The Conservatism of British Banks in the Interwar Period Re-examined

Haelim Park Department of Economics

University of California at Irvine

April 12, 2012

Motivation

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Advances to Deposit Ra-tio

Dec

imal

Advances: Lending to Private sectorInvestments: Long-term government securities

A collapse in the ratio of advances against deposits occurred around Feb 1932

Motivation - Historical DebateChanged After 1931 Not Changed After 1931It was widely felt that the banks did not pursue liberal lending policies and charged high interest rates (Thomas, 2006).

Banks substituted toward long-term government securities (investments) (Morton, 1978).

Changes in the distribution of assets, switches from advances to investments, had begun in 1929 (Pohl and Freitag, 1994).

In 1932, the liquidation of existing advances and the collapse in demand for loans accelerated the rates of fall in advances.

The Chairman of Midland ordered that Midland should conduct their business as normal.

The Objective of This PaperThis paper attempts to settle this debate by doing the following…1. This paper examines banks’ behavior in

reaction to deposit constraints for the periods 1921-1931 and 1932-1938.

2. This paper computes the stability of coefficients to compare banks’ behavior between the periods 1921-1931 and 1932-1938.

3. This paper compares long run adjustment patterns between the two periods.

Data• Bankers', Insurance managers', and

Agents' Magazine. -Changed name to Bankers’ Magazine in

1954• Each issue published monthly data.Asset Classes Liability ClassesCoin, Bank of England notes, balances at the Bank of England

Deposits

Money at call and short notice

Bills discounted InvestmentsAdvances

British Commercial Banks• By the beginning of the 1920s, the English

banking industry became very concentrated.

‘Big Five’ Banks (>80%)

Other Banks (<20%)

Barclays Coutts and Co.Lloyds District (entered in 1936)Midland Glyn, Mills, and Co.Westminster Martins Bank

National Provincial NationalWilliam and Deacon’s

Testing for Deposit Constraints 1• Fixed Effects Regressions (Jayarante and

Morgan (2000))• Test whether a bank lending channel, which

examines the failure of Modigliani-Miller Theorem, exists in the financial market.

• If the M-M Theorem fails, deposits and assets are correlated.

• Δ Assetsk,i,t = μi + dt + β0 + β1 Δ Depositflowsi,t

+γXt-1 + εi,t k = types of assets, i = bank, t = time

Testing for Deposit Constraints 1

Explanatory Variables DefinitionΔ Depositflowsi,t Growth Rate of DepositsXt-1 Lagged Bank Characteristics, GDP

Growth, InflationLag(cash/Deposit) Lagged Cash to Deposit RatioLag((money at call+billsDiscounted)/Deposits)

Lagged Secondary Liquidity Ratio

Lag(capital/deposit)) Lagged Capital to Deposit RatioLag(LN(Asset) Lagged Total Asset

Δ Assetsk,i,t = μi + dt + β0 + β1 Δ Depositflowsi,t +γXt-1 + εi,t

Result from Model 1: Big Banks

1921M4-1932M1 1932M2-1938M12

Explanatory Variables

Bills Discounted

Investment Advances Bills Discounted

Investment Advances

(1) (2) (3) (4) (5) (6)

Deposit Flows

2.857*** 0.522*** 0.348*** 3.645*** 0.472*** 0.216***

(0.224) (0.139) (0.045) (0.308) (0.129) (0.043)

Observations 645 645 645 415 415 415

R-squared 0.337 0.268 0.337 0.398 0.419 0.396

Result from Model 1: Small Banks

1921M4-1932M1 1932M2-1938M12

Explanatory Variables

Bills Discounted

Investment Advances Bills Discounted

Investment Advances

(1) (2) (3) (4) (5) (6)

Deposit Flows

0.580** 0.485*** 0.372*** 2.686*** 0.758*** 0.258***

(0.278) (0.088) (0.046) (0.406) (0.092) (0.073)

Observations 642 642 642 450 450 449

R-squared 0.048 0.177 0.206 0.147 0.281 0.071

Refining the Test for Deposit ConstraintsSeparating the effect of deposit outflows versus deposit inflows on assets is important1.The bank lending channel emphasizes

tight monetary policy and a subsequent decline in (insured/demand) deposits, and a decline in loans/liquid assets due to informational asymmetry problems.

2. Search theoretic models assert that the costs of disinvestment and investment differ for banks.

Testing for Deposit Constraints 2

• Piecewise Linear Fixed Effects Regressions

• Δ Assetsk,i,t = μi + dt + β0 IntOutflows + β1 Δ DepositOutflowsi,t + β2

IntInflows + β3 Δ DepositInflowsi,t + γXt-1 +

εi,t

Variable Name Description Coefficient

Δ DepositOutflowsi,t Δ D <0

Δ Deposit Inflowsi,t Δ D ≥0

IntOutflows dummy=1 if Δ D<0

IntInflows dummy=1 if Δ D≥0

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2

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RegressionsLinear Regression Piecewise Linear Regression

Testing for Financing Constraints 2

• T-tests for asymmetry

Δ DepositOutflowsi,t = Δ DepositInflowsi,t

• If results are insignificant, then Model 1 can be used to estimate sensitivities.

Result from Model 2: Big Banks 1921M4-1932M1 1932M2-1938M12

Explanatory Variables

Bills Discounted

Investment Advances Bills Discounted

Investment Advances

(1) (2) (3) (4) (5) (6)

Deposit Outflows 2.615*** 0.521 0.267*** 3.044*** 0.256 0.188*

(0.516) (0.321) (0.103) (0.79) (0.331) (0.111)

Deposit Inflows 2.637*** 0.527** 0.336*** 3.496*** 0.702*** 0.251***

(0.359) (0.223) (0.072) (0.49) (0.205) (0.068)

Outflows=Inflow0.022 0.006 0.069 0.452 0.446 0.063

(0.605) (0.377) (0.121) (0.920) (0.386) (0.129)Outflows 312 312 312 194 194 194

Inflows 330 330 330 221 221 221

R-squared 0.049 0.184 0.226 0.4 0.46 0.4

Result from Model 2: Small Banks 1921M4-1932M1 1932M2-1938M12

Explanatory Variables

Bills Discounted

Investment Advances Bills Discounted

Investment Advances

(1) (2) (3) (4) (9) (10)

Deposit Outflows 0.494 0.313 0.584*** 1.793** 0.417** 0.610***

(0.672) (0.212) (0.11) (0.885) (0.199) (0.159)

Deposit Inflows 0.574 0.461*** 0.325*** 2.036*** 1.062*** 0.205

(0.483) (0.153) (0.079) (0.762) (0.172) (0.136)

Outflows=Inflow0.080 0.148 -0.259* 0.244 0.645** -0.405*

(0.888) (0.281) (0.145) (1.255) (0.283) (0.225)Outflows 312 312 312 219 219 218

Inflows 330 330 330 231 231 231

R-squared 0.049 0.184 0.226 0.157 0.3 0.09

Chow Test Results with Model 1

Table 6. Chow Test F-values for the Deposit Outflows and Deposit Inflows Coefficients.

Explanatory Variables

Bills Discounted

Investments

Advances

(1) (2) (3)

Big Five Banks 4.00** 0.93 7.51**

Small Banks 19.46** 4.38** 1.89

Chow Test Results with Model 2Table 6. Chow Test F-values for the Deposit Outflows and Deposit Inflows Coefficients.Explanatory

VariablesBills Discounted

Investments Advances

(1) (2) (3)

Big Five BanksDeposit Outflows 0.03 0.6 0.47Deposit Inflows 1.61 0.02 1.16Joint 0.82 0.31 0.83

Small BanksDeposit Outflows 2.35 0.01 0.01Deposit Inflows 2.23 8.56** 0.55Joint 2.66* 4.33** 0.27

Lagged Effect of Deposit Flows on Bank Portfolio Behavior

Δ Assetsk,i,t = μi + μt + β0 IntOutflows + β1 Δ DepositOutflowsi,t + β2 Δ DepositOutflowsi,t-1 +β3 Δ DepositOutflowsi,t-2 + … + βT Δ DepositOutflowsi,t-T + γ0 IntInflows + γ1 Δ DepositInflowsi,t + γ2 Δ DepositInflowsi,t-1 + γ3 Δ DepositInflowsi,t-2 +…+ γT Δ DepositInflowsi,t-T + λXi,t-1 + εi,t

Lagged Cumulative Effect of Deposit Flows: Big Banks

1921M4-1932M1 1932M2-1938M12

Deposit Outflows Deposit Inflows Deposit Outflows Deposit Inflows

Lags in months

Point Estimate

SE Point Estimate

SE Point Estimate

SE Point Estimate

SE

Investments

3 2.320*** 0.600 1.391*** 0.484 0.544 0.640 1.779*** 0.358

6 2.756*** 0.843 1.793*** 0.640 0.099 0.923 2.304*** 0.430

9 3.136*** 1.053 2.259*** 0.702 0.773 1.130 2.466*** 0.512

12 2.146* 1.252 3.140*** 0.821 0.588 1.343 2.638*** 0.644

Advances

3 0.258 0.195 0.556*** 0.157 0.341 0.221 0.470*** 0.123

6 0.227 0.274 0.378* 0.208 0.677** 0.319 0.579*** 0.148

9 0.087 0.342 0.281 0.228 1.011** 0.390 0.470*** 0.177

12 0.055 0.407 0.490* 0.267 1.637*** 0.464 0.639*** 0.223

Lagged Cumulative Effect of Deposit Flows: Small Banks

1921M4-1932M1 1932M2-1938M12

Deposit Outflows Deposit Inflows Deposit Outflows Deposit Inflows

Lags in months

Point Estimate

SE Point Estimate

SE Point Estimate

SE Point Estimate

SE

Investments

3 0.177 0.251 0.548*** 0.183 2.297*** 0.409 1.180*** 0.306

6 0.229 0.334 0.657*** 0.226 2.119*** 0.569 1.915*** 0.389

9 0.506 0.425 0.738*** 0.268 1.732** 0.694 1.882*** 0.478

12 0.556 0.463 0.938*** 0.314 1.898** 0.768 1.897*** 0.585

Advances

3 0.463* 0.188 0.382* 0.137 0.387 0.341 0.100 0.256

6 0.068 0.250 0.198 0.169 0.376 0.475 0.424 0.325

9 -0.182 0.318 0.188 0.200 0.398 0.579 0.351 0.399

12 -0.216 0.347 0.070 0.235 0.434 0.641 0.953* 0.488

Conclusion• Only small banks’ short-term

responses of government securities became highly sensitive to deposit inflows.

• Both big and small banks’ long-run responses of long-term government securities and advances to deposit outflows and inflows changed.