By analyzing 20 developed economies over 1920–2012, we find the following evidence of overoptimism and neglect of crash risk by bank equity investors during credit expansions: (i) bank credit expansion predicts increased bank equity crash risk, but despite the elevated crash risk, also predicts lower mean bank equity returns in subsequent one to three years; (ii) conditional on bank credit expansion of a country exceeding a 95th percentile threshold, the predicted excess return for the bank equity index in subsequent three years is −37.3%; and (iii) bank credit expansion is distinct from equity market sentiment captured by dividend yield and yet dividend yield and credit expansion interact with each other to make credit expansion a particularly strong predictor of lower bank equity returns when dividend yield is low.

We examine historical banking crises through the lens of bank equity declines, which cover a broad sample of episodes of banking distress with and without banking panics. To do this, we construct a new data set on bank equity returns and narrative information on banking panics for 46 countries over the period of 1870 to 2016. We find that even in the absence of panics, large bank equity declines are associated with substantial credit contractions and output gaps. Although panics are an important amplification mechanism, our results indicate that panics are not necessary for banking crises to have severe economic consequences. Furthermore, panics tend to be preceded by large bank equity declines, suggesting that panics are the result, rather than the cause, of earlier bank losses. We use bank equity returns to uncover a number of forgotten historical banking crises and create a banking crisis chronology that distinguishes between bank equity losses and panics.

We study the mechanisms driving bank losses across historical banking crises in 46 economies and the effectiveness of policy interventions in restoring bank capitalization. We find that bank stocks experience large, permanent declines at the onset of crises. These losses predict commensurate long-term declines in banks’ earnings and dividends, rather than elevated future equity returns. Bank losses are primarily driven by write-downs of nonperforming assets, not asset sales during panics. Forceful liquidity-based interventions during crises predict only small, temporary increases in bank market value. Overall, these results suggest that bank losses during crises are not primarily due to temporary price dislocations. Early liquidity interventions can avert banking crises, but only under specific conditions. Once large bank equity declines have occurred, policy responses have historically failed to prevent persistent undercapitalization in the banking sector.