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There’s Usually a Banking Crisis Somewhere!

Wednesday, September 21, 2011

Add together fundamental illiquidity and smallness of capital, and what have you got?

Should we be surprised by banking crises? No. We simply have to face the fact that banking is fundamentally risky. As I realized long ago while working in banks, the reason bankers needed to wear dark suits and have classic buildings was to look conservative in order to offset the real riskiness of what we were doing.

In their book This Time Is Different, Carmen Reinhart and Kenneth Rogoff point out that some countries seem to have “graduated” from defaults on the debt of their own government (although the continuing European sovereign debt crisis may make us less sanguine about this). But no one has figured out how to avoid periodic crises in banking. “Thus far,” they observe, “no major country has been able to graduate from banking crises.”

Indeed, drawing from Reinhart and Rogoff’s very long list of banking crises, we find that in the century between 1901 and 2000, a banking crisis began in one or more countries (often in several simultaneously) in 54 of the 100 years! The crises can last multiple years; the list below shows the initial years. Of course, this data does not include the great international banking crisis of 2007-09, now rekindled in Europe from 2010-?, and looks instead back to a century of “good old days.”

So let us consider the entire 20th century, in which there were both vast catastrophes and amazing progress, and in which a great many things changed dramatically, but in which, the record shows, the tendency of banking to experience a crisis did not change.

Banking Crises, 1901-2001, According to Reinhart and Rogoff*

Year          Countries

1901-1910

1901        Germany, Japan

1902        Denmark

1904        Canada

1907        United States, France, Italy, Denmark, Sweden, Japan, Chile, Egypt

1908        Canada, Scotland, India, Mexico

1910        Switzerland

Years in decade with a crisis started: 6


1911-1920

1912        Canada

1914        Belgium, Italy, Netherlands, Argentina, Brazil, United States

1917        Japan

1920        Spain, Portugal

Years in decade with a crisis started: 4


1921-1930

1921        Denmark, Finland, Norway, Italy, Netherlands

1922        Sweden

1923        Canada, China, Japan, Brazil, Portugal

1924        Austria, Spain

1925        Belgium

1926        Poland

1927        Japan

1929        United States, Austria, Mexico

1930        France, Italy, Estonia

Years in decade with a crisis started: 9


1931-1940

1931        Germany, Austria, Belgium, Czechoslovakia, Denmark, Finland, Norway, Sweden, Estonia, Latvia, Greece,

    Hungary, Poland, Romania, Portugal, Spain, Switzerland, Argentina, Egypt, Turkey, China

1933        Switzerland, United States

1934        Argentina, Belgium, China

1935        Italy

1936        Norway

1939        Belgium, Finland, Netherlands

Years in decade with a crisis started: 6


1941-1950

Years in decade with a crisis started: 0


1951-1960

Years in decade with a crisis started: 0


1961-1970

1963        Brazil

Years in decade with a crisis started: 1


1971-1980

1971        Uruguay

1974        United Kingdom

1976        Chile, Central African Republic

1977        Spain, Germany, Israel, South Africa

1978        Venezuela

1979        Thailand

1980        Argentina, Chile, Egypt, Chad

Years in decade with a crisis started: 7


1981-1990

1981        Ecuador, Mexico, Philippines, Uruguay

1982        Mexico, Hong Kong, Singapore, Columbia, Congo, Ghana, Trinidad and Tobago, Turkey

1983        Canada, Taiwan, Thailand, Hong Kong, Israel, Peru, Kuwait, Morocco, Equatorial Guinea, Niger

1984        United States, United Kingdom, Mauritania

1985        Argentina, Brazil, Gambia, Guinea, Kenya, Malaysia, Iceland

1986        Korea, Brunei

1987        Denmark, Norway, New Zealand, Bolivia, Costa Rica, Nicaragua, Cameroon, Mali, Mozambique, Tanzania,

    Bangladesh

1988        Lebanon, Benin, Burkina Faso, Central African Republic, Cote d’Ivoire, Lesotho, Madagascar, Senegal, Nepal,

    Panama

1989        Australia, Argentina, South Africa, El Salvador, Jordan, Papua New Guinea, Sri Lanka

1990        Brazil, Egypt, Algeria, Italy, Romania, Sierra Leone

Years in decade with a crisis started: 10


1991-2000

1991        United Kingdom, Sweden, Finland, Czech Republic, Hungary, Poland, Slovakia, Greece, Congo, Djibouti,

    Liberia, Rwanda, Tunisia, Georgia, Guatemala

1992        Japan, Mexico, Indonesia, Estonia, Albania, Bosnia and Herzegovina, Angola, Chad, Congo, Kenya, Nigeria

1993        Venezuela, India, Iceland, Macedonia, Slovenia, Eritrea, Guinea, Kenya, Togo, Kyrgyz Republic

1994        France, Indonesia, Mexico, Brazil, Bolivia, Costa Rica, Ecuador, Estonia, Latvia, Armenia, Botswana, Burundi,

    Congo, Cote d’Ivoire, Ethiopia, Uganda, Jamaica, Turkey

1995        Russia, United Kingdom, Taiwan, Argentina, Paraguay, Azerbaijan, Belarus, Bulgaria, Lithuania, Cameroon,

    Gabon, Guinea-Bissau, Swaziland, Zambia, Zimbabwe, Jamaica

1996        Thailand, Croatia, Dominican Republic, Ecuador, Kenya, Myanmar, Tajikistan, Yemen

1997        China, Indonesia, Korea, Taiwan, Malaysia, Philippines, Vietnam, Ghana, Mauritius, Nigeria, Ukraine

1998        Russia, Hong Kong, Columbia, Ecuador, El Salvador, Estonia

1999        Bolivia, Honduras, Peru

2000        Nicaragua, Turkey

Years in decade with a crisis started: 10


Total years in which a banking crisis started:

        1901-1950: 26 (52%) **

        1951-2000: 28 (56%)

Grand Total: 54 (54%)

*Source: Carmen M. Reinhart and Kenneth S. Rogoff, ‘This Time Is Different’ (2009), Appendix A.4, Historical Summaries of Banking Crises, pp 348-392.

** I have made one addition to Reinhart and Rogoff’s list: the United States in 1933, since I consider the nationwide collapse and closing of the banks that year to rank as a new crisis.


Obviously, it is normal to have banking crises. They were especially frequent in the last three decades of the 20th century (let alone the first decade of the succeeding 21st century!) The 1980s and 1990s have the distinction of having had 100 percent of their years feature crises starting somewhere. Is there group learning in banking? If so, it is not observable on this list.

You will have noticed that the different decades were the 1940s, 1950s, and 1960s. In the 1940s, countries were busy destroying each other, which required running up government debt in service of the war with no questions asked and using the banks to help do so. The disaster was unimaginably greater than a mere financial crisis, and was followed by the disappearance of the old governments and currencies of the losers, the financial exhaustion of a victorious but bankrupt Britain, and then the anomalous postwar era of U.S. dominance, which allowed that country to bail out Europe with the Marshall Plan.

In the 1950s, the U.S. economy and its financial markets, banking system, companies, and currency enjoyed global dominance—a unique historical period bound not to last. It was fading in the 1960s and gone by the 1970s, which began with the United States abrogating its international commitment to redeem dollars for gold, and the steep depreciation of the dollar that followed. The normal round of banking crises returned and has not departed.

What is it about banking? The problem seems pretty straightforward. First, since banks promise to make everyone else liquid by par redemption of short-dated liabilities, they are themselves fundamentally illiquid and cannot on their own survive a liquidity panic. “Against such panic,” as economist David Ricardo wrote, “banks have no security on any system.” Second, banking is the most leveraged of businesses. The great banking theorist Walter Bagehot pointedly observed, “The main source of the profitableness of established banking is the smallness of the requisite capital.”

Add together fundamental illiquidity and smallness of capital, and what have you got? Usually a banking crisis somewhere.

Alex J. Pollock is a resident fellow at the American Enterprise Institute.

FURTHER READING: Pollock also writes “National Debt Is Larger, More Subtle Than Thought,” “Goodbye, Gold Redemption of the Dollar,” “The Delicious Irony of the Downgrade,” and “The Government’s Four-Decade Financial Experiment.”

Image by Rob Green | Bergman Group

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