Financing Capacity and Fire Sales: Evidence from Bank Failures

44 Pages Posted: 19 Nov 2013  

Raghuram G. Rajan

University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Rodney Ramcharan

Date Written: November 18, 2013

Abstract

Theory suggests the reduction in financing capacity after the failure of a financial intermediary can reduce the value of financial assets. Forced sales of the intermediary’s assets could consume liquidity, depressing the liquidation value of the assets of healthy intermediaries and causing contagious runs. This paper investigates these predictions using a new dataset of bank failures during the farm depression just before the Great Depression. Using regulatory impediments to lending across state borders as a means of identification, we find that the reduction in local financing capacity as a result of bank failures reduces the recovery rates on failed assets of nearby banks, depresses local land prices, renders land markets illiquid, and is associated with subsequent financial sector distress among nearby banks. All this indicates a rationale for why bank failures are contagious.

Suggested Citation

Rajan, Raghuram G. and Ramcharan, Rodney, Financing Capacity and Fire Sales: Evidence from Bank Failures (November 18, 2013). Available at SSRN: https://ssrn.com/abstract=2356224 or http://dx.doi.org/10.2139/ssrn.2356224

Raghuram G. Rajan

University of Chicago - Booth School of Business ( email )

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International Monetary Fund (IMF) ( email )

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National Bureau of Economic Research (NBER)

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No contact information is available for Rodney Ramcharan

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