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Small Business Economics
Published in: Small Business Economics 4/2022

03-04-2021

Bank failures, local business dynamics, and government policy

Authors: Salvador Contreras, Manthos D. Delis, Amit Ghosh, Iftekhar Hasan

Published in: Small Business Economics | Issue 4/2022

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Abstract

Using MSA-level data over 1994–2014, we study the effect of bank failures on local business dynamics, in the form of net business formation and net job creation. We find that at least one bank failure in the metropolitan statistical area (MSA) with the mean population prevents approximately 475 net businesses from forming in that area, compared with MSAs that experience no bank failures, ceteris paribus. The equivalent effect on net job creation is 16,433 net job losses. Our results are even stronger for small businesses, which are usually more dependent on bank-firm relationships. These effects point to significant welfare losses stemming from bank failures, highlighting an important role for government intervention. We show that the Troubled Asset Relief Program (TARP) is effective in reducing the negative effects of bank failures on local business dynamics. This positive effect of TARP is quite uniform across small and large firms.
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Appendix
Available only for authorised users
Footnotes
1
The expenses cover unpaid principal amounts deemed unrecoverable and only reflect the costs to taxpayers because of the processes involved in resolving the failures. For example, Kang et al. (2015) estimate that during the S&L crisis the median cost incurred by the FDIC for closing a potentially distressed bank was about $1.2 million.
 
2
In additional estimations (reported on request), we examine the effect of both types of bank failures. We find both to reduce local business dynamics. However, there are too few liquidation bank observations to draw strong conclusions.
 
3
We treat those MSAs that cover multiple states as part of the state that has the highest population concentration.
 
4
Unfortunately, we do not have MSA-level information on whether the employees of the branches of failed banks are part of Net job creation. In any case, this number must be small; more so because in many cases some or all the employees of the failed bank branches are employed by the acquiring bank.
 
5
The BDS is a public data set of annual aggregate statistics describing different facets of local entrepreneurship: establishment entries and exits, as well as job creation and destruction by firm size and age at the MSA level.
 
6
An establishment is a business entity with multiple stores, outlets, or branch locations.
 
7
The pairwise correlation coefficient between the logarithmic value of MSA-level personal income and net business formation is 0.69 and significant at the 95% level. Moreover, when we estimate the effect of MSA-level personal income on net business formation using state-year fixed effects we find a 1% rise in personal income to statistically significantly increase net business formation by 1.03%.
 
8
Defined as assets 90 or more days past due and still accruing interest, plus assets that are no longer accruing interest divided by total assets.
 
9
If bank balance sheets already deteriorate, then the enforcement action would have been one related to financial safety and soundness.
 
10
dy/dFAILURE is computed using the delta method.
 
11
In addition, to rule out that outliers may drive our results, we winsorize all variables at the 5th and 95th percentile and re-estimate Table 3. Our baseline results remained unchanged. We show these results in appendix table A1.
 
12
The correlation between local economic crisis and bank failures is positive. Although there is some overlap between local economic crisis and bank failures, not all local economic crises coincide with branch failures and not all branch failures occur during local economic crises.
 
13
In addition, when we drop observations for MSAs with a local economic crisis, we get similar results with negative and statistically significant coefficients for the interaction term FAILURE x Personal income.
 
14
We also dropped the unemployment rate as an explanatory variable as well as state-year fixed effects and re-estimated eq. (2). Results remained largely unchanged with the local crisis term being negatively significant. We show these results in appendix table A2.
 
15
We provide these results in the appendix (table A3).
 
16
CAMELS stands for capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to market risk.
 
17
We also estimate our results in Tables 3, 4, and 5 using the one-year lagged values of all the right-hand side variables. This might reduce concerns that effects are not immediately observable. The results remain largely unchanged and are available on request.
 
18
As reflected in Fig. 2, bank failures occur in waves. To examine whether year-specific clustering drives our inferences, we additionally report results from double clustering the variables by MSA and year. The statistical significance remains similar to that of baseline Table 4 with interaction terms (results are shown in table A4 in the online appendix).
 
19
Commercial real estate loans are for the acquisition, development and construction of business properties like retail malls, shopping centers, office buildings and complexes, and hotels.
 
20
To put our results into context, Berger and Roman (2017) find that the TARP creates eight jobs per 1000 people. Our results are not directly comparable because Berger and Roman conduct their analysis by state and do not account for the effect of bank failures. We find a lower effect that is consistent with offsetting the adverse effect of bank failures on local business dynamics.
 
21
We also place the cutoff at TARP banks controlling 30% of deposits yielding similar results.
 
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Metadata
Title
Bank failures, local business dynamics, and government policy
Authors
Salvador Contreras
Manthos D. Delis
Amit Ghosh
Iftekhar Hasan
Publication date
03-04-2021
Publisher
Springer US
Published in
Small Business Economics / Issue 4/2022
Print ISSN: 0921-898X
Electronic ISSN: 1573-0913
DOI
https://doi.org/10.1007/s11187-021-00478-5

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