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Governance and Financial Fragility: Evidence from a Cross-Section of Countries

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  • Michael Francis

Abstract

The author explores the role of governance mechanisms as a means of reducing financial fragility. First, he develops a simple theoretical general-equilibrium model in which instability arises due to an agency problem resulting from a conflict of interest between the borrower and lender. In particular, when governance is weak and transaction costs are high, the share of capital assets that creditors can claim as collateral is highly sensitive to shocks. As a result, there is financial fragility, in that the willingness of agents to finance productive investments is sensitive to shocks. Second, using a data set that contains over 90 industrialized and developing economies, the author tests the hypothesis that governance is important in explaining financial fragility (measured as the likelihood of a banking crisis and investment volatility). His results show that institutions, rules, and laws that govern the financial environment are of first-order importance for the stability of financial systems. The author finds that, while better legal systems are particularly important, so are democratic institutions that limit the power of the executive.

Suggested Citation

  • Michael Francis, 2003. "Governance and Financial Fragility: Evidence from a Cross-Section of Countries," Staff Working Papers 03-34, Bank of Canada.
  • Handle: RePEc:bca:bocawp:03-34
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    References listed on IDEAS

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    5. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    6. Eric Santor, 2003. "Banking Crises and Contagion: Empirical Evidence," Staff Working Papers 03-1, Bank of Canada.
    7. Johnson, Simon & Boone, Peter & Breach, Alasdair & Friedman, Eric, 2000. "Corporate governance in the Asian financial crisis," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 141-186.
    8. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 459-472, November.
    9. Kaufmann, Daniel & Kraay, Aart & Zoido-Lobaton, Pablo, 1999. "Governance matters," Policy Research Working Paper Series 2196, The World Bank.
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    15. 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.
    16. repec:hrv:faseco:30747188 is not listed on IDEAS
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    Cited by:

    1. Gamberger, Dragan & Smuc, Tomislav, 2013. "Good governance problems and recent financial crises in some EU countries," Economics Discussion Papers 2013-39, Kiel Institute for the World Economy (IfW).
    2. Robert Lavigne, 2006. "The Institutional and Political Determinants of Fiscal Adjustment," Staff Working Papers 06-1, Bank of Canada.
    3. Tidiane Kinda & Montfort Mlachila & Rasmané Ouedraogo, 2016. "Commodity Price Shocks and Financial Sector Fragility," IMF Working Papers 16/12, International Monetary Fund.
    4. Taiji Harashima, 2004. "The Bad Government: A Source of Uncertainty and Business Fluctuations," Microeconomics 0407010, EconWPA.
    5. Saoussen Ben Gamra & Dominique Plihon, 2007. "Qualité Des Institutions, Libéralisation Et Crises Bancaires Le Cas Des Pays Émergents," CEPN Working Papers hal-00574136, HAL.

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    JEL classification:

    • G0 - Financial Economics - - General

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