‘How do Financial Crises Redistribute Risk?’

We examine how financial crises redistribute risk, employing novel empirical methods and micro data from the largest financial crisis of the 20th century -- the Great Depression. Using balance-sheet and systemic risk measures at the bank level, we build an econometric model with incidental truncation that jointly considers bank survival, the type of bank closure (consolidations, takeovers, and failures), and changes to bank risk. Despite roughly 9,000 bank closures, risk did not leave the system; instead, it increased. We show that risk was, in fact, redistributed to banks that were healthier prior to the financial crisis. A key mechanism driving the redistribution of risk was bank acquisition. Acquiring banks exhibit balance-sheet and systemic risk changes that are between 20-25\% higher than non-acquirers. Our findings suggest that financial crises do not purge risk from the system, and that merger policies commonly used to deal with troubled financial institutions during crises have important implications for systemic risk.

Kris James Mitchener is the Robert and Susan Finocchio Professor of Economics at Santa Clara University. He is a Research Associate at the National Bureau of Economic Research (NBER) and the Centre for Competitive Advantage and the Global Economy (CAGE), and Research Fellow at the Centre for Economic and Policy Research (CEPR) and CESifo.

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