This article is from WeChat official account:Economic Observer Observer (ID: eeoobserver)< span class = "text-remarks">, author: Zhiwu, from the head of FIG: unsplash
In recent years, there has been a lot of discussion about the challenges facing the banking industry, especially many market participants have suspicions about how many non-performing loans the banking industry has. So why do they have so many concerns? Will bad assets really lead to a banking crisis and further extend into an economic crisis? What are the general causes of banking crises? Today we will talk about this topic.
Speaking of the banking crisis, you may immediately think of the American financial crisis in the 1930s and the Great Depression that it triggered, which is also the most serious economic crisis experienced by the modern world. Beginning with the Wall Street stock market crash in October 1929, a large number of industrial and commercial enterprises went bankrupt, and then a number of bank runs crises occurred between 1930 and 1933, which forced many commercial banks to close their business. Together with active liquidation and mergers and acquisitions, the total number of US commercial banks Therefore, it is reduced by more than 1/3.
What was the economic and social impact of the crisis? Either way, the US economy has contracted by more than 1/3, and the unemployment rate exceeded 25% at its peak. The reason why that period is called the “Great Depression” is because of the long duration of the crisis, the high degree of austerity, and the great social harm. Even the economies of Britain, Germany, Japan and even China have experienced severe recessions. Due to the impact of the Great Depression, trade protectionism and left-wing populism prevailed rapidly in the United States and other countries. Countries set up trade barriers and closed national doors, and finally fermented to the outbreak of World War II in 1939. In this sense, the whole process of the financial crisis that began in 1929 included the Great Depression of the 1930s, and it was not until the end of World War II in 1945 that it really ended.
So why did the unprecedented Great Depression happen? How could it be so destructive?
The unprecedented banking crisis
In the late 1920s, the U.S. stock market had an unprecedented boom. This was inseparable from the Fed’s loose monetary policy to bring European countries back to the gold standard, which allowed a lot of international capital to flow to the United States, and many bank funds to the stock market and Real estate has led to soaring stock prices and real estate prices, creating a serious asset bubble. The stock market bubble began to burst in October 1929, and by mid-1932, the stock index had fallen to 10% of its peak in 1929. The stock market crash also pierced the real estate bubble that had long been inflated, breaking various capital chains one after another. Many studies have also shown that the real estate and stock market bubbles in the 1920s were the fundamental premise of the Great Depression.
But how did the bubble burst into a banking crisis? As mentioned before, even today, banks in various countries still play a key role in the financial system. The people store their remaining change and most of their financial assets in the bank. Therefore, Banks are the anchor of the people’s sense of wealth and security. Once the banking system becomes insecure Society will collapse.
The bank’s profit model mainly relies on earning interest margins, that is, absorbing deposits, guaranteeing interest returns to depositors, and then lending out the pooled deposits to obtain loan interest rates. Here, the interest to depositors is fixed. Therefore, whether the bank is safe or not depends mainly on whether the loan can be recovered and whether the loan interest rate is high enough. In the late 1920s, a considerable amount of bank loans were invested in the stock market and real estate, so it is not surprising that the bursting of these asset bubbles immediately hit the banks.
So, how exactly did the banking crisis evolve?
Within one year after the stock market crash began, by October 1930, a large number of banks in the United States had gone bankrupt. People were worried that demand deposits and time deposits were generally withdrawn from banks and converted into hard currency, causing the loss of a large number of deposits. . At the beginning, the bank realized the liquid assets first to meet the demand for withdrawals, but then the current assets became less and less, which caused more depositors to rush to the bank for withdrawal, panic spread, and the run situation intensified. In November 1930, 256 banks went bankrupt, and 352 banks went bankrupt in December, especially the Bank of the United States at the time (not the current Bank of America “Bank of America”)‘s bankruptcy, because its name can easily be mistaken for an official bank, severely damaging people’s confidence.
In March 1931, the second bank run crisis came and lasted until August. During this period, international events also interacted with the Bank of America crisis. In May 1931, Austria’s largest private bank collapsed, shocking the entire European continent. Immediately afterwards, some German banks went bankrupt in July, and the banking industry of other countries was not immune. A large number of bank failures in the United States caused deposits in the banking system to fall by 7% in six months.
In the fourth quarter of 1932, a wave of bank failures swept the United States again, this time mainly in the Midwest. By February 1933, bank failures occurred in more regions, and bank closures spread. Before President Roosevelt officially took office in early March, the governors of several states announced that banks would be closed statewide.
On March 5, 1933, Roosevelt was sworn in as President of the United States. At midnight on March 6, he announced that the National Bank would take a week’s holiday, so he had no choice but to stabilize market sentiment.
The reason why the banking crisis was so serious was also because of some structural problems in the US banking industry at that time. On the one hand, the issue of loan liquidity we will talk about in the future, on the other hand, is the single banking system adopted by the United States before the Great Depression(unit banking ), that is, banks are not allowed to have multiple branches or branches, which greatly restricts the ability of banks to diversify risks. By 1929, only 2% of banks had branches nationwide, 3.6% of banks had branches in the state, and the remaining banks had only one branch; and even banks with branch branches had an average number of branches per bank Less than 4.4. This is in great contrast to Canada at the time, because Canada only had 18 banks, but 4,676 branch banks, and among the more than 30,000 banks in the United States, there were only 1,281 outlets outside the head office. The reason why the Bank of America was structured like this at that time was because they were worried that the banks were too large, and that they would control too many economic resources when they were too large.
From the perspective of bank risks, the single banking system has the lowest risk tolerance, because the survival of a single bank depends entirely on the local economy, and the local economy is easily threatened by large fluctuations It survives, and those banks that open branches across regions can take advantage of the incomplete correlation of local economies to diversify risks, and their ability to resist economic fluctuations will obviously be higher, just like Indian farmers like to marry their daughters away. The truth is the same. The structural differences in the banking system made the experiences of the United States and Canada in North America completely different between 1929 and 1933: no bank in Canada went bankrupt(Although about 10% of the outlets are closed), and one-third of the banks in the United States are closed. Bank runs have occurred one after another This has seriously affected the blood supply of the financial system to the real economy, and the sharp shrinkage of credit support has caused more real companies to close down, making the US economy’s downturn and unemployment pressure far more serious than Canada’s. These lessons should be remembered.
The Great Depression reshaped the U.S. banking industry
The Great Depression has profoundly affected all aspects of American politics, economy, and social life. In 1933, Congress passed the famous “Glass-Steagall Act” in the history of American financial legislation, also known as the “Banking Act of 1933”, which had two huge impacts on the US banking industry. The first was to establish a federal Deposit Insurance Company. In just six months since then, 97% of commercial banks in the United States have participated in deposit insurance, and less than 400 commercial banks have not participated in insurance, and their deposits accounted for less than 1%. The establishment of the deposit insurance system eliminates the panic of depositors, so that they do not need to run on banks in the event of a crisis, maintain financial stability, and also greatly reduce the losses of depositors when banks fail. Let’s look at a set of data: During the 13 years from 1921 to 1933, all commercial banks in the United States suffered a bankruptcy loss of 45 cents per year for every $100 in deposits. In the 27 years since the establishment of the deposit insurance system, for every $100 in deposits, the bankruptcy losses suffered less than 0.2 cents per year.
Secondly, the “Glass-Steagall Act” stipulates that commercial banks, investment banks and insurance must be separated to establish a so-called separate operation, so that U.S. commercial banks cannot engage in investment for more than 60 years. Bank business. The well-known Morgan Consortium was split into Morgan Commercial Bank and Morgan Stanley Investment Bank under this bill. The division of operations in the financial industry has its profound truths, because commercial banks mainly provide indirect financing services and provide people with a stable sense of wealth security, while investment banks are engaged in direct financing, especially with the development of financial products and businesses. With increasing complexity, separate business operations are a better way to control risks. However, this restriction was formally abolished in 1999, which to a certain extent paved the way for the 2008 financial crisis.
The Federal Reserve is another target of reforms after the Great Depression. The Federal Reserve was formally established in 1913, but at first its power was limited and concentrated in the New York Federal Reserve. Until the early 1930s, the Fed’s understanding of monetary policy was still on the gold standard and true.According to the level, it does not possess the ideas and knowledge of a modern central bank. After the Great Depression, the Fed’s structure and powers have undergone major changes. The Banking Act of 1935 reorganized the original Federal Reserve Board, extended the term of committee members, reformed the Federal Open Market Committee, and cancelled the Reserve Bank’s power to buy and sell government bonds. . At the same time, the power of the Federal Reserve System has also been expanded to include three powers in monetary policy, credit policy, and bank supervision, making the Federal Reserve a truly modern central bank.
The financial system in the United States today, especially the banking system, was basically established by a series of legislation after the Great Depression and continues to this day.
One of today’s key points is that in the late 1920s, the U.S. housing market and stock market were unprecedentedly prosperous, which allowed a lot of international capital to flow to the U.S., and bank funds flowed to the stock market and real estate, leading to soaring stock prices and real estate prices. , The bubble is unprecedented. Second, on October 19, 1929, the US stock market began to fall sharply and entered a bear market. The stock market crash also pierced the huge housing market bubble, causing large-scale bank losses, which in turn triggered continuous runs and a large number of bank failures, and stopped the banks’ previous blood supply function. The unprecedented Great Depression just happened, but the premise was a real estate bubble and a stock market bubble. Third, the Great Depression brought about a series of reforms in the American financial system, including the separation of commercial banks, investment banks and insurance businesses, the establishment of a nationwide deposit insurance system, and so on. The rebuilding of the financial system in the United States, especially the banking system, continues to this day.
(This article is the lecture text of “Professor Chen Zhiwu’s Finance Lesson” by Xiang Zhi)
This article is from WeChat official account:Economy Observer Observer (ID: eeoobserver), author: Chen Zhiwu