Why Do Banks Fail? Study Finds Insolvency Is the True Killer

Why It Matters

The research reshapes risk‑management priorities, urging regulators and banks to focus on capital adequacy to safeguard stability. It highlights that addressing solvency can stop runs from becoming fatal, protecting the broader financial system.

Key Takeaways

• Insolvency drives most bank failures, not liquidity
• Historical runs show solvent banks rarely collapse
• SVB's loss on securities highlighted hidden insolvency
• Strong capital buffers enable banks to survive runs

Pulse Analysis

The National Bureau of Economic Research’s new paper overturns the conventional narrative that bank runs are the primary cause of failures. By cataloguing over 4,000 runs between 1863 and 1934, the authors show that banks with solid balance sheets almost never collapsed, even when depositors rushed to withdraw cash. The research identifies insolvency—losses on loans or securities—as the underlying trigger that turns a liquidity squeeze into a terminal event. This historical perspective reframes the run as a symptom rather than the root problem.

Contemporary cases confirm the study’s findings. Silicon Valley Bank’s 2023 demise was precipitated by more than $15 billion in unrealized losses on long‑term Treasury holdings, leaving the institution technically insolvent before a social‑media‑fueled run amplified the panic. By contrast, Western Alliance Bancorp faced a sizable withdrawal surge but survived by publicly demonstrating a strong capital position and securing a Federal Reserve backstop. These examples illustrate how robust equity cushions and transparent communication can convert a liquidity shock into a manageable episode rather than a fatal collapse.

The policy takeaway is clear: regulators should prioritize capital adequacy over short‑term liquidity safeguards. Raising equity requirements would give banks a larger loss‑absorbing buffer, reducing the likelihood that asset devaluations translate into insolvency. For banks, rigorous risk‑management practices and proactive disclosure can preserve confidence during stress events. As interest‑rate volatility and digital banking accelerate, the industry’s resilience will increasingly depend on the depth of its capital base, making solvency the decisive factor in future stability.