Abstract

We examine the impact of economy wide credit tightening on bank failures and investigate the relationship between bank failures and tighter monetary policy while accounting for bank balance sheet variables. Using a sample of U.S. banks from 1984 to 2020, we find the following: i) increases in corporate credit spreads lead to a significant increase in aggregate bank failures; ii) lower aggregate bank return on equity and higher allowances for loan losses are associated with a higher incidence of bank failures; iii) no robust evidence suggesting that tighter monetary policy drives higher bank failures. Finally, we show that lower bank failures, contraction in corporate credit spreads, higher bank profitability, and higher stock market returns contribute to higher economic growth, highlighting the interconnectedness of banking, stock markets, credit availability, and the macro-economy. These results may have potential macro-prudential policy implications.

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