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A theory of linkage between monetary policy and banking failure in developing countries

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  • Raulin L Cadet

Abstract

Purpose – The purpose of this paper is to present a model that studies the impact of a tightening monetary policy on banking failure in a developing country. Design/methodology/approach – The interest rate on treasury bills is included in the model to measure monetary policy. Since the model considers developing countries with low-income level, the paper assumes that a secondary market does not exist. Findings – The model shows that, despite treasury bills constituting an alternative source of profit for banks in developing countries, a tightening monetary policy increases the probability of banking failure. In addition, the model shows that efficiency level explains the asymmetric effect of monetary policy on the profit of the banks. Practical implications – The policy implication of the results of the paper is that the central bank should take into account the adverse effect of a tightening monetary policy on banking failure, when planning policy decisions. Originality/value – The paper offers insights into the linkage between monetary policy and banking failure in developing countries.

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Bibliographic Info

Article provided by Emerald Group Publishing in its journal Journal of Financial Economic Policy.

Volume (Year): 1 (2009)
Issue (Month): 2 (May)
Pages: 143-154

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Handle: RePEc:eme:jfeppp:v:1:y:2009:i:2:p:143-154

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Related research

Keywords: Banking; Business failures; Developing countries; Interest rates; Monetary policy;

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References

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  1. Patrick Bolton & Xavier Freixas, 2006. "Corporate Finance and the Monetary Transmission Mechanism," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 829-870.
  2. David C. Wheelock & Paul W. Wilson, 2000. "Why do Banks Disappear? The Determinants of U.S. Bank Failures and Acquisitions," The Review of Economics and Statistics, MIT Press, vol. 82(1), pages 127-138, February.
  3. Arena, Marco, 2008. "Bank failures and bank fundamentals: A comparative analysis of Latin America and East Asia during the nineties using bank-level data," Journal of Banking & Finance, Elsevier, vol. 32(2), pages 299-310, February.
  4. Zarruk, Emilio R. & Madura, Jeff, 1992. "Optimal Bank Interest Margin under Capital Regulation and Deposit Insurance," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(01), pages 143-149, March.
  5. Christina D. Romer & David H. Romer, 1990. "New Evidence on the Monetary Transmission Mechanism," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1), pages 149-214.
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