Advanced Search
MyIDEAS: Login

Financial liberalization and banking crises in emerging economies

Contents:

Author Info

  • Betty C. Daniel
  • John Bailey Jones

Abstract

In this paper, we provide a theoretical explanation of why financial liberalization is likely to generate financial crises in emerging market economies. We first show that under financial repression the aggregate capital stock and bank net worth are both likely to be low. This leads a newly liberalized bank to be highly levered, because the marginal product of capital—and thus loan interest rates—are high. The high returns on capital, however, also make default unlikely, and they encourage the bank to retain all of its earnings. As the bank’s net worth grows, aggregate capital rises, the marginal product of capital falls, and a banking crisis becomes more likely. Although the bank faces conflicting incentives toward risk-taking, as net worth continues to grow the bank will become increasingly cautious. Numerical results suggest that the bank will reduce its risk, by reducing its leverage, before issuing dividends. We also find that government bailouts, which allow defaulting banks to continue running, induce significantly more risk-taking than the liability limits associated with standard bankruptcy.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.frbsf.org/publications/economics/pbcpapers/2001/pb01-03.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Pacific Basin Working Paper Series with number 01-03.

as in new window
Length:
Date of creation: 2001
Date of revision:
Handle: RePEc:fip:fedfpb:01-03

Contact details of provider:
Postal: 101 Market Street, MS 1130, San Francisco, CA 94105-1579
Phone: (415) 974-3184
Fax: (415) 974-2168
Email:
Web page: http://www.frbsf.org/economics/pbc/
More information through EDIRC

Order Information:
Email:
Web: http://www.frbsf.org/popups/fiporder.html

Related research

Keywords: Developing countries ; Financial crises;

Other versions of this item:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Charles T. Carlstrom & Timothy S. Fuerst, 1996. "Agency costs, net worth, and business fluctuations: a computable general equilibrium analysis," Working Paper 9602, Federal Reserve Bank of Cleveland.
  2. Aaron Tornell & Frank Westermann & Lorenza Martinez, 2004. "The Positive Link Between Financial Liberalization, Growth and Crises," NBER Working Papers 10293, National Bureau of Economic Research, Inc.
  3. Sergio L. Schmukler & Graciela Laura Kaminsky, 2003. "Short-Run Pain, Long-Run Gain: The Effects of Financial Liberalization," IMF Working Papers 03/34, International Monetary Fund.
  4. Diaz-Alejandro, Carlos, 1985. "Good-bye financial repression, hello financial crash," Journal of Development Economics, Elsevier, vol. 19(1-2), pages 1-24.
  5. Robert J. Barro, 2012. "Inflation and Economic Growth," CEMA Working Papers 568, China Economics and Management Academy, Central University of Finance and Economics.
  6. Corsetti, G. & Pesenti, P. & Roubini, N., 1998. "What Caused the Asian Currency and Financial Crisis?," Papers 343, Banca Italia - Servizio di Studi.
  7. Felipe Meza & Erwan Quintin, 2005. "Financial crises and total factor productivity," Center for Latin America Working Papers 0105, Federal Reserve Bank of Dallas.
  8. Gregor Andrade & Steven N. Kaplan, 1997. "How Costly is Financial (not Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed," NBER Working Papers 6145, National Bureau of Economic Research, Inc.
  9. Rui Albuquerque & Hugo A. Hopenhayn, 2004. "Optimal Lending Contracts and Firm Dynamics," Review of Economic Studies, Wiley Blackwell, vol. 71(2), pages 285-315, 04.
  10. Milne, Alistair & Robertson, Donald, 1996. "Firm behaviour under the threat of liquidation," Journal of Economic Dynamics and Control, Elsevier, vol. 20(8), pages 1427-1449, August.
  11. Kenneth Kletzer & Robert Dekle, 2001. "Domestic Bank Regulation and Financial Crises: Theory and Empirical Evidence from East Asia," IMF Working Papers 01/63, International Monetary Fund.
  12. Bacchetta, Philippe & Aghion, Philippe & Banerjee, Abhijit, 2004. "Financial Development and the Instability of Open Economies," Scholarly Articles 4554209, Harvard University Department of Economics.
  13. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
  14. William C. Gruben & Jahyeong Koo & Robert R. Moore, 2003. "Financial liberalization, market discipline and bank risk," Center for Latin America Working Papers 0303, Federal Reserve Bank of Dallas.
  15. Burnside, C. & Eichenbaum, M. & Rebelo, S., 1998. "Prospective Deficits and the Asian Currency Crisis," RCER Working Papers 458, University of Rochester - Center for Economic Research (RCER).
  16. Bruce C. Greenwald & Joseph E. Stiglitz, 1993. "Financial Market Imperfections and Business Cycles," NBER Working Papers 2494, National Bureau of Economic Research, Inc.
  17. Thomas F. Cooley & Vincenzo Quadrini, 2001. "Financial Markets and Firm Dynamics," American Economic Review, American Economic Association, vol. 91(5), pages 1286-1310, December.
  18. Jason Furman & Joseph E. Stiglitz, 1998. "Economic Crises: Evidence and Insights from East Asia," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 1-136.
  19. Mendoza, Enrique G. & Smith, Katherine A., 2006. "Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices," Journal of International Economics, Elsevier, vol. 70(1), pages 82-114, September.
  20. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  21. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  22. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  23. C. John McDermott & Eswar Prasad & Pierre-Richard Agénor, 1999. "Macroeconomic Fluctuations in Developing Countries - Some Stylized Facts," IMF Working Papers 99/35, International Monetary Fund.
  24. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December.
  25. Cook, David, 2004. "Monetary policy in emerging markets: Can liability dollarization explain contractionary devaluations?," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1155-1181, September.
  26. Hanson, James A., 2003. "Banking in developing countries in the 1990s," Policy Research Working Paper Series 3168, The World Bank.
  27. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  28. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
  29. Allen, Franklin & Gale, Douglas, 2000. "Bubbles and Crises," Economic Journal, Royal Economic Society, vol. 110(460), pages 236-55, January.
  30. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680, December.
  31. Felipe Meza & Erwan Quintin, 2005. "Financial Crises and Total Factor Productivity: The Mexican Case," 2005 Meeting Papers 478, Society for Economic Dynamics.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Bastidon, Cécile & Gilles, Philippe & Huchet, Nicolas, 2008. "The international lender of last resort and selective bail-out," Emerging Markets Review, Elsevier, vol. 9(2), pages 144-152, June.
  2. Jordi Caballé & Xavier Jarque & Elisabetta Michetti, 2004. "Chaotic Dynamics in Credit Constrained Emerging Economies," Working Papers 121, Barcelona Graduate School of Economics.
  3. Julian Caballero, 2012. "Do Surges in International Capital Inflows Influence the Likelihood of Banking Crises? Cross-Country Evidence on Bonanzas in Capital Inflows and Bonanza-Boom- Bust Cycles," Research Department Publications 4775, Inter-American Development Bank, Research Department.
  4. Batuo Enowbi, Michael & Kupukile, Mlambo, 2012. "Financial instability, financial openness and economic growth in african countries," MPRA Paper 43340, University Library of Munich, Germany.
  5. Puspa Amri & Apanard P. Angkinand & Clas Wihlborg, 2011. "International comparisons of bank regulation, liberalization, and banking crises," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 3(4), pages 322-339, November.
  6. Houssem Rachdi, 2010. "The Link between International Supervision and Banking Crises," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 57(3), pages 321-332, September.
  7. Enowbi Batuo, Michael & Mlambo, Kupukile, 2012. "Financial liberalisation, Banking Crises and Economic Growth in African Countries," MPRA Paper 41524, University Library of Munich, Germany.
  8. Sufian, Fadzlan, 2009. "Determinants of bank efficiency during unstable macroeconomic environment: Empirical evidence from Malaysia," Research in International Business and Finance, Elsevier, vol. 23(1), pages 54-77, January.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:fip:fedfpb:01-03

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Diane Rosenberger).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.