A banking crisis is often seen as a self-fulfilling prophecy: banks fail because too many people, anticipating failure, pull their money out at the same time. But a newly published paper coauthored by finance professor Emil Verner suggests that banks can suffer losses serious enough to cause economic downturns even when that dramatic panic never happens.
The researchers examined bank stock prices and dividends, gross domestic product, inflation, and other data from 46 countries between 1870 and 2016. They found that a 30% decline in banking-sector equity predicts a 4.6% drop in real GDP after three years when creditors visibly panic—and a 2.7% drop when they don’t.
These quiet panics tend to happen when banks have lost assets through decisions such as bad loans. In those cases, Verner says, banks reduce lending, leaving businesses and households with less access to the credit that fuels economic growth.
“The panics don’t just come out of the blue. They tend to be preceded by bank stocks declining,” he says. “The bank equity investors recognize the bank is going to suffer losses on the loans it has. And so what that suggests is that panics are really often the consequences, rather than the fundamental cause, of troubles that have already built up in the banking system due to bad loans.”
The researchers have presented their findings to policymakers in hopes that it will help them respond to future crises.