A Crash Course on Crises by Markus K. Brunnermeier;Ricardo Reis;

Author:Markus K. Brunnermeier;Ricardo Reis;
Language: eng
Format: epub
Publisher: Princeton University Press
Published: 2023-03-06T00:00:00+00:00

6.2  The Run on the German Banking System in 1931

If illiquidity problems are not addressed in time, they morph into a solvency problem. They can spread and bring the whole financial system down and even impair the real economy.

On May 11, 1931, an Austrian bank called Creditanstalt failed. On July 13, 1931, the second largest bank in Germany, the Danatbank, went bankrupt, leading to a system-wide banking crisis in Germany. Danatbank was not contractually linked to Creditanstalt. But the failure of the first stoked fears among the creditors of banks across Europe, and triggered a shift into the equilibrium where Danatbank became illiquid. Soon after, the whole German financial system had a systemic meltdown, which contributed to the Great Depression, hitting this country especially harshly and contributing to the rise of Adolf Hitler.

The meltdown took place in three phases. First, German banks refused to lend to each other in the interbank market. In the second phase, the wholesale market also dried up. Finally, retail depositors ran on their banks. At that time there was no deposit insurance. Initially, people only reshuffled demand deposits, withdrawing funds from one bank and redepositing them with other (safer) banks. Later, the run occurred on the whole system.

As banks faced increased funding liquidity problems, they sold off their liquid asset holdings. Figure 6.2 depicts the decline of assets across the banking system in the shaded areas. While banks also cut back on loans, the decline in interbank lending and liquid securities was sharper. One banks’ reduction in interbank liquid asset holdings is another bank’s reduction in funding liquidity, since when one bank no longer buys short-term debt from the other banks, then they must sell their short-term liquid assets and lend less to other banks. The lines in figure 6.2 depict the liability side of the consolidated banking system, showing that, initially, primarily the interbank borrowing declined, followed by a sharper decline in deposits in June 1931.

FIGURE 6.2. Germany’s banks in 1931

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