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This Time Is Different: Causes and Consequences of British Banking Instability over the Long Run

Journal: Journal of Financial Stability

Date: 20161201

Author: Campbell, Gareth; Coyle, Christopher; Turner, John D.

Abstract:
This paper addresses three questions: (1) How severe were the episodes of banking instability experienced by the UK over the past two centuries? (2) What have been the macroeconomic indicators of UK banking instability? and (3) What have been the consequences of UK banking instability for the cost of credit? Using a unique dataset of bank share prices from 1830 to 2010 to assess the stability of the UK banking system, we find that banking instability has grown more severe since the 1970s. We also find that interest rates, inflation, lending growth, and equity prices are consistent macroeconomic indicators of UK banking instability over the long run. Furthermore, utilising a unique dataset of corporate-bond yields for the period 1860 to 2010, we find that there is a significant long-run relationship between banking instability and the credit-risk premium faced by businesses.

Link: Google Scholar

Background and Context

Research Focus

This study examines 181 years of British banking history from 1830-2010 using a unique dataset of bank share prices to assess banking system stability and its relationship with macroeconomic indicators.

Methodology

The research uses vector autoregression models and Granger causality tests to analyze relationships between banking instability and macroeconomic variables, as well as impacts on corporate bond risk premiums.

Data Sources

The study utilizes hand-collected monthly share price data for British commercial banks, along with corporate bond yields and macroeconomic indicators spanning 1830-2010.

Growing Severity of UK Banking Instability Over Time

  • Shows the volatility in bank returns during documented crisis periods from 1836-2008
  • Demonstrates increasing severity of banking instability in recent decades
  • The 2007-8 crisis represented an unprecedented decline in bank returns

Bank Performance During Major Crisis Episodes

  • Compares the percentage of banks losing over 20% of their value during major crises
  • Shows significantly higher systemic impact in modern crises (1974, 2007-8)
  • The 1974 secondary banking crisis affected all banks in the sample

Rising Corporate Bond Risk Premiums During Banking Crises

  • Demonstrates differential impact on high-risk vs low-risk firms during banking crises
  • High-risk firms face significantly higher borrowing costs during crises
  • Effect persists for multiple years after crisis onset

Key Macroeconomic Indicators of Banking Instability

  • Shows key macroeconomic variables that predict banking instability
  • Elevated levels of these indicators precede banking crises
  • Suggests importance of monitoring these variables for early warning systems

Impact of 2007-8 Crisis on Corporate Bond Risk Premium

  • Shows unprecedented spike in corporate bond risk premium during 2008
  • Represents largest increase in borrowing costs in sample period
  • Demonstrates effectiveness of policy response in returning premium to normal levels by 2009

Contribution and Implications

  • Provides first long-run quantitative measure of UK banking stability using share price data
  • Identifies consistent macroeconomic indicators of banking instability over 181-year period
  • Demonstrates increasing severity of modern banking crises and their disproportionate impact on smaller firms

Data Sources

  • Bank returns chart based on Table 2 showing performance during documented crisis periods
  • Bank losses chart constructed from Table 2 data on percentage of banks losing value
  • Risk premium chart based on Table 6 showing average variable changes during banking crises
  • Macroeconomic indicators chart based on Table 3 Panel A data
  • 2007-8 crisis impact chart constructed from Table 6 Panel B data