Net external position, financial development, and banking crisis

Does the external position of a country that is conditioned on financial development impact the likelihood of a systemic banking crisis? We address this question using data from 149 emerging, developing, and advanced countries from 1970 to 2011, as well as a variety of statistical tools. Our findings are twofold. First, we find that the net external position of a country significantly affects its likelihood of a systemic crisis depending on the level of financial development. Conditional on low to moderate financial development, countries can lower the risk of banking crises significantly by maintaining a net foreign creditor status. Second, we find that the level of financial development raises a country’s crisis risk significantly, while its impact depends on the net asset position. This indicates a potential amplification effect in which countries with more developed and complex financial systems that are also debtor countries have a higher potential of incurring a systemic banking crisis.