Fighting Failure: The Persistent Real Effects of Resolving Distressed Banks

Abstract

We study the real effects of resolving distressed banks using quasi-experimental variation in resolutions introduced by a threshold-based rule of the FDIC Improvement Act. Our fuzzy regression discontinuity estimates indicate that resolutions lead to reductions in employment and establishments growth of up to six percentage points. These effects are concentrated in small, less urban counties, and translate to large declines in SME lending and increases in corporate bankruptcies. These results imply that large acquiring banks restrict lending to the small business borrowers of distressed target banks. Overall, current bank resolution policy may have costly externalities for local economic activity.