Interbank Connections, Contagion and Bank Distress in the Great Depression

Charles W. Calomiris, Matthew S. Jaremski, David C. Wheelock

NBER Working Paper No. 25897
Issued in May 2019
NBER Program(s):Development of the American Economy

Liquidity shocks transmitted through interbank connections contributed to bank distress during the Great Depression. New data on interbank connections reveal that banks were much more likely to close when their correspondents closed. Further, after the Federal Reserve was established, banks’ management of cash and capital buffers was less responsive to network liquidity risk, suggesting that banks expected the Fed to reduce that risk. Because the Fed’s presence removed the incentives for the most systemically important banks to maintain capital and cash buffers that had protected against liquidity risk, it likely contributed to the banking system’s vulnerability to contagion during the Depression.

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Acknowledgments

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Document Object Identifier (DOI): 10.3386/w25897