A History of UK Banking Crises: Is This Time Different?
A long shadow has been cast over the British economy by the banking crisis of 2007-8. The economy slumped by about five per cent in 2009 and has been slow to recover. Economic growth, for example, was three per cent per year on average in the ten years before 2007 but has been little more than one per cent in the decade since. How does the aftermath of this banking crisis compare with those from Britain’s past? Is this time different?
In new research, we investigated the causal effect of banking crises on the British economy between the beginning of the Industrial Revolution and the Second World War. To do so, we developed a new data set of banking crises in the UK, which we identified as periods in which more than three per cent of banks failed. We began by reconstructing the banking population year-by-year. We then counted the number of banks that failed in each year.
The ratio of failures to the population is plotted in figure 1, which shows that 1772, 1815-6, 1825-6, 1841, 1866 and 1929-30 were crises based on our definition. Our new data set reveals fresh insights about the history of banking crises in the UK. A number of commonly cited episodes such as 1847, 1857, 1878, 1890 and 1914 were not associated with a critical mass of bank failures, while other episodes that have been overlooked were, such as 1841 and 1929-30. The crises of 1815-6 and 1825-6 were extremely severe, involving more than 100 failures each.
Armed with this new data set, we then investigated how these banking crises affected the economy. In the aftermath of a crisis, we find that real GDP contracted by more than three percentage points (figure 2). In order to understand how these shocks were transmitted through the economy, we also looked at the effect on different sectors. The effect was greatest on the industrial sector, while services were less affected, and agriculture was not impacted at all. These results are robust to a number of checks, such as controlling for macroeconomic and policy variables, changing the statistical specification and the definition of our crisis indicator, including altering the threshold or weighting the banks by capital to reflect their size.
Our results are not a statistical artefact but were recognised by people at the time. On 19 July 1816, for example, the Morning Chronicle explained the effects of a local bank failure:
"We continue to receive the most distressing accounts of the state of business at Sunderland. The failure of Cooke and Co. has paralysed everything. Nearly the whole of the ship carpenters have been discharged, and several vessels have come round from Sunderland to Newcastle to load coals, which they cannot now procure at Sunderland. Credit is completely destroyed, for since the failure of the bank not a single bill has been paid. Never, perhaps, in any place before were the ruinous effects of a sudden deprivation of capital so strikingly exemplified. How to avert the total ruination of the town will be a consideration of the greatest difficulty."
It seems that banking crises of the past had a similar effect on the economy as those of the present. There is, however, one major difference. In previous crises, our results show that the effect is concentrated in the first year, with no longer-term consequences, while the recent crisis has been persistent. In this respect, this time is different. Why?
There are two possible explanations. The first is that the recent banking crisis was more severe than its predecessors. Evidence from the volatility of bank share prices does suggest that it was unusually large compared to other episodes in recent history.
Another possible explanation is the policy response. In the wake of the recent banking crisis, austerity was imposed in Britain, while in previous crises this was not the case. Given the evidence that the fiscal multiplier is positive, it could be that austerity, as opposed to the crisis itself, has led to the decade of stagnation. In other words, the treatment may have been worse than the disease.
In short, our results suggest that previous banking crises have been associated with short, sharp drops in economic activity in the UK. This time is different because the crisis has persistently affected the economy. This could be because this crisis was unusually large, but it could also be down to the policy response of fiscal consolidation.
Jason Lennard is a senior economist at NIESR. Sean Kenny is a Postdoctoral fellow at Lund University. John D. Turner is a Professor at Queen’s University, Belfast.