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The slack banker dances: deposit insurance and risk-taking in the banking collapse of the 1920s

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  • David C. Wheelock
  • Subal C. Kumbhaker

Abstract

This paper studies the effects of deposit insurance on bank behavior using individual bank data from Kansas in the 1920s. Kansas banks were severely stressed by the collapse of agricultural prices in 1920 and resulting increase in farm mortgage defaults. Because membership in the state deposit insurance system was voluntary, it is possible to compare the behavior of insured and non-insured banks facing similar exogenous circumstances. We find that deposit insurance encouraged excessive risk-taking, which helps to explain the comparatively high failure rate of insured banks. The deposit insurance fund ultimately failed to reimburse many depositors of failed banks. We find, however, no evidence of a decline in the credibility of insurance, and hence in the ability of insured banks to take excessive risks, before the system’s collapse in 1926.

Suggested Citation

  • David C. Wheelock & Subal C. Kumbhaker, 1992. "The slack banker dances: deposit insurance and risk-taking in the banking collapse of the 1920s," Working Papers 1992-002, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:1992-002
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    References listed on IDEAS

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    1. Frederick T. Furlong & Michael C. Keeley, 1991. "Capital regulation and bank risk-taking: a note (reprinted from Journal of Banking and Finance)," Economic Review, Federal Reserve Bank of San Francisco, issue Sum, pages 34-39.
    2. Wheelock, David C & Kumbhakar, Subal C, 1995. "Which Banks Choose Deposit Insurance? Evidence of Adverse Selection and Moral Hazard in a Voluntary Insurance System," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(1), pages 186-201, February.
    3. Gerald P. O'Driscoll, 1988. "Bank Failures: The Deposit Insurance Connection," Contemporary Economic Policy, Western Economic Association International, vol. 6(2), pages 1-12, April.
    4. Kareken, John H & Wallace, Neil, 1978. "Deposit Insurance and Bank Regulation: A Partial-Equilibrium Exposition," The Journal of Business, University of Chicago Press, vol. 51(3), pages 413-438, July.
    5. Thornton Cooke, 1909. "The Insurance of Bank Deposits in the West," The Quarterly Journal of Economics, Oxford University Press, vol. 24(1), pages 85-88.
    6. Furlong, Frederick T. & Keeley, Michael C., 1989. "Capital regulation and bank risk-taking: A note," Journal of Banking & Finance, Elsevier, vol. 13(6), pages 883-891, December.
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    Cited by:

    1. Imai, Masami, 2006. "Market discipline and deposit insurance reform in Japan," Journal of Banking & Finance, Elsevier, vol. 30(12), pages 3433-3452, December.
    2. Eugene N. White, 2011. ""To Establish a More Effective Supervision of Banking": How the Birth of the Fed Altered Bank Supervision," NBER Working Papers 16825, National Bureau of Economic Research, Inc.
    3. Ramírez, Carlos D., 2009. "Bank fragility, "money under the mattress", and long-run growth: US evidence from the "perfect" Panic of 1893," Journal of Banking & Finance, Elsevier, vol. 33(12), pages 2185-2198, December.
    4. Jaremski, Matthew & Wheelock, David C., 2017. "Banking on the Boom, Tripped by the Bust: Banks and the World War I Agricultural Price Shock," Working Papers 2017-36, Federal Reserve Bank of St. Louis.
    5. Mayes, David G., 2004. "Who pays for bank insolvency?," Journal of International Money and Finance, Elsevier, vol. 23(3), pages 515-551, April.

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