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Transparency, liberalization, and banking crisis

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Author Info

  • Mehrez, Gil
  • Kaufmann, Daniel

Abstract

The authors investigate how transparency affects the probability of a financial crisis. They construct a model in which banks cannot distinguish between aggregate shocks and government policy, on the one hand, and firm'quality, on the other. Banks may therefore overestimate firms'returns and increase credit above the level that would be optimal given the firms'returns. Once banks discover their large exposure, they are likely to roll over loans rather than declare their losses. This delays the crisis but increases its magnitude. The empirical evidence, based on data for 56 countries in 1977-97, supports this theoretical model. The authors find that lack of transparency increases the probability of a crisis following financial liberalization. This implies that countries should focus on increasing transparency of economic activity and government policy, as well as increasing transparency n the financial sector, particularly during a period of transition such as financial liberalization.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2286.

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Date of creation: 29 Feb 2000
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Handle: RePEc:wbk:wbrwps:2286

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Related research

Keywords: Economic Theory&Research; Payment Systems&Infrastructure; Banks&Banking Reform; Financial Intermediation; International Terrorism&Counterterrorism; Economic Theory&Research; Financial Crisis Management&Restructuring; Insurance&Risk Mitigation; Financial Intermediation; Banks&Banking Reform;

References

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  1. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  2. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 1999. "Capital Markets and the Instability of Open Economies," CEPR Discussion Papers 2083, C.E.P.R. Discussion Papers.
  3. George Kopits & J. D. Craig, 1998. "Transparency in Government Operations," IMF Occasional Papers 158, International Monetary Fund.
  4. Asli Demirgüç-Kunt & Enrica Detragiache, 1998. "The Determinants of Banking Crises in Developing and Developed Countries," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 81-109, March.
  5. Kaufmann, Daniel & Mehrez, Gil & Schmukler, Sergio, 1999. "Predicting currency fluctuations and crises - do resident firms have an informational advantage?," Policy Research Working Paper Series 2259, The World Bank.
  6. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  7. Honohan, Patrick, 1999. "A model of bank contagion through lending," International Review of Economics & Finance, Elsevier, vol. 8(2), pages 147-163, June.
  8. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
  9. Calvo, Guillermo A. & Mendoza, Enrique, 1997. "Rational Herd Behavior and the Globalization of Securities Markets," Working Papers 97-26, Duke University, Department of Economics.
  10. Joseph Zeira, 2000. "Informational overshooting, booms and crashes," Proceedings, Federal Reserve Bank of San Francisco, issue Apr.
  11. Demirguc-Kent, Asli & Detragiache, Enrica, 1998. "Financial liberalization and financial fragility," Policy Research Working Paper Series 1917, The World Bank.
  12. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
  13. Burkhard Drees & Ceyla Pazarbasioglu, 1998. "The Nordic Banking Crisis: Pitfalls in Financial Liberalization," IMF Occasional Papers 161, International Monetary Fund.
  14. 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.
  15. Laura E. Kodres & Matthew Pritsker, 1998. "A rational expectations model of financial contagion," Finance and Economics Discussion Series 1998-48, Board of Governors of the Federal Reserve System (U.S.).
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Citations

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Cited by:
  1. Charles WYPLOSZ, 2001. "How Risky Is Financial Liberalization In The Developing Countries?," G-24 Discussion Papers 14, United Nations Conference on Trade and Development.
  2. Jonathan David Ostry & Jeromin Zettelmeyer, 2005. "Strengthening IMF Crisis Prevention," IMF Working Papers 05/206, International Monetary Fund.
  3. Ben Rejeb, Aymen & Boughrara, Adel, 2013. "Financial liberalization and stock markets efficiency: New evidence from emerging economies," Emerging Markets Review, Elsevier, vol. 17(C), pages 186-208.

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