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

1. The Conservatism of British Banks in the Interwar Period Re-examined Haelim Park Department of Economics University of California at Irvine • April 12, 2012

2. Motivation A collapse in theratioofadvancesagainstdepositsoccurredaround Feb 1932

3. Motivation - Historical Debate

4. The Objective of This Paper This paper attempts to settle this debate by doing the following… • This paper examines banks’ behavior in reaction to deposit constraints for the periods 1921-1931 and 1932-1938. • This paper computes the stability of coefficients to compare banks’ behavior between the periods 1921-1931 and 1932-1938. • This paper compares long run adjustment patterns between the two periods.

5. Data • Bankers', Insurance managers', and Agents' Magazine. -Changed name to Bankers’ Magazine in 1954 • Each issue published monthly data.

6. British Commercial Banks • By the beginning of the 1920s, the English banking industry became very concentrated.

8. 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

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

10. Result from Model 1: Big Banks

11. Result from Model 1: Small Banks

12. Refining the Test for Deposit Constraints Separating the effect of deposit outflows versus deposit inflows on assets is important • 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.

13. Testing for Deposit Constraints 2 • Piecewise Linear Fixed Effects Regressions • Δ Assetsk,i,t= μi + dt + β0IntOutflows + β1 Δ DepositOutflowsi,t+ β2 IntInflows + β3 Δ DepositInflowsi,t+ γXt-1 + εi,t

14. Regressions Linear Regression Piecewise Linear Regression

15. 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.

16. Result from Model 2: Big Banks

17. Result from Model 2: Small Banks

18. Chow Test Results with Model 1 Table 6. Chow Test F-values for the Deposit Outflows and Deposit Inflows Coefficients.

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

20. Lagged Effect of Deposit Flows on Bank Portfolio Behavior Δ Assetsk,i,t= μi + μt + β0IntOutflows + 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 +…+ γTΔ DepositInflowsi,t-T + λXi,t-1+ εi,t

21. Lagged Cumulative Effect of Deposit Flows: Big Banks

22. Lagged Cumulative Effect of Deposit Flows: Small Banks

23. 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.