Academic journal article
By Kaufman, George G.
The Reserve Bank of New Zealand Bulletin , Vol. 67, No. 2
This article is a revised version of the paper presented by Professor George Kaufman in Wellington, New Zealand, on 7 April this year, when he was Professorial Fellow in Monetary and Financial Economics at Victoria University, on a programme sponsored by the Reserve Bank of New Zealand.*
The American novelist F. Scott Fitzgerald started one of his books by noting that the rich "are different"; and there is a widespread perception that banks are also different from other firms, and that bank failures are different from the failure of other firms, particularly failures of large, systemic banks. There would probably be far fewer in the audience tonight if this lecture had been on grocery stores or steel mills. Banks have long been treated differently with respect to public policy. In the United States, banks need to obtain special charters from the states, and may be chartered by the federal government, an advantage that is not available to most other firms. In New Zealand, banks must be registered by the Reserve Bank to use the word "bank" in their name. In the United States, bank insolvencies are resolved under a special bank code by the bank regulators rather than under the general bankruptcy code by the bankruptcy courts. To a large extent, this is because bank failures are widely perceived to be more damaging to the customers of the affected banks, both depositors and borrowers, than the failure of like-sized other firms and more likely to spill over to other banks through knock-on (contagion, cascade or domino) effects, the payments system, the financial system as a whole, and even beyond to the wider economy.
But beyond the direct damage, bank failures are widely perceived to be more frightening than the failure of other firms. This may result in indirect, collateral damage. "Horror" books and movies based on bank failures are not uncommon, while few such books or movies are based on the failure of grocery stores or steel mills. Bank failures are perceived as being more frightening for a number of reasons:
* Banks deal in intangibles, which cannot be seen. This make it more difficult for many to understand their operations than, say, operation of grocery stores or steel mills; and causes banks to be shrouded in mystery and uncertainty.
* Almost everyone has contact with banks in their daily life as either or both a depositor and/or borrower.
* Bank deposits make up a large percentage of the national money supply.
* Bank deposits frequently represent the owners' principal and most liquid assets.
* Banks operate the payments system.
* Bank assets can be moved very quickly.
* Bank assets are very large in the economy.
* Banks operate internationally.
* Banks operate in highly sophisticated and complex markets, such as derivatives markets, which are both very large and very volatile.
Breakdowns in these areas are highly disruptive. Indeed, failed banks are sometimes closed physically as well as legally so that depositors cannot access their accounts and borrowers their credit lines, and payments in process are not completed, leading to defaults. Whether or not the great public fear of bank failures is rational or justified, it exists; and perception is often as important as reality and requires recognition in the formation of public policy.
Researchers at the World Bank have identified nearly 120 systemic bank crises in 93 countries since the mid-1970s--some countries suffered more than one crisis--and another 50 or so near-crises in 45 countries. (1) Thus, more than one half of all countries in nearly all parts of the world have experienced serious banking crises in recent memory. Many of the countries that did not suffer such crises are emerging economies that do not have a functioning banking system.
The costs of these crises have been high. Bank crises are often associated with recessions in the macroeconomy, although they are more frequently the result rather than the cause of the economic downturns. …