Richard Davies



Why banks fail


Financial crises are common. What a crash occurs the building blocks of finance—equity and debt, risk and return, liquidity and leverage—come to the fore. Crises are therefore a good introduction to finance and macroeconomics. This page contains material used in my classes on bubbles and crashes.


There are hundreds of fascinating historical crashes to pick from. Among them five events, the focus here, help understand key aspects of modern finance. The five crashes from the past are:

1792. America’s first crash

1825. The first ‘emerging market’ crash and the birth of modern banking.

1857. The first global crash.

1907. A perfect storm on Wall Street and the origins of the Federal Reserve.

1929. The crash that led to the Great Depression.

These five provide a lens on more modern crashes and crises, including the events of 2007-09, and, more recently, evidence of a growing bubble in some asset markets in early 2021.

In addition to helping us understand finance, crises offer lessons in the way policy works too. Each crash covered here led to new rules, regulations, and institutions. In each case the reforms took just a few years but their impact—intended and accidental—is felt centuries later.

How frequent are crises?

Crises happen relatively often. The chart below shows over 200 years of data on various types of crash, starting in 1800. You can use the drop-down box to select the crisis—banking, currency—that you are interested in. It is noticeable from the stacked version of the bar chart that crises often come together. That said, the focus for this page is banking crises.

A common cause: leverage.

One factor turns up time and time again with financial crises: leverage. By leverage I mean the ratio of assets (A) to equity (E). If this ratio is 1, then A = E. This means the asset in question (a house, say) was bought with no debt i.e. fully equity funded. If the ratio is 2, then assets are double the equity, so that a £300,000 house purchase has only £150,000 of equity, and relied on £150,000 in debt. Higher leverage rations mean more debt and less equity.

Given the repeated role that leverage will play in the stories below, it would be simple to say there should be as little leverage as possible. That is the wrong conclusion. Leverage is not a ‘bad’ thing, to be minimised. Taking on debt is a vital way to fund ideas and projects—confident CEOs will want to take on more leverage. If things go well, leverage magnifies the gains. But leverage has to be treated with caution. Higher leverage will tend to lead to more bankruptcies if asset prices fall fast.

The reason for this is the simple point that debts are fixed in value. This means that equity rises and falls with asset prices. Equity is the balance sheet's shock abosorber. To see how this works, toggle the values in the chart below to see how the value of equity changes at various property values. In the example the house was bought for £300,000 at leverage ratios of 1, 2, 5 and 10 respectively.

Reading and links

Some papers and articles by me

The Evolution of the UK Banking System. A Bank of England report, with some coverage of 1825 and the implications for the modern UK mega-banks, and in particular RBS.

The Slumps that Shaped Modern Finance. This essay, in The Economist, sets out some introductor detail on the crises above, including lots of maps and protraits of some of the heroes and villians behind each of the crashes.

Articles I recommend as a first read for each crisis

1792. Sylla, R. (2007). ‘Alexander Hamilton: Central Banker and Financial Crisis Manager’, Financial History, 87 (Winter): 20–5.

1825. Neal, L. (1998). ‘The Financial Crisis of 1825 and the Restructuring of the British Financial System’, Federal Reserve Bank of St Louis, May.

1857. Calomiris, C. W. and Schweikart, L. (1991). ‘The Panic of 1857: Origins, Transmission, and Containment’, The Journal of Economic History, 51(4): 807–34.

1907. Tallman, E. W. and Moen, J. R. (1990). ‘Lessons from the Panic of 1907’, Federal Reserve Bank of Atlanta Economic Review, 75, May-June.

1929. White, E. (1990), 'The Stock Market Boom and Crash of 1929 Revisited', Journal of Economic Perspectives, 4(2), Spring.


Data and code for charts used in this page can be found here.

The Reinhart and Rogoff data, which cover many types of crisis, are here.

Data back to 1086 is available from the Bank of England's, Millenium of Macroeconomic data publication.