Trust in banks is a core determinant of financial system effectiveness. A high degree of confidence in banks improves participation in the financial system by contributing to the pooling of savings and expansion of credit by banks. Trust is also essential for the stability of the financial system, as it reduces the danger and intensity of bank runs. Can banking crises hamper one’s trust in banks for good? It is well-established that trust in banks fell sharply in countries hit hard by the Global Crisis (Sapienza and Zingales 2012). The experiences of loss in a banking crisis become embedded in a society’s memory and personal perceptions (Mudd et al. 2010), which in turn affect decision-making and risk preferences (Malmendier and Nagel 2011). While these studies note the
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Trust in banks is a core determinant of financial system effectiveness. A high degree of confidence in banks improves participation in the financial system by contributing to the pooling of savings and expansion of credit by banks. Trust is also essential for the stability of the financial system, as it reduces the danger and intensity of bank runs.
Can banking crises hamper one’s trust in banks for good?
It is well-established that trust in banks fell sharply in countries hit hard by the Global Crisis (Sapienza and Zingales 2012). The experiences of loss in a banking crisis become embedded in a society’s memory and personal perceptions (Mudd et al. 2010), which in turn affect decision-making and risk preferences (Malmendier and Nagel 2011). While these studies note the detriment caused by banking crises, however, they do not examine the long-term impact on trust in banks.
In a recent paper (Fungáčová et al. 2019a), we combine the banking crises dataset from Laeven and Valencia (2018) with the latest wave of World Values Survey conducted between 2010 and 2014 to investigate how past experience with banking crises influences an individual’s trust in banks. We have information on past banking crises and a measure of trust in banks for over 66,000 individuals in 52 countries.
On a scale of 1 to 4 (with 4 indicating greatest trust), we find the average level of trust in banks to be 2.55. There are large differences across countries with values ranging from a low of 1.77 for Spain to a high of 3.24 for Uzbekistan (Figure 1).
Figure 1 Mean trust in banks by country
Source: World Values Survey
In order to study the effect that past banking crises experiences have on an individual’s trust in banks, we compare the respondent’s year of birth with the information on banking crises. For the 52 countries in our sample, 73% of respondents have experienced a systemic banking crisis during their lifetime and out of those, 33% have experienced two separate crises.
Our estimations1 show that past experiences of banking crises erode the individual’s trust in banks. Just living through any systemic banking crisis decreases the probability that the individual responds with positive confidence in banks by 5.2 percentage points, which exceeds the corresponding figures for other variables. The longer the crisis, the greater the detrimental effect on trust.
Although the length of the crisis affects trust in banks, the frequency of crises does not. The sheer experience of a banking crisis is related to lower trust in banks and experiencing two separate crises does not change this result. Moreover, the loss of trust in banks is long-lasting. No matter how long ago the crisis occurred, it continues to have a negative impact on trust in banks.
‘Skin in the game’
We find that a banking crisis experience diminishes trust in banks most for individuals who, at the time of the crisis, were between 41 and 60 years of age. Such individuals likely suffer the greatest losses during a crisis because they have the most ‘skin in the game’ at this point in their lives. This interpretation agrees with Mudd et al. (2010), who show that experiencing losses in a banking crisis influences the behaviour of individuals. Merely witnessing a banking crisis at a young age does not lower one’s trust in banks.
Does the type of crisis matter?
As no two banking crises are the same, we further explored whether the characteristics of particular banking crises influence the degree of trust in banks. To this end, we divide the banking crises into two types: those with severe economic consequences and those with only moderate effects.
We find that all banking crises, severe or mild, erode trust in banks. The trust in banks of older people deteriorates even if the banking crisis they experience is only moderate. However, if a banking crisis is connected with severe output losses, the trust of younger people is hit hardest. Experiencing a severe banking crisis early in life is comparable to (or intertwined with) deep economic depressions in that they have a life-long influence on the beliefs of individuals (Malmendier and Nagel 2011).
Interestingly, pure banking crises affect trust in banks the most of any type of financial crises. Past experiences of currency crises or twin crises also reduce trust in banks, but their detrimental impact is weaker than that of a pure banking crisis. Confirming the special role of banking crises, the fact that an individual has lived through major stock market crashes has no effect on trust in banks.
Our work provides an additional reason for policymakers to prevent banking crises and, above all, to mitigate their economic consequences. Banking crises not only generate output losses and fiscal costs but lead to a long-term loss of trust in banks. In particular, the severer banking crises worsen the trust of the younger generation. Given the key role of trust in banks in ensuring the effectiveness of the financial system, such crises can have a detrimental and long-lasting impact on the economy.
In order to set proper policy, future research needs to determine if changes in bank supervision and deposit insurance implemented after the crises help mitigate the negative influence of crises on trust in banks and if they improve this trust. Moreover, a natural question to investigate is the possible impact lower trust in banks has on financial intermediation. Individuals’ lower trust in banks may hinder their willingness to deposit money in a bank and thus restrain the ability of the banking sector to extend credit.
Fungáčová, Z, E Kerola and L Weill (2019a), “Does experience of banking crises affect trust in banks?”, BOFIT Discussion Papers 21/2019, Bank of Finland.
Fungáčová, Z, I Hasan and L Weill (2019b), “Trust in banks”, Journal of Economic Behaviour & Organization 157: 452–76.
Giuliano, P, and A Spilimbergo (2014), “Growing up in a recession”, Review of Economic Studies 81: 787–817.
Kroszner, R, L Laeven and D Klingebiel (2007), “Banking crises, financial dependence and growth”, Journal of Financial Economics 84: 187–228.
Laeven, L, and F Valencia (2018), “Systemic banking crises revisited”, IMF Working Paper, WP/18/296.
Malmendier, U, and S Nagel (2011), “Depression babies: Do macroeconomic experiences affect risk-taking?”, Quarterly Journal of Economics 126(1): 373–416.
Mudd, S, K Pashev and N Valev (2010), “The effect of loss experiences in a banking crisis on future expectations and behavior”, B.E. Journal of Macroeconomics 10(1): 1–21.
Sapienza, P, and L Zingales (2012), “A trust crisis”, International Review of Finance 12(2): 123–31.
1 In addition to individual characteristics, we also include country fixed effects in these estimations as our previous work (Fungáčová et al. 2019b) confirms only financial crisis as significant determinant of trust in banks at the country level.