Relationship between Bank Failure and Economic Activities: A Review of Literature

Document Type: Review Article


Faculty of Business, IT and Communication, St. Paul’s University, Kenya


The banks are very important institutions in any given economy due to their role of financing the economy. Banks if not properly regulated can fail and hinder their primary role. The main aim of the study was to carry out a literature review on the Relationship between bank failure and economic activities. The specific objectives of the study are; to review the theoretical literature that anchors the study that links bank failure and economic growth, to review the empirical literature on the channels that link bank failure and economic growth, to investigate the gaps in the theoretical and empirical literature on the channels that link bank failure and economic growth and to propose a theoretical framework for linking bank failure and economic growth. The study is anchored by the agency theory, the contagion and the theory of lemons. The study empirically reviewed past studies in similar area and established gaps. The result indicated that the essential cause of the banking crunch is a physical one. Deregulation made it conceivable for commercial banks to also achieve activities of speculation banks, and for investment banks to also achieve actions of commercial banks. This had the effect of letting these organizations to association liquidity and credit risks in an unrestrained way. Double liability disclosures shareholders of deteriorating banks to misplace not only the original amount capitalized but also an amount identical to the par value of shares periods the number of shares possessed. The bank channels have a precarious role in the determining of the economy in the following ways. In the direct wealth effect when the banks fail, the investors who did not have the credits insured will have reduced wealth. This will in turn affect the real economy due to abridged consumer expenditure. Conclusion was made that bank failure remains a major threat to consistent economic growth that leads to development. The impact caused by economic contraction prevalent during this phase originated due to several shocks resulting in liquidity preference increase among depositors who preferred holding more currency to demand deposits and other liabilities. To this end, capital squeeze created reduction in money supply that affected entrepreneurial financing leading to slowdown in economic activity.


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