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Private inflows when crises are anticipated: a case study of Korea

  • Michael P. Dooley
  • Inseok Shin

Models of financial crises based on distortions in capital markets have strong implications for the behavior of investors leading up to crises. In this paper we evaluate the hypothesis that deregulation of financial markets in Korea provided the incentives and opportunities for a sequence of capital inflows and crisis. We show that deregulation was associated with a sharp declines in the franchise value of Korean banks. Banks responded by expanding their balance sheets and accumulating high risk, high return assets. The regulatory mechanism appears to have failed because of the failure to consolidate onshore and offshore activities of banks. Foreign banks that supplied deposits to Korean banks behaved as if they were insured in that they did not discriminate between weak and strong Korean banks. Finally, this expectation was validated at the time of crisis by government intervention that allowed foreign banks to liquidate their claims on Korean banks.

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Volume (Year): (1999)
Issue (Month): Sep ()
Pages:

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Handle: RePEc:fip:fedfpr:y:1999:i:sep:x:11
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  1. Barry Eichengreen & Charles Wyplosz, 1993. "The Unstable EMS," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(1), pages 51-144.
  2. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  3. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
  4. Michael P. Dooley, 1998. "A model of crises in emerging markets," International Finance Discussion Papers 630, Board of Governors of the Federal Reserve System (U.S.).
  5. Gerald Caprio & Michael Dooley & Danny Leipziger & Carl Walsh, 1996. "The lender of last resort function under a currency board: The case of Argentina," Open Economies Review, Springer, vol. 7(1), pages 625-650, March.
  6. Diaz-Alejandro, Carlos, 1985. "Good-bye financial repression, hello financial crash," Journal of Development Economics, Elsevier, vol. 19(1-2), pages 1-24.
  7. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  8. Stanley Fischer, 1999. "On the Need for an International Lender of Last Resort," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 85-104, Fall.
  9. Ilan Goldfajn & Rodrigo Valdés, 1997. "Balance of Payments Crises and Capital Flows: The Role of Liquidity," Working Papers Central Bank of Chile 11, Central Bank of Chile.
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