Mortgages
G32 - Financing Policy • Financial Risk and Risk Management • Capital and Ownership Structure • Value of Firms • Goodwill

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Abstract: Recent models of banking under asymmetric information argue that depositors penalize banks that offer high-risk deposits. Focusing on New York City banks in the 1920's and 1930's, this study examines how banks manage risk during normal times and in response to severe shocks. We develop and apply a simple framework that identifies the tradeoffs among alternative means of satisfying depositors' preferences for low-risk deposits (i.e. low asset risk versus high capital). During the 1920's profitable lending opportunities and low costs of raising capital prompted banks to increase their asset risk, while increasing capital to maintain low default risks on deposits. Cross-sectional differences in the cost of raising equity explain differences in banks' choices of asset risk and capital ratios. In the wake of the loan losses produced by the Depression, high default risk was penalized with deposit withdrawals. To reduce deposit risk, banks increased their riskless assets and cut dividends, but avoided costly equity issues. Banks with high default risk or with high costs of raising equity contracted dividends the most during the 1930's.

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Holdings
Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w6649 (Browse shelf(Opens below))	Not For Loan

Total holds: 0

July 1998.

Recent models of banking under asymmetric information argue that depositors penalize banks that offer high-risk deposits. Focusing on New York City banks in the 1920's and 1930's, this study examines how banks manage risk during normal times and in response to severe shocks. We develop and apply a simple framework that identifies the tradeoffs among alternative means of satisfying depositors' preferences for low-risk deposits (i.e. low asset risk versus high capital). During the 1920's profitable lending opportunities and low costs of raising capital prompted banks to increase their asset risk, while increasing capital to maintain low default risks on deposits. Cross-sectional differences in the cost of raising equity explain differences in banks' choices of asset risk and capital ratios. In the wake of the loan losses produced by the Depression, high default risk was penalized with deposit withdrawals. To reduce deposit risk, banks increased their riskless assets and cut dividends, but avoided costly equity issues. Banks with high default risk or with high costs of raising equity contracted dividends the most during the 1930's.