Insider Bank Runs: Community Bank Fragility and the Financial Crisis of 2007

Abstract

From 2007 to 2010, more than 200 community banks in the United States failed. Many of these failed community banking organizations (CBOs) held less than $1 billion in total assets. As economic conditions worsen, banking organizations are expected to preserve capital to withstand unexpected losses. This study examines CBOs prior to failure or becoming problem institutions to understand if, on average, a run on capital by insiders via dividend payouts led to greater financial fragility at the onset of the crisis. We use a control group of similar-sized banks that did not fail or become problem institutions to compare our results and to draw statistical conclusions. We use standard control variables highlighting corporate governance and managerial ownership, such as S-corporation designation and bank complexity that might create incentives more conducive to insider enrichment than to the welfare of depositors or debtholders. Although the new Dodd-Frank legislation exempted smaller banks from many proposed requirements, our results show that capital distributions to insiders contributed to community bank weakness during the financial crisis.

Keywords: Dividend Policy, Financial Crisis, Bank Lending, Bank Risk, Bank Regulation, Risk Management

JEL Classification: E44, G01, G21, G32, G35