Why Do Banks Fail? Evidence from the 1920s

Abstract

This paper examines the causes of rural bank failures during the 1920s using a newly created state-level data series. By focusing on rural banks we are able to investigate the impacts of agricultural distress and government policies on the class of banks accounting for 80% of the failures in the decade. Failure rates were highest where farm acreage and land values had increased the most before 1920 because these regions suffered the worst agricultural distress subsequently. Agricultural distress caused more bank failures in states with deposit insurance systems, suggesting that insurance encouraged banks to increase risk as their net worth declined.

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