Cohen, Hachem, and Richardson estimate that small-bank failures explain roughly a third of the Great Depression’s economic contraction. When small banks failed, valuable soft information essentially died with those banks, and that hurt the economy more than if a failure had destroyed a new relationship.
But the researchers also say that banking relationships can help mitigate a crisis. When large banks failed, Cohen, Hachem, and Richardson argue, people ended up at smaller banks, giving those banks the deposits they needed to support their ongoing lending relationships. Factoring that in, the researchers find that the economic effect of small-bank failures shrinks from one-third to one-eighth of the Depression’s contraction. Large bank failures and the ensuing migration of deposits toward smaller relationship lenders kept the Great Depression from being even worse.
And although the Great Depression ruined many long-standing banking relationships, surviving banks that rebuilt their relationships were stronger and better able to weather later economic contractions. Comparing the performance of commercial banks across geographic areas, Cohen, Hachem, and Richardson find that areas where banks rebuilt “the types of continuing relationships that they embraced in the 1920s” fared better during the 1937–38 recession than areas where banks didn’t rebuild those long-term relationships.