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

Motivation - Historical Debate Changed After 1931Not Changed After 1931 It 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 Paper This paper attempts to settle this debate by doing the following… 1.This paper examines banks’ behavior in reaction to deposit constraints for the periods and This paper computes the stability of coefficients to compare banks’ behavior between the periods and 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 ClassesLiability Classes Coin, Bank of England notes, balances at the Bank of England Deposits Money at call and short notice Bills discounted Investments Advances

British Commercial Banks By the beginning of the 1920s, the English banking industry became very concentrated. ‘Big Five’ Banks (>80%)Other Banks (<20%) BarclaysCoutts and Co. LloydsDistrict (entered in 1936) MidlandGlyn, Mills, and Co. WestminsterMartins Bank National ProvincialNational William 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 Assets k,i,t = μ i + d t + β 0 + β 1 Δ Depositflows i,t +γX t-1 + ε i,t k = types of assets, i = bank, t = time

Testing for Deposit Constraints 1 Explanatory VariablesDefinition Δ Depositflows i,t Growth Rate of Deposits X t-1 Lagged Bank Characteristics, GDP Growth, Inflation Lag(cash/Deposit)Lagged Cash to Deposit Ratio Lag((money at call+bills Discounted)/Deposits) Lagged Secondary Liquidity Ratio Lag(capital/deposit))Lagged Capital to Deposit Ratio Lag(LN(Asset)Lagged Total Asset Δ Assets k,i,t = μ i + d t + β 0 + β1 Δ Depositflows i,t +γX t-1 + ε i,t

Result from Model 1: Big Banks 1921M4-1932M11932M2-1938M12 Explanatory Variables Bills Discounted InvestmentAdvances Bills Discounted InvestmentAdvances (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 R-squared

Result from Model 1: Small Banks 1921M4-1932M11932M2-1938M12 Explanatory Variables Bills Discounted InvestmentAdvances Bills Discounted InvestmentAdvances (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 R-squared

Refining the Test for Deposit Constraints Separating the effect of deposit outflows versus deposit inflows on assets is important 1.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 Assets k,i,t = μ i + d t + β 0 IntOutflows + β1 Δ DepositOutflows i,t + β2 IntInflows + β3 Δ DepositInflows i,t + γX t-1 + ε i,t Variable NameDescriptionCoefficient Δ DepositOutflows i,t Δ D <0 Δ Deposit Inflows i,t Δ D ≥0 IntOutflowsdummy=1 if Δ D<0 IntInflowsdummy=1 if Δ D≥0

Regressions Linear RegressionPiecewise Linear Regression 14

Testing for Financing Constraints 2 T-tests for asymmetry Δ DepositOutflows i,t = Δ DepositInflows i,t If results are insignificant, then Model 1 can be used to estimate sensitivities.

Result from Model 2: Big Banks 1921M4-1932M11932M2-1938M12 Explanatory Variables Bills Discounted InvestmentAdvances Bills Discounted InvestmentAdvances (1)(2)(3)(4)(5)(6) Deposit Outflows2.615*** ***3.044*** * (0.516)(0.321)(0.103)(0.79)(0.331)(0.111) Deposit Inflows2.637***0.527**0.336***3.496***0.702***0.251*** (0.359)(0.223)(0.072)(0.49)(0.205)(0.068) Outflows=Inflow (0.605)(0.377)(0.121)(0.920)(0.386)(0.129) Outflows Inflows R-squared

Result from Model 2: Small Banks 1921M4-1932M11932M2-1938M12 Explanatory Variables Bills Discounted InvestmentAdvances Bills Discounted InvestmentAdvances (1)(2)(3)(4)(9)(10) Deposit Outflows ***1.793**0.417**0.610*** (0.672)(0.212)(0.11)(0.885)(0.199)(0.159) Deposit Inflows ***0.325***2.036***1.062***0.205 (0.483)(0.153)(0.079)(0.762)(0.172)(0.136) Outflows=Inflow * **-0.405* (0.888)(0.281)(0.145)(1.255)(0.283)(0.225) Outflows Inflows R-squared

Chow Test Results with Model 1 Table 6. Chow Test F-values for the Deposit Outflows and Deposit Inflows Coefficients. Explanatory Variables Bills Discounted InvestmentsAdvances (1)(2)(3) Big Five Banks4.00** ** Small Banks19.46**4.38**1.89

Chow Test Results with Model 2 Table 6. Chow Test F-values for the Deposit Outflows and Deposit Inflows Coefficients. Explanatory Variables Bills DiscountedInvestmentsAdvances (1)(2)(3) Big Five Banks Deposit Outflows Deposit Inflows Joint Small Banks Deposit Outflows Deposit Inflows **0.55 Joint 2.66*4.33**0.27

Lagged Effect of Deposit Flows on Bank Portfolio Behavior Δ Assets k,i,t = μ i + μ t + β 0 IntOutflows + β 1 Δ DepositOutflows i,t + β 2 Δ DepositOutflows i,t-1 + β 3 Δ DepositOutflows i,t-2 + … + β T Δ DepositOutflows i,t-T + γ 0 IntInflows + γ 1 Δ DepositInflows i,t + γ 2 Δ DepositInflows i,t-1 + γ 3 Δ DepositInflows i,t-2 +…+ γ T Δ DepositInflows i,t-T + λX i,t-1 + ε i,t

Lagged Cumulative Effect of Deposit Flows: Big Banks 1921M4-1932M11932M2-1938M12 Deposit OutflowsDeposit InflowsDeposit OutflowsDeposit Inflows Lags in months Point Estimate SE Point Estimate SE Point Estimate SE Point Estimate SE Investments *** *** *** *** *** *** *** *** *** * *** ***0.644 Advances *** *** * ** *** ** *** * *** ***0.223

Lagged Cumulative Effect of Deposit Flows: Small Banks 1921M4-1932M11932M2-1938M12 Deposit OutflowsDeposit InflowsDeposit OutflowsDeposit Inflows Lags in months Point Estimate SE Point Estimate SE Point Estimate SE Point Estimate SE Investments *** *** *** *** *** *** *** ** *** *** ** ***0.585 Advances * * *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.