New evidence on the impact of economic conditions and banking legislation on the bank failure rate in the US, 1970 to 2014

Abstract

Purpose This study aims to identify factors influencing the bank failure rate in the USA over the period from 1970 to 2014 with an emphasis on economic/financial factors on the one hand and on banking legislation on the other hand. Regarding the latter, this study empirically investigates four major banking statutes: the Community Reinvestment Act of 1977; the Depository Institutions Deregulation and Monetary Control Act of 1980; the Federal Deposit Insurance Corporation Improvement Act of 1991; and the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. After adopting the technique of generalized method of moments (GMM), a robustness check in the form of autoregressive conditional heteroskedasticity (ARCH) is undertaken. Overall, the estimations imply that the bank failure rate was a decreasing function of the percentage growth rate of real gross domestic product (GDP) and the real interest rate yields on both three-month US Treasury bills and 30-year fixed-rate mortgages and an increasing function of the real cost of funds. In addition, there is strong evidence that the bank failure rate was increased by provisions in the Community Reinvestment Act of 1977 and the Depository Institutions Deregulation and Monetary Control Act of 1980, whereas the bank failure rate was decreased as a result of provisions in the Federal Deposit Insurance Corporation Improvement Act of 1991 and the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Finally, there also is evidence that higher federal budget deficits elevated the bank failure rate. Design/methodology/approach After modeling the bank failure rate as a function of financial/economic variables and banking legislation, the times series from 1970 to 2014 is estimated by GMM and then by the ARCH techniques. Findings The results of the GMM and ARCH estimations imply that the bank failure rate in the US was a decreasing function of the percentage growth rate of real GDP as well as the real interest rate yields on both three-month US Treasury bills and 30-year fixed-rate mortgages and an increasing function of the real cost of funds. Furthermore, there is strong empirical support indicating that the bank failure rate was elevated by various provisions in the Community Reinvestment Act of 1977 and in the Depository Institutions Deregulation and Monetary Control Act of 1980, while the bank failure rate was reduced by certain provisions in the Federal Deposit Insurance Corporation Improvement Act of 1991 and the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. There also is evidence that higher federal budget deficits increased the bank failure rate. Originality/value This study is the most contemporary (1970-2014) analysis of potential causes of the bank failure rate in the USA. The study also may be the first to apply the GMM and GARCH models to the problem. Also, some interesting policy implications are provided in the Conclusion.