Are Prudential Supervision and Regulation Pillars of Financial Stability? Evidence from the Great Depression

Abstract

Drawing on the variation in financial distress across U.S. states during the Great Depression, this article suggests how bank supervision and regulation affected banking stability during the Great Depression. In response to well-organized interest groups and public concern over the bank failures of the 1920s, many U.S. states adopted supervisory and regulatory standards that undermined the stability of state banking systems in the 1930s. Those states that prohibited branch banking, had higher reserve requirements, granted their supervisors longer term lengths, or restricted the ability of supervisors to liquidate banks quickly experienced higher state bank suspension rates from 1929 to 1933.

Shareholder Liability and Bank Failure

“…Because state banking laws closely followed the National Banking Act (which regulated National banks), the laws were relatively homogenous. Nevertheless, important differences remained (Mitchener 2005(Mitchener , 2007. The choice of single or double liability, discussed in the next section, was one of them.…”

“…We investigate these concerns by hand-collecting and comparing banking regulations across our state-Fed district pairs. To determine which elements of regulation were important, we follow the existing literature, especially Federal Reserve (1932), White (1983), and Mitchener (2005Mitchener ( , 2007.…”

“…Third, we assess the quality of the state regulator. Federal Reserve (1932) documents considerable variation across states (see also Mitchener 2005Mitchener , 2007. Based on a 1929 American Bankers Association survey of state regulators (amended with state statutes), Federal Reserve (1932) discusses nine categories of regulator quality, some of which have multiple sub-categories.…”

Changing Retail Banking Supply-Demand Mismatch

“…These benefits lead some to claim that branch banking helps increase the stability of the banking system (Preston, 1924;Southworth, 1928;Gart, 1994). Various empirical studies confirm that the branch banking system is indeed less prone to banking crisis than the unit banking system, both domestically (Wernette, 1932;Wheelock, 1995;Mitchner, 2000), and internationally (Bordo, 1985;Grossman, 1994).…”