Five Decades of Banking Crises: What Have We Learned?

The history of banking crises is more than a chronicle of bank-management errors and failures; it is a recurring narrative of systemic vulnerabilities shaped by repeated policy errors. Having had a role in many banking crises, I have observed that each episode—whether in the 1980s, 2008, or 2023—reveals common elements that policymakers and practitioners ignore at their peril.

These crises collectively underscore a central truth: Banking stability hinges not on predicting the unpredictable, but on addressing the causes of instability rooted in policy, regulation, and market incentives.

The Roots of Financial Instability

Banking crises often originate in the corridors of power, not just the boardrooms of individual institutions. Consider the inflationary spiral of the 1970s, when loose fiscal policies and accommodative monetary regimes fueled an expansion of lending against inflated collateral. Banks, lured by soaring asset values, overlooked cash-flow fundamentals—a misstep that unraveled when the Federal Reserve hiked rates to 20 percent in the early 1980s, triggering mass failures. Decades later, similar dynamics played out: Post-2000 monetary easing incentivized excessive mortgage leverage, while excessive post-pandemic stimulus pushed banks into precarious bets on long-term bonds.

In each case, the seeds of collapse were sown not by rogue traders, but by macroeconomic policies that distorted market risk perceptions. Adding insult to injury, the regulatory response often misfired, targeting the remedy toward instances of industry misjudgments and individual misconduct rather than systemic policy flaws. This pattern persists today, as debates over banking rules fixate on compliance minutiae while sidestepping the effects of poor macroeconomic policy and the moral hazard of explicit and implicit government guarantees.

Beyond fiscal and monetary policy, policymakers have come to focus mostly on liquidity rather than capital as the source of systemic instability, and this change in focus has weakened the system. Policymakers have framed liquidity and capital as distinct challenges, but these two pillars of bank stability are intertwined inextricably. A bank becomes illiquid precisely when stakeholders doubt its solvency—when liabilities eclipse assets and losses erode capital. Before federal deposit insurance, that link was clear, and institutions emphasized capital and managed liquidity with acute caution, knowing that the public’s loss of confidence in the bank’s viability would precipitate a deposit run and spell extinction.

Modern safety nets focused on liquidity backstops have provided short-term stability but weakened banks’ accountability to depositors. Deposit insurance and bailouts have substituted for market discipline, as depositors look more to the safety net and less to bank capital for protection. The 2023 crisis exemplified this: Institutions like Silicon Valley Bank grew dramatically with too little capital, gambling that the Fed would keep rates low indefinitely. But inflation rose, rates increased suddenly and significantly, and because capital was sparse, there was no confidence that the bank could absorb the loss. Unsure of government protections and fearing insolvency, uninsured depositors ran, accelerating the bank’s failure. The government ultimately bailed out all depositors—but at significant cost.

Liquidity demands confidence, and under stress, confidence demands strong and transparent equity capital.

Framework Flaws

This importance of strong capital exposes deeper flaws in modern regulatory frameworks. The Basel Accords, conceived to harmonize global capital standards, have become a case study in unintended consequences. Risk-weighted capital rules, allowing supervisors to employ complex models to align capital buffers to risk, were gamed by banks to minimize those very buffers. For instance, classifying all sovereign debt or packages of subprime mortgage loans as “no or low risk” enables institutions to dangerously concentrate exposures in these mis-weighted asset categories while appearing well capitalized. In 2008, for example, Lehman Brothers reported a moderate risk-weighted leverage ratio under Basel capital rules, but it effectively operated with an unweighted, extreme leverage ratio exceeding 30:1, almost guaranteeing failure under stress. Post-crisis reforms led to more rules and complexity without addressing the core issue: Banks still manipulate the rules to increase leverage and maximize returns, not resilience.

The lesson is clear: Unnecessary complexity breeds fragility. A straightforward leverage ratio—equity against total assets—would offer a more reliable gauge of health than risk-weighted calculus.

The Too-Big-to-Fail Dilemma

Compounding the systemic flaws outlined above is the corrosive effect of “Too Big to Fail” (TBTF) subsidies. It is an established fact that failure among certain of the largest banks would destabilize the financial system, and rather than allow them to fail, the government will bail them out. By insulating these largest banks from failure, policymakers have distorted market discipline and favored one category of banks over all others. TBTF institutions can borrow more cheaply and grow larger because depositors and other creditors trust the government will shield them from losses if the bank collapses. This implicit guarantee creates a perverse equilibrium: Profits are privatized, losses are socialized, and competition is stifled. Smaller banks, lacking such protections, face disproportionate scrutiny despite posing lesser systemic risk. The result is a bifurcated industry in which ultimate accountability is illusory for the most consequential players.

Regulation Without Accountability

In place of market accountability and strong capital, banks now face a complex maze of thousands of regulations. Since the 1970s numerous banking laws have been passed that direct or control bank activities. These include, for example, the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989, which increased the rules around appraisals; the Federal Deposit Insurance Corporation Improvement Act of 1991 (FIDICIA), which expanded agency examination powers; and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), which added rules around financial derivatives and other bank activities. Dodd-Frank also created an entire new agency, the Consumer Financial Protection Bureau.

From these laws, and nearly 40 others passed over five decades, the number of rules governing bank operations has increased by the thousands. While this regulatory environment raises costs for all banks, it inadvertently favors the largest and more powerful institutions. The Dodd-Frank Act alone has added tens of billions of dollars in legal and operational costs to the industry. These regulatory burdens create artificial barriers to entry and promote consolidation, as larger institutions can spread their costs over more assets, reducing relative unit costs.

A Path Forward

The path forward demands a return to simplicity and substance. Policymakers should better appreciate the deleterious effects of unthrottled fiscal and monetary policies. Capital—real, unencumbered equity—must serve as the bedrock of resilience. Complex liquidity mandates and stress-test models should yield to a focus on robust leverage ratios and credible resolution outcomes—with no exceptions. History shows that banks with strong capital buffers weather financial storms best; those that game the rules tend to fail or require bailouts. Policymakers must simplify and strengthen capital standards and allow institutions to fail—orderly wind-downs reinforce accountability far more effectively than bailouts do.

Finally, the stakes extend beyond banking. In an era of fintech disruption and digital currencies, the system’s credibility hinges on learning from past missteps. Crises will inevitably occur, but their frequency and ferocity depend on choices made today. By implementing disciplined monetary and fiscal policy—by prioritizing transparency over complexity, accountability over protectionism, and capital over complacency—we can build a financial ecosystem that fuels growth without recurring collapses. The lessons of 50 years can serve not just as a complaint, but as a blueprint for the future.