Bank Capital and Portfolio Management: The 1930's Capital Crunch and Scramble to Shed Risk

Charles W. Calormiris and Berry Wilson
Authors registered in the RePEc Author Service: Charles W. Calomiris

No 6649, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Recent models of banking under asymmetric information argue that depositors penalize banks that offer high-risk deposits. Focusing on New York City banks in the 1920's and 1930's, this study examines how banks manage risk during normal times and in response to severe shocks. We develop and apply a simple framework that identifies the tradeoffs among alternative means of satisfying depositors' preferences for low-risk deposits (i.e. low asset risk versus high capital). During the 1920's profitable lending opportunities and low costs of raising capital prompted banks to increase their asset risk, while increasing capital to maintain low default risks on deposits. Cross-sectional differences in the cost of raising equity explain differences in banks' choices of asset risk and capital ratios. In the wake of the loan losses produced by the Depression, high default risk was penalized with deposit withdrawals. To reduce deposit risk, banks increased their riskless assets and cut dividends, but avoided costly equity issues. Banks with high default risk or with high costs of raising equity contracted dividends the most during the 1930's.

JEL-codes: G21 G32 (search for similar items in EconPapers)
Date: 1998-07
New Economics Papers: this item is included in nep-ifn
Note: DAE
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (18)

Published as Charles W. Calomiris & Berry Wilson, 2004. "Bank Capital and Portfolio Management: The 1930s "Capital Crunch" and the Scramble to Shed Risk," Journal of Business, University of Chicago Press, vol. 77(3), pages 421-456, July.

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Working Paper: Bank capital and portfolio management: the 1930s capital crunch and scramble to shed risk (1996)
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