We investigate the effect of financial liberalization on the probability of a banking crises in economies with poor transparency We construct a model with imperfect information where banks cannot distinguish between aggregate shocks on the one hand, and government’s policy and firms’ quality, on the other. Thus, a sequence of positive shocks or non- transparent policy causes banks to increase their credit above the optimal level given the underlying value of the firms. Once banks discover their large exposure, they are likely to roll-over bad loans rather than declare their losses. This delays the crisis, but increasing its magnitude. Empirical investigation using data on 56 countries from 1977 to 1997 supports the theoretical model. We find that the probability of a crisis is higher in the period following financial liberalization, significantly so in countries with poor transparency.
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Paper provided by EconWPA in its series Finance with number
0308008.
Find related papers by JEL classification: D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook F02 - International Economics - - General - - - International Economic Order; Noneconomic International Organizations;; Economic Integration and Globalization: General F30 - International Economics - - International Finance - - - General F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance G00 - Financial Economics - - General - - - General G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies G15 - Financial Economics - - General Financial Markets - - - International Financial Markets G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation H0 - Public Economics - - General
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