Working Paper: NBER ID: w25897
Authors: Charles W. Calomiris; Matthew S. Jaremski; David C. Wheelock
Abstract: Liquidity shocks transmitted through interbank connections contributed to bank distress during the Great Depression. New data on interbank connections reveal that banks were much more likely to close when their correspondents closed. Further, after the Federal Reserve was established, banks’ management of cash and capital buffers was less responsive to network liquidity risk, suggesting that banks expected the Fed to reduce that risk. Because the Fed’s presence removed the incentives for the most systemically important banks to maintain capital and cash buffers that had protected against liquidity risk, it likely contributed to the banking system’s vulnerability to contagion during the Depression.
Keywords: Interbank connections; Contagion; Bank distress; Great Depression
JEL Codes: G21; L14; N22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Closure of correspondent banks (F65) | Closure probability of respondent banks (G21) |
| Number of respondent banks (G21) | Closure risk of correspondent banks (F65) |
| Closure of other banks in local market (G21) | Bank failure probability (G21) |
| Establishment of the Federal Reserve (E58) | Reduction in banks' liquidity risk management (G21) |