Bank Stability: A Study of the Stability of Lancaster

County Banks during the Recession of 2007/2008

Ryan Groff
Econ 488
Fall 2014

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Abstract
The financial crisis of 2007/2008 was a force that affected everyone in some way, and banks
were no exception. The purpose of this study is to analyze if Lancaster County banks remained
stable during the recession using a leverage ratio used to find the market leverage. It is
hypothesized Lancaster County banks did remain stable during the recession due to high
amounts of capital held, lower unemployment levels in Lancaster County, a lower amount of Fed
Funds purchased, the ability for banks to branch, and higher levels of bank competition in
Lancaster County. The study is important because the ability to know that the local bank that so
many are invested in is stable is reassuring for the community. Almost everyone has money in
the bank, and showing that banks remained stable during the recession gives investors a sense of
security knowing their money is safe. This keeps investor confidence high, which keeps a bank
healthy and can help it to continue to perform highly and prepare if there ever were another
recession.

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Introduction
Ho Chi Minh was once quoted by saying, Remember, the storm is a good opportunity
for the pine and the cypress to show their strength and their stability (BrainyQuote). The
financial crisis of 2007/2008 was a storm that came through and sent the economy into one of the
deepest recessions America has ever seen. The storm gave some of the smaller banks around the
country the opportunity to show just how strong they were. It was all of the news how big banks
were struggling fiscally. However, most of the smaller banks around the country remained strong
and kept operating fairly normally. Not everyone has heard the story of the small bank that
required no bailout and no outside help to remain in business during the crisis. However, the
small banks story is perhaps one of the most important to tell.
This study analyzes the stability of local Lancaster County banks during the recession of
2007/2008 and years directly before and after for a basis of comparison. For the purpose of the
study, only three banks in Lancaster County were chosen. Those banks include the Ephrata
National Bank, Susquehanna Bank, and Fulton Bank. These three banks were chosen because
they are the largest three banks in Lancaster County that also have their headquarters based in
Lancaster.
Small banks play a pivotal role in the local communities and counties where they set up
their headquarters. Biz2Credit is a small banking lending index featured on sites such as the
Wall Street Journal and the Los Angeles Times. Biz2Credit measures all of the lending done to
small businesses and reports that data to help a borrower decide on the best option for their
business. Biz2Credit has reported lending by small banks to small businesses averages 30%
higher than the lending of a large bank. This statistic shows that the small banks are the ones

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that are more likely to give the loan to a borrower who would need to start up a business.
Obviously, if a loan is needed for a start-up, a small bank is a good choice. Small banks are very
important in communities. A small bank can lend the money that will help a local economy
thrive. If that money were to dry up, the community could dry up with the bank. Showing why
a small bank has a better chance of remaining stable can improve the confidence of the
community, and help keep lending flowing.
In this paper, stability is the main subject of focus. A lot of factors go into determining
whether or not a bank is stable. Bank stability is when a bank remains resilient to economic
shock and doesnt have to alter its day to day business. Capital is the money that a bank requires
to invest into other investment areas. Capital is a banks Total Assets minus their Total
Liabilities. Leverage is the most agreed upon method of determining the stability of a bank.
Leverage can be defined multiple ways. In this study, leverage is defined as

Market Price per Bank ShareNumber of Outstanding Shares

Bank ' s Total Assets

(Chen). In order to calculate

the leverage, it is necessary to collect data on the closing market price for the bank stock on the
last day at the end of each quarter, how many shares the bank had outstanding at the end of the
quarter, and how many total assets the bank was holding on to at the end of each quarter.
There are theories on why outside factors play a role in the stability of the bank, and this
study samples a few of the theories and then expands on how those theories impact financial
stability of a bank. Amount of capital a bank holds, unemployment, isolation of the bank,
branching, competition, and leverage are all theoretical ideas that potentially boost stability. The
leverage of the bank tells a lot about the stability. For example, a lower leverage ratio means that
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the bank has less debt per dollar of equity that they own. Essentially, the bank is taking on less
debt when investing into the market. This project takes the leverage and converts the leverage
into a z-statistic to allow a comparison between the two numbers. Converting the leverage into a
z-statistic is found by taking the leverage of a particular quarter subtracted by the average
leverage for a bank and the dividing the difference by the standard deviation of the banks
leverage. Finding the z-statistic puts the leverage ratios into common numbers that allows
comparison. If a z-statistic is negative, that means the leverage ratio was below the mean for that
quarter. A negative z-statistic indicates a lower leverage ratio than normal, which indicates
increased stability for the quarter and vice versa if the z-statistic were positive.
This study hypothesizes that leverage ratios remained constant during the recession,
which would indicate that the recession did not affect day to day business of the bank. The
reasoning behind the hypothesis is based off of multiple theories. The first theory used is that
Lancaster banks remained stable during the Financial Crisis of 2007/2008 because they held onto
large amounts of capital and experienced a regional economy with lower levels of unemployment
when compared to the national average. Also, local banks purchased fewer Fed Funds during the
recession, which showed strength to investors, which increased their stability. This study also
argues that an increase in branching and competition also allowed banks to keep their level of
stability throughout the crisis. At the end of the study, when the leverage ratios are found, it is
predicted that Lancaster banks are going to have low leverage ratios, helping show that Lancaster
banks were stable during the crisis.
Literature Review

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Chen studies how leverage ratios affect bank performance, with his goal to show market
leverage ratios are more accurate than book leverage ratios when trying to show stability of
banks (Chen). Leverage ratios are defined by Chen as the amount of equity that changes in a
bank with respect to the amount of total assets owned by the bank (Chen). Essentially a bank
that would have a higher leverage ratio is more vulnerable because a percent change in a banks
assets would cause a higher percent change in the equity of the bank (Chen). Chen finds that
market leverage ratios are indeed a better way to find out how a bank is performing and can
show how stable a bank is at any point in time (Chen). He went on to state that market leverage
is a good indicator of which banks are distressed, which is important because the ratio could
provide policy makers good insight as to which banks need help (Chen). With this number, it is
possible to predict the probability of a bank going bankrupt. Fu did a similar analysis on bank
stability and competition in Asia-Pacific countries (Fu). She included bank competition in her
study to see if bank competition lead to an increase in bank stability (Fu). The findings in Fus
study indicated that bank competition did indeed increase a banks stability, because it made the
bank risk adverse, meaning they invested in safer assets (Fu). Once the bank was invested in
safer assets, the bank was more stable and less likely to go bankrupt (Fu). Fu and Chen both did
studies on banks to find how stable they remained throughout volatile times in an economy. One
study however disputes market leverage ratios being the most accurate depicter of the stability of
a bank. Calmes claims that his approach using a Kalman filter is a better way to find stability
because normal leverage ratios do not capture systemic risk, which according to his study, is a
good indicator of bank stability (Calmes). For the purpose of this study however, leverage ratios
will be used due to the complexity of the Kalman filter, which would violate the time constraints
given for this project.

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Market Leverage ratios are important to the study being conducted on the stability of
local banks because the leverage ratios will be able to give an exact number which could
definitively show how stable a bank is. There are parameters set by Chen which help show what
a stable bank would look like compared to an unstable bank. These parameters are useful to
show just how stable a local bank would be. These parameters are then applied to the numbers
found using data based off of the Lancaster County bank data. This data will either support or
deny the hypothesis that Lancaster County banks remained stable during the recession. Chen
supplied a formula that is significant to find stability in banks and can be applied to this study.
Stability is a huge factor in the market; in fact the study by Fu suggests that bank
competition actually increases stability. She suggests that bank stability comes from competition
because a bank that has to deal with competition is less likely to take risks, which increases
stability (Fu). This idea makes sense because when a bank has to compete against other banks to
bring in customers is less likely to take risks. The less risk a bank takes, it decreases the
probability of a default on any loans or investments it may make. According to Fu then, when a
bank is less likely to receive a default on their loans, it increases their stability because that is
money the bank has a higher probability of receiving (Fu). This study matches with the study
being researched because a simple look at the number of banks in the area could give an insight
into the competition in the area. With the logic used in Fus study, finding the amount of
branches can then lead to helping find the stability of banks in the local area, which would
support the research question being asked.
Wheelock and Wilson studied what major factors are involved that could cause a bank to
be acquired or fail (Wheelock and Wilson). Ultimately, they found that banks with more capital
experienced a lower risk of facing failure (Wheelock and Wilson). Wheelock and Wilson also
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found that a banks ability to create branch banks allows the bank to become more stable
(Wheelock and Wilson). The branching of more banks allows the bank to diversify and become
less at risk to local economic shocks (Wheelock and Wilson). Branching is important because if
one bank were to fail, there are a multitude of other banks that are available to lessen the shock
defined by Wheelock and Wilson. Diversification is always a major idea taught by business
professors everywhere, and has become a fundamental idea. It is never wise to invest in heavily
in similar markets, and branching allows a bank to invest in different places which makes lessens
the effect if one bank were to close. Amount of capital is an important idea when finding the
stability of a bank. Capital is so important because it allows investment, investment entices
investors to start buying into the bank, and an increase in the level of investors will allow a bank
to become more stable due to the increase in the money supply.
Berger and Bouwman wanted to know how capital influences a banks performance and
see how the influence of capital changes over periods of boom and bust (Berger and Bouwman).
They hypothesized that a banks capital increased the probability of survival during recessions
and normal times and that capital increases a banks market share during recessions and normal
times (Berger and Bouwman). They empirically proved that capital can increase the odds of a
banks survival (Berger and Bouwman). Berger and Bouwman created a formula that will show
the probability of a bank surviving during a period of time (Berger and Bouwman). Their results
also showed that small banks, which had smaller amounts of market share, had an increased
probability of survival during any during throughout their tested time period. This article is
important because it proves that smaller banks were more likely to survive a financial crisis. The
probability of survival is important when it comes to the idea of stability, because a stable bank is
going to have a low probability to fail. Once again, another paper proves that capital is so
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important for a bank to survive during tough economic times, to try and offset the turmoil in the
economy. Capital in a bank allows the bank to offset any defaults it may incur during a
recession, and also allows them to reinvest at any point.
Carlson, Shan, and Warusawitharana did a study to show how capital ratios affect bank lending
between banks (Carlson, Shan, and Warusawitharana). They were searching to find if an
increase in capital ratios indicated that a bank was more willing to lend during a period of time
(Carlson, Shan, and Warusawitharana). Carlson, Shan, and Warusawitharana found that capital
ratios were a good indicator of bank lending during the recession, but were not a good indicator
during other times (Carlson, Shan, and Warusawitharana). In their study, the leverage ratio was a
strongest indicator which was the strongest indicator of the lending activities of banks during
recession and expansionary times (Carlson, Shan, and Warusawitharana). This article once again
shows that leverage ratios are one of the most reliable figures to look at when you are trying to
determine anything about a bank. In Carlson, Shan, and Warusawitharana article, leverage ratios
were yielded the most significant figure to the test. This helps show that leverage ratios are very
important, and reliable when showing the bank stability in Lancaster County. Carlson, Shan, and
Warusawitharana find that banks with higher bank capital reduce adverse selection because
capital allows a bank to see the value of their assets (Carlson, Shan, and Warusawitharana). If a
bank can easily find the value of their assets, they are more prone to make safer decisions, which
can increase the stability of a bank (Carlson, Shan, and Warusawitharana).
Geanakoplos argued that leverage ratios were the key indicator in macroeconomic
stability (Geanakoplos). He argues that leverage is a better indicator of a boom or bust cycle
because when creditors are afraid of default they ask for leverage, or collateral, or the loan to
decrease the risk in their investment (Geanakoplos). Geanakoplos uses leverage as a tool used
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by banks and lenders as a way to loan out money to an investor to lessen the fear of default
(Geanakoplos). Geanakoplos uses graphs and figures on prices from 1999-2008 to show that
asset prices leaped up until the recession and the collapsed (Geanakoplos). He theorizes this is
because of the leverage cycle where good times leave investors feeling good about their
investment, which allows creditors to loosen the reins on their loans due to a decrease in the fear
of default (Geanakoplos). Once a hint of bad news hits, this causes a downward spiral in prices
which leads to buyers losing more off of their investments, which multiplies the negative effects
of the downward effects causing a recession (Geanakoplos). Leverage is important because it
allows an investor to experience higher gains or losses off of an investment (Geanakoplos). If
your investment takes a loss, the loss experienced on the investors return is much higher than if
the investor had used only their money (Geanakoplos). This article is important because it shows
just how much leverage can affect the economy, and how much it can worsen the economy if
leverage ratios are not kept in check.
Chiaramonte and Casu wanted to know if Credit Default Swaps (CDS) spreads are a good
indicator of bank performance (Chiaramonte and Casu). Credit Default Swaps are when a party
decides to protect themselves from the default of a third party by selling a credit, typically a
bond, to a prospective buyer (Chiaramonte and Casu). The buyer makes payments to the seller
for the bond, and in return the seller is guaranteed to pay the buyer if the third party should
default on their loan (Chiaramonte and Casu). They used basic bank balance sheet ratios to try
and show that CDS spreads indicate how a bank is performing (Chiaramonte and Casu).
Chiaramonte and Casu also included leverage ratios into their study. In their study they defined
leverage as Equity divided by Total Assets which shows how in debt a firm is at any specific
point in time (Chiaramonte and Casu). Chiaramonte and Casu found that different variables are
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important to CDS spreads during different times such as recession or expansion times
(Chiaramonte and Casu). They found that leverage was not a major determinant of bank CDS
spreads, but their article does a lot in defining leverage ratios. That is why this article is
important to the study of Lancaster Banks because Chiaramonte and Casus study shows another
way to define leverage. Chiaramonte and Casus way of defining leverage is much more
simplistic and can be used as a base to show how in debt a bank might have been over the
recession era, which can give insights to stability.
Marshall wanted to know if the history behind a geographic area had any effect on the
performance of banks in certain areas around Great Britain during the financial crisis (Marshall).
He wanted to see if events that occurred as early as the 19th century had any affect may have
caused certain banks to fail during the recession (Marshall). Marshall found that centralization
of banks ultimately lead to those banks failing (Marshall). Centralization is when a bank
becomes focused in one location, making all of its major decisions within the organization with
little to no outside influence (Marshall). Marshall claimed that the latest recession in Britain was
just a culmination of previous decisions made by banks leading all the way back as early as the
19th century (Marshall). The fact that banks were becoming more and more independent from
each other ultimately caused their failure (Marshall). Banks in England that were not in London
were not interacting with other banks, sot their fate was in their own hands (Marshall). When
those banks started to fail, there was no one to fall back on, so when they failed they needed to
be saved by the government if they hoped to remain in business like Northern Rock (Marshall).
This article is important to this study because it shows how banks coexist with each other in
markets. Showing that banks in the area do not do business by themselves, but instead do

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business in the community helps show that a bank was more stable during a certain time period
and gives doubts that the bank was at any risk of failing.
Hendrickson and Nichols wanted to know why banks were failing in uneven patterns
across the United States and figure out why over sixty-five percent of those failed banks were
spread out between only six states (Hendrickson and Nichols). They were not able to find any
proof that mortgage backed securities or how well real-estate loans were performing were any
indication of the probability of a bank failure, but instead find that the amount of capital a bank
was holding to be a major indicator of failure (Hendrickson and Nichols). To find this out
Hendrickson and Nichols used a CAMELS bank rating system to make a model that would show
if a bank failed or not (Hendrickson and Nichols). With this information, they were able to find
similarities in the economies of the banks that did fail and draw their conclusions (Hendrickson
and Nichols). They concluded that bank failures today basically come down to poor balance
sheet performance (Hendrickson and Nichols). Hendrickson and Nichols also found that the
local economies played a major factor in the performance of the bank that played into whether or
not the bank failed such as the unemployment level and the home price index (Hendrickson and
Nichols). The article is important because it goes a long way in explaining why certain areas of
the United States were hit harder than other areas. Hendrickson and Nichols explain why banks
were able to hold more capital than other areas because of the local economies which gives
background into why certain banks failed while others where less affected by the recession.
There are a lot of studies out there that show that capital is important to a bank to survive
and that leverage ratios are the best way to find a banks probability to survive at any point in
time. There are studies that even show why certain areas are more prone to boom and bust
cycles. With the information found during research, it is possible to take that information and
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apply it to Lancaster County banks to see if they were really as stable as they seemed during the
recession, or if it was all smoke and screen. Using the regional context, figuring out why
Lancaster County banks were affected by the recession is possible too. Adding the regional
context of how Lancaster County banks performed during the recession will be an addition to the
knowledge already set on how banks performed during the recession.
Theoretical Analysis
Capital is one of the most important aspects of a bank. It allows investment and provides
a certain level of security if an investment goes into the negative on returns. It is conceivable
that Lancaster Banks held on to large amounts of capital. For the purpose of this project, Bank
capital is going to be defined as the banks Total Assets minus their Total Liabilities. Capital is
important to a bank because it gives the bank confidence in its ability to invest. An increase in
capital causes an increase in confidence in the bank from an outside perspective. This increase in
confidence decreases the probability of the bank experiencing a bank run. During a recession,
the ability to decrease the probability of a bank run is very important. Investors want to know
that their money will be available for withdrawal when they need it again. The average investor
just wants security in the fact that the bank is a safe deposit, guaranteeing that their money is not
going to disappear. The decrease in the probability of bank run increases the secure feelings
outside investors have when thinking about the bank. The increase in secure beliefs towards a
bank causes the deposits going into a bank to increase, which in effect increases their stability
even more. The cash from the deposits becomes an asset to the bank when they can use the
deposits to invest elsewhere in an attempt to increase their capital. The reinvestment of capital
could cause a cycle where investors keep investing in the bank, keeping the bank stable, despite
the recession. From the banks perspective, a large amount of capital is beneficial to their
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interests because that capital allows the bank to invest in higher profit investment options, which
in return increases the banks revenues.
According to Hendrickson and Nichols unemployment played a pivotal role in the failure
of banks around the country. Unemployment is defined as individuals who currently are not
working, but are available and still looking for work. Hendrickson and Nichols found that 65
percent of all bank failures around the country happened in six states. What was in common
between those six states? All six experienced higher levels in unemployment, which caused the
banks in those six states to experience disappointing fiscal periods and caused a large number of
those banks to fail. With this information in mind, it seems logical to conclude that Lancaster
did not experience high levels of unemployment when compared to the rest of the United States.
Figure 1 shows that unemployment in Lancaster County never was as high as the national
average. Hendrickson and Nichols found in their research that most banks that failed
experienced increased levels of unemployment in their community. An increase in
unemployment is going to cause a decrease of wealth in the community due to falling income. A
decrease in wealth is going to cause a decrease in investment and is going to shift consumption
as unemployed individuals start spending their money on different items. Assuming investment
would decrease is logical because a decrease in wealth may be associated with a decrease in
wages. The decrease in wages means that the consumer has less money to spend in the economy,
so the consumer is going to purchase the necessities such as food, water, or rent. The decrease
in wages means the family has less left over after purchasing their necessities which means the
family has less to invest for the future, which is going to cause a decrease in investment. Banks
rely heavily on investment, which is going to decrease if wages decrease. If wages decrease,
then that leaves less available money for deposits, so in effect, deposits are going to go down,
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which decreases stability in the bank. Hendrickson and Nichols find that unemployment is a
significant determinant of a bank close on the 10% significance level in the six states where most
bank failures occurred, showing unemployment can ultimately lead to a bank closing in an area
of high unemployment. Since unemployment was below the national average in Lancaster,
Lancaster banks did not experience the full brunt of the recession other banks felt around the
nation as unemployment sky rocketed. Lancaster County banks remained stable during the
recession because unemployment levels were less volatile in Lancaster County.
US bank to bank lending is done through the Federal Funds Market. In this market,
banks circulate loans to one another, providing a loan for a bank to cover deposits or a reserve
requirement. Normally these loans are paid back overnight and have a low interest rate. The
ability for a bank to cover a small shortage of money via the federal funds market is important
because the loan allows the bank to avoid default. People pay a lot more attention to news about
default than about a bank to bank loan. The ability to avoid a default avoids the news of the
default. Whenever an investor hears of a bank defaulting, the investors reaction may be to pull
their money from what is perceived to be a failing bank. This causes a downward spiral for the
bank. However, trust is an important aspect when considering the bank to bank lending model.
Marshall states that money will only flow if there is trust that it will be paid back. Assuming
money flows because of trust, and there is trust between banks, the trust is going to increase the
confidence a bank has that their loan is going to be repaid. In effect, this will cause inter-bank
lending to increase which will allow money flow between banks to also increase. An increase in
money flow decreases the risk of investing in a bank. Investor confidence increases as risk
decreases which leads to an increase in deposits which increases the stability in the bank.

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However during the recession, a lot of bank to bank lending froze because most of the
banks lost trust in their counterparts to repay the loans. There was a constant fear in the financial
markets that banks were not going to be able to open the next morning. The fear of the potential
fall out of the financial market led to banks deciding to keep their money within the bank and not
lend it out in fear of losing it all. It is still possible to measure how stable a bank was during the
financial crisis. The Fed Funds purchased tells the amount of overnight loans a bank needed to
purchase from the Fed. The number of Fed Funds purchased is important because the number
purchased tells how much money a bank needed to be able to balance their debits and credits. If
the Fed Funds purchased by Lancaster County banks is lower than the national average, then
Lancaster County banks required fewer quick fixes. Showing that banks require less help from
the Federal Funds market to balance overnight budgets is an important indicator. Banks are
required to keep a minimum amount of reserves with the Fed. Figure 2 shows the amount of Fed
funds purchased by a bank from Quarter 4 of October 2004 until Quarter 1 of January 2012.
Ephrata National Bank is excluded from the graph because its Federal Funds purchased is an
insignificant number that does not show up on the graph. Figure 2 shows how often
Susquehanna Bank and Fulton Bank purchased Fed Funds to cover their reserve during the
period. Figure 2 shows that these banks were below the national average for the amount of
Federal Funds purchased from the Fed. Using the information from Figure 2, Lancaster County
banks were more stable during the recession because they required less additional support from
the Fed in the form of Fed Funds.
Another possible source of stability in a bank is the ability for the bank to branch.
Branching is essentially just when a bank opens up another bank under the same name. For
example, Susquehanna has banks in Pennsylvania, New Jersey, West Virginia, and Maryland.
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Having banks in multiple states allows Susquehanna diversify their risk according to how the
local markets are performing. All the banks in Lancaster have multiple branches as shown in
Figure 3. However, Ephrata National Bank has a far fewer amount of banks as compared to the
other two banks in Lancaster. Ephrata National is also solely based in Pennsylvania, with all but
one of their branches being outside of Lancaster County. With the vast majority of their
branches being in Lancaster County, Ephrata National doesnt apply to the branch argument
because Ephrata National only operates in Lancaster markets.
The reason branching is so important to a banks survival is because branching allows a
bank to diversify risk. The concept of diversifying risk is the notion that diversification allows a
bank to use branches as investment tools to help avoid investing all eggs in one basket.
Diversifying means a bank opens branch banks and uses the new bank as an opportunity to invest
in different markets. For example, if a bank has 4 branches located in different states like
Susquehanna does, when one of the local markets in Maryland experiences an economic
downturn, there are enough banks in other local markets that may reinforce the bank in
Maryland. This logic is based off the assumption there are other banks in the area. The increase
in bank branches also increases the possible areas of investment. The investment possibilities are
increased because each bank branch exists in a different market which increases their investment
diversity. If the market performance in one sector were to decrease then the other branches are
still capable of supporting the struggling branch, based on the assumption that all other markets
hold constant. The ability to diversify decreases banks risk, which ensures that a bank run is not
going to happen, which keeps the bank functioning stable.
Another theory on how banks are able to stay stable, even during a recession, is the
concept that bank competition contributes to bank stability. Fu studies banks in the Asia Pacific
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to see how competition affects stability, and she finds that bank competition gives banks more
stability. Fu uses the Lerner Index, which is a bank-level indicator of competition. The Lerner
Index describes a firms market power, with a 1 showing a monopoly and a 0 indicating pure
competition. Using the Lerner Index, she ran two tests on the data. The first test was on the
banks probability of failure and the second was on the financial soundness (Z-test) to find the
stability of a bank (Fu). Fu theorizes that a decrease in competition is going to increase risk
taking by banks. The risk taking of a firm is going to increase because markets recognize the
importance of banks and what they represent to the public. When a bank recognizes that they are
the price-makers in an economy, the bank is going to start engaging in risky behavior because the
bank knows that they are too important to fail. The increase in risk taking is going to increase
the number of banks that require assistance from the government. This increases the amount of
subsidies a bank receives from the government based off of the Too big to fail notion (Fu). A
bank recognizes when it controls a majority of the market share, so the bank knows that there
will be government bailouts if they were to need them when investments begin to fail. Bailouts
take away the risk from banks, meaning that the bank can only win on investment, so the bank
will increase risky behavior because of the lack of competition in the market. The increase of
risky behavior is why competition is needed in a market to keep stability. Taking Fus concept a
step further, the fact that a bank is taking subsidies from the government is going to decrease
investor confidence. When a bank loses the confidence of its investors, their deposits are going
to decrease which decreases their stability.
Another method that is can be used to measure competition in a market, and is a lot easier
to collect data on is the Herfindahl Index. The Herfindahl Index measure how much market
share a firm has and squares it. The market share is squared to add emphasis on the amount of
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market share controlled by larger bank. This is done for every firm in the market. Then all the
squared market shares are added up for the Herfindahl Index. Anything under 1500 is considered
competitive according to the Herfindahl Index. The Herfindahl Index for Lancaster County
banks is 1550, which means that Lancaster County has a fairly competitive market for banks.
Method
There are multiple ways to measure stability of a bank. One of the most popular ways is
Leverage Ratios. Almost every paper uses Leverage Ratios in some way to try and show
stability. To add complication to the matter, there are multiple ways to measure Leverage Ratios.

For the purpose of this project,

( Market Price per ShareNumber of Outstanding Shares)

(Bank ' s Total Assets)

is

used as the formula to solve for the Leverage Ratios of the banks (Chen). In the formula, market
price per share is the closing price of the banks stock on the final day of the quarter. Figure 4
shows the closing price of the stock for Lancaster County banks at the end of the quarter. The
number of shares outstanding is the number of shares a bank had outstanding at the end of the
quarter. The banks total assets are the amount of assets the bank owned at the end of the quarter.
Stock price shows how the company is faring in the market, and the stock price shows how much
of the market share a bank owns when multiplied by outstanding shares. The data needed to
compute the leverage was collected from Yahoo Finance where they posted the historic stock
prices and how many shares were outstanding. Yahoo Finance has one of the most
comprehensive lists of historical stock prices, and has been shown to have accurate
representation of stock prices by multiple sources. Yahoo Finance is one of the leaders in market
research, and is used by many financial teachers.
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In the project, Leverage Ratios are used because Leverage Ratios are often regarded as
the best measure of financial health (Chen). Leverage Ratios are important because they
measure the sensitivity of the value of equity ownership in a bank (Chen). With that being said,
banks with higher leverage tend to be more vulnerable because a percentage change in the banks
asset value would cause a higher percentage change in the value of a banks equity (Chen).
Lancaster County banks kept low leverage ratios during the recession. The leverage ratios of all
three banks hovered around 1-2%. A leverage ratio that is around 1-2% is considered to be a low
leverage ratio. The low leverage ratio indicates that Lancaster County banks maintained stability
during the recession, by maintaining their market share and keeping assets in the bank. During
the recession, all three banks actually saw their total assets rise. When totals assets start to rise,
the denominator in the leverage ratio rises, this causes the leverage ratio to decrease. The
decrease in the leverage ratio indicates that the bank has more assets to back up their market
share, which is an indicator of stability.
One of the best ways to know for sure that the Lancaster County banks were all stable is
to then convert the leverage ratio into a z-statistic. A z-statistic allows comparison between two
numbers. As previously stated, a z-statistic that is negative indicates that the number being
tested was below the mean. Applying leverage to the example, a z-statistic that is negative
indicates that the leverage for that particular quarter was below the banks average leverage.
This is important because a negative z-statistic indicates that the bank was actually more stable
during the quarter. If the z-statistic is negative, then the quarters leverage was below the
average, and as previously stated, the lower the leverage ratio, the higher the stability of a bank
during any quarter. The negative leverage ratio indicates that the bank was actually gained
stability during the quarter. All three banks had negative leverage ratios during the recession
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with the exception of the Ephrata National Bank, who had a positive leverage ratio for the first
quarter when the recession hit. Fulton Bank and Susquehanna Bank both had negative zstatistics during the entire recession. Showing that the banks had negative z-statistics during the
recession provisionally confirms that Lancaster County banks experienced increased stability
during the recession, which confirms the hypothesis that Lancaster County banks maintained
stability during the recession.
Conclusion
Banks in Lancaster County were able to remain stable during the financial crisis as by the
leverage ratio used in this study. Leverage ratios were low for the big three banks in Lancaster
County, which supports the hypothesis. However, not all of the factors thought to be associated
with stability actually factored into the stability of the bank. The number of branch banks does
not always increase the stability of a bank. By comparison to the other two banks in the study,
Ephrata National Bank had a lower amount of branch banks, but remained stable during the
recession. This disproved the hypothesis that a bank needs to have the ability to branch in order
to remain stable. Also, by comparison to the national average, Lancaster County banks
purchased fewer Fed funds, meaning they were not lending as much and took a more isolated
approach to bank lending. This helped to provisionally confirm that the ability to keep from
purchasing Fed Funds is beneficial to a bank, and keeps their stability. However, in the
Lancaster County region unemployment was not nearly as high as it was around the country,
averaging almost 2% below what the national average was for all periods. Also, competition
does play a part in the stability of Lancaster County Banks. Lancaster has a large number of
banks, while none of them holding on to large amounts of the market. Capital is always a
positive for stability. Lancaster County banks held on to larger amounts of capital compared to
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their total assets which improved their stability over the course of the recession. The best
evidence produced during the study that supported the hypothesis was the leverage ratios. Each
one of the ratios calculated by the leverage ratio came out to a low number. Lower leverage is
always considered a good thing because it means less debt is being taken on by a bank to
complete their projects. Lancaster County banks kept low leverage ratios, helping to support the
hypothesis that Lancaster County banks remained stable during the recession. In conclusion, this
study believes that increased amounts of capital, lower local unemployment, a small amount of
Fed Funds purchases, increasing bank branches, and competition in the banking sector all
increase the stability of a bank. Leverage ratios confirmed the stability of Lancaster County
banks during the recession, by remaining below 3% during the recession. The study
provisionally confirmed that increased amounts of capital, lower unemployment, a small amount
of Fed Funds purchases, and competition all increase the stability of a bank. This study also
shows that a bank doesnt need multiple branches in order to maintain stability.

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Figure 1

Data Accessed from BLS.gov

Figure 2

Fed Funds Purchased

$10,000,000
$9,000,000
$8,000,000
$7,000,000
$6,000,000

Average Fed funds

purchased by bank

$5,000,000

Fulton Bank

$4,000,000

Susquehanna Bank PA

$3,000,000
$2,000,000
$1,000,000
$-

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Data Accessed through DataPlanet

Source: FDIC

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Figure 3

Number of Bank Branches in Lancaster

300
250
200
150
100
50
0
Fulton Bank

Susquehanna

Ephrata National Bank

Stock Prices of Lancaster Banks

$40.00
$35.00
$30.00
Fulton Bank

$25.00

Susquehanna Bank

$20.00

The Ephrata National Bank

$15.00
$10.00
$5.00
$-

Source: FDIC
Figure 4

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Source: Yahoo Finance

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