THE BLOG

How a Banking Crisis Can Kill You

21/03/2013 17:59 GMT | Updated 21/05/2013 10:12 BST

Researchers are uncovering different and surprising ways Banking Crises can kill.

'Do Banking Crises Cause Terrorism?' is the title of a new research paper analysing the effect of banking crises on terrorist activity for 146 countries between 1972 and 2006. The study, from the Universities of Paderborn and of Freiburg, Germany, is about to be published in the prestigious academic journal Economics Letters. It showed that banking crises are followed by increases in domestic terrorism.

The authors, Thomas Gries and Daniel Meierrieks, were inspired to investigate this link partly by a statement by the Real IRA in 2011. This Northern Ireland terrorist group explained that banks, and similar financial institutions, had now become legitimate targets because of the hardship imposed on working class families arising from the financial crisis, which the Real IRA in turn blamed on bankers.

The recent public anger and demonstrations outside parliament in Cyprus, while Members of their Parliament debated solutions to their current banking crisis, hints of the possibility of less peaceful civil unrest in the future.

Gries and Meierrieks wondered about the mechanism for such a link. Cut backs in essential public services follow from Governments diverting resources to bailing out banks, producing unemployment, hardship and resentment.

But there are also other theories; suffering losses after investing in stocks and shares may be disappointing, but the process seems "fair". However, bank deposits are assumed (possibly erroneously) to absolutely safe, with a corresponding low opportunity for personal gain. So losses now feel like theft. An antagonistic reaction to the "thieving" naturally follows, even redefining what is acceptable, and what is criminal.

Terrorism may become more likely following a banking crisis not just due to poverty, but because the very moral contract on which societies rest, are now perceived to have been redrawn. This might explain why Banking Crises could provoke more civil unrest than other financial crunches - remember the London riots?

Gries and Meierrieks' study found that a banking crisis was followed by an overall 54 per cent increase in domestic terrorism in the subsequent five years across the world. For developing economies or poorer countries, a banking crisis has greater impact and more than doubles the number of domestic terrorist incidents in the following five-year interval.

But banking crises produce not just unique shocks to the financial system, but also to the psychology of the community and the individual. For example, a bank may be perfectly sound, but if a rumour was to spread that it was not, a panic or run may be started. No bank, no matter how fundamentally strong, can survive if every depositor turned up at its door demanding to withdraw all their savings.

So a viable financial institution can be ruined by public sentiment, rumour and panic, as disastrously as if economic fundamentals were in play.

Part of the grave gamble involved in the Cyprus crisis is precisely that a 'sentiment' swing, despite the parliament vote, may still provoke a run on the banks, which could nevertheless generate institutional collapses. Another special psychological aspect of the predicament is that banks, unlike other organisations, have an exceptional ability to induce contagion, as emotions, panic and depositor withdrawal, spread elsewhere.

Most other kinds of corporate failure do not generate contagion in such a dangerous manner as banking crises.

The people of Cyprus may have stood together against their persecutors but how much solidarity will remain when their banks eventually open?

If the whole community holds together and no one runs to close out accounts, then a banking crisis might be averted. However, if there is mass panic and a subsequent run on the banks, their collapse is near inevitable.

A run on banks poses a distinctively psychological conundrum. The first depositors to break and run, get their money back. But the further down the queue you are, the less likely you are to recoup your deposit. The last depositors who turn up at the bank get nothing. So there is a uniquely powerful psychological incentive to panic first, when it comes to runs on the banks.

Britain experienced its own run on a bank with Northern Rock, but unlike the relatively youthful demonstrators outside the Cypriot parliament this week, the majority who queued outside this UK financial institution on the brink of collapse, appeared to be disproportionately older. The elderly are not just the most sensitive to acute financial stress, they are also more likely to suffer predisposing cardiovascular risk factors. An acute stress, such as a banking crisis, might elevate cardiac risks.

Just how traumatic banking crises are, even in richer countries, is illuminated by a recent study entitled, 'Can a bank crisis break your heart?' from the Universities of Cambridge and California.

David Stuckler, Christopher Meissner and Lawrence King tested whether banking crises are linked to increases in cardiovascular mortality rates, using data from 1960 to 2002 for high- and low-income countries.

In their study, published in the academic journal Globalization and Health, a banking crisis on average is connected with a 6.4% short-term increase in cardiovascular disease mortality in high income countries, and for low-income countries, the estimated effect is roughly four times as large, with a banking crisis corresponding to a 26.0% increase in mortality.

How many deaths does this correspond to in the United Kingdom? In 2004/2005, there were 50,544 male deaths due to heart disease in Britain. If a severe banking crisis were to hit, these results suggest that it would cause anywhere from 1280 to 5130 additional heart disease deaths.

To put this effect in perspective, these authors calculate this is more than ten-times the number of British troops who have died in Iraq, up until the date the study was published.

David Stuckler, Christopher Meissner and Lawrence King (Professor in Sociology and Political Economy, University of Cambridge), conclude by arguing containing the spread of financial 'hysteria' is desirable not only for preventing systemic bank crises, but also because more people die earlier as a consequence.

Daniel Meierrieks, argues that his findings on increases in domestic terrorism mean that the Cypriot government should avoid drastic welfare cuts or other anti-crisis policies that produce socio-economic 'quarrels'. Meierrieks contends that a "deposit tax" does just that. He points out that given the history of Cyprus (Remember EOKA's violent campaign for the end of British colonial rule and union with Greece; plus the Turkish military conflict still unresolved), there remains potential for increased terrorism risk there.

On the other hand, Stuckler, Meissner and King point out that bailing financial miscreants, may simply encourage more risky financial behaviour. This is referred to as the "moral hazard" of bank bailouts.

Saving banks could appear to postpone some early deaths in the short term, but if they merely increase the risk of future bank crises, we are just postponing yet more serious, even deadlier problems.

These two recent studies remind us that banking crises are not just about financial health, they are also about social cohesion and mortality.

Banking is too important to be left to bankers.