SYSRI-30 : Systemic Risk in the 1930s

Principal investigator : Angelo Riva ; grant by Agence Nationale de la Recherche
This project aims at studying the causal dynamics of banking crisis during the Great Depression in France, their impact on the performances of French economy at national and regional levels, and the systemic risk management by the monetary authorities, with a genuine interdisciplinary approach based on quantitative and qualitative exploitation of primary and secondary sources.
Failures in the management of banks’ risks undermine the well-being of citizens, weaken their strength to future shocks, and arouse mistrust vis-à-vis both decision makers and scientists. Banking crises thus affect society’s capability to innovate and to be open, tempted by to turn in on itself and to refuse the challenges raised by rapid global changes.

Gathering together historians, economists, sociologists, accounting and IT experts, the project proposes for the first time in Europe a comprehensive country-level study of the banking crisis during the Great Depression, topic till now dominated by the literature on the United States. It is well known that the United States’ responses to the current financial crisis were based on the study of the 1930s banking crisis. The lack of methodical studies of banks’ systemic risk in 1930s European countries may lead European decision makers to base policy responses on the results of research focused on the United States, without properly taking into account both US and European specificities. To study French banking crisis, the project constructs original datasets that merged with the data already stored into the Equipex DFI-H provide researchers with databases comparable to the US ones and allow conducting for the first time large-scale quantitative studies. On the other hand, qualitative analysis of primary and secondary sources sheds light on the actual working of banking system and power balances among stakeholders surrounding authorities’ decisions.
This ANR project benefits from the data of the Equipex DFI-H, but also from its resources already in place and its innovative process of sources’ digitization. It cooperates with the TGIR Progedo and Huma-Num to disseminate collected data and make scanned primary sources public. The project targets various audiences to disseminate its scientific results. First, it informs decision makers involved in the debate on systemic risk management, particularly by presentations at seminars and conferences organized by central banks members of the Eurosytem thanks to institutional links to and affiliation of project’s members with the Banque de France. Second, it disseminates the results through presentations at international conferences and publications on leading journals as well. Third, it disseminates the results among society by setting a website with tailored documentation. Fourth it contributes to high education training with material adapted to university students, while it prepares teaching material for high-school senior students.
The results of research on US banking crisis are often considered as extensible for elaborating policy responses in other countries. However the US banking systems had very specific features : not only the peculiar US regulation imposed unit and specialized banking, there was also a distinctive political bargaining surrounding the decisions of the monetary authority and distribution of the losses resulting from the banks’ failures among citizens, creditors, shareholders and various business interest groups (Calomiris and Haber 2014). In interwar France, banking was not submitted to any formal regulation and the power balance surrounding monetary authorities’ decisions was different from the US one. As a consequence, general conclusions cannot be drawn from research on the US case.
This project aims at studying with a genuine interdisciplinary approach the causal dynamics of banking crisis during the Great Depression in France, their impact on the performances of French economy at national and regional levels, and the systemic risk management by the monetary authorities. Both quantitative and qualitative primary and secondary sources will be used to achieve such aims.
The empirical and theoretical literature shows that variables of different order can act upon banking stability. From a micro point of view, several variables can explain the resilience (weakness) of a bank in time of crisis. First, the balance sheet structure : to sketch the argument, high liquidity and capital ratios can make a bank resilient, but they can also hamper its lending capability. Second, the governance rules of a bank may prevent it from excessive risk taking, but may also decrease its financing role in the economy. The disclosure (voluntary in interwar France) of information by a bank is crucial. The networks of administrators among firms and banks may explain the relative weakness of a bank : if interlocking directorates can be a valuable source of information for banks, they can also be the precondition for conflicts of interest. The banks’ organization plays also a pivotal role, such as the resources the bank devotes to its management of informational asymmetries, the skills and experience of its officials, the organization of internal information flows, particularly through analytical accounting.
From a macro point of view, the economic and financial environment also acts upon the strength of a bank and in turn could be influenced by it. Economic growth is all important as well as interest rates such as the repo and the money market rates. Moreover, the recursive interaction between banks and the financial market is crucial : financial markets are not only a channel for banks to raise capital in times of distress, but also the place where the prices of banks’ collaterals and securities are set. The quality of financial markets’ can also ensure the success of fire sales by the banking sector.
From an institutional point of view, in spite of the lack of banking regulations in France, other rules matter. The tax system may set incentives that act upon the balance sheets structure of the banks and the incentives of borrowers to repay the bank. At the same time, bankruptcy law can exert influence on both the robustness of a bank and counterparty risk management. Jurisprudence plays a pivotal role in harmonizing rules and practices. Last, the discount window access rules impact banks’ business and organization.
When facing with banks’ failures, monetary authorities can choose among several options ranging from abstaining from any intervention to direct and complete bailout, through the application of the Bagehot’s rule. If abstention may heavily increase the cost of the current crisis, it can also successfully deal with moral hazard and reduce the cost of future failures. The choice of the monetary authority can be driven by the objective of minimizing (cumulative) losses. Nevertheless, the redistribution of the cost of a banking crisis is never neutral for stakeholders.
From the point of view of political economy, the gains of the banking intermediation as well as the losses from banking crises are not equally redistributed among stakeholders : government, citizens, and various interest groups including banks and bankers. The balance of power among stakeholders can act on the monetary authorities’ decisions not only at the occasion of crisis, but more broadly when setting bankruptcy law and tax rules. Within this framework, the representation of the reality and its drivers (media, political parties and interest groups) as well as dominant economic theories may play a significant role in the public arena.
In the end, five main questions emerge from these elements : i) What are the drivers of bank’s failure/resilience in times of crisis (balance sheet structure, organization, governance, the directors of a bank, and its economic environment) and what is the very nature of the failures (liquidity or solvency issues) ? ; ii) What role do the financial markets and non-bank financial institutions have on the nature and course of the crisis ? ; iii) Why did a banking crisis occur and what are the channels of contagion ? ; iv) Can monetary authorities’ interventions limit the risk of contagion and, if any, what form should this intervention take ? ; v) What is the balance of power surrounding authorities’ decisions and how the representations of the crisis, social movements and economic doctrines affect this intervention ?
The project is planned to last 5 years (from January 2016 to December 2020)