Determinants of Financial Stress and Recovery during the Great Recession

In this paper, we explore the link between stress in the domestic financial sector and the capital flightfaced by countries in the 2008-9 global crisis. Both the timing of emergence of internal financial stress indeveloping economies, and the size of the peak-trough declines in the stock price indices was comparableto that in high income countries. The main difference was the greater dispersion of the decline in low andmiddle countries, with standard deviation that was twice that of the high income countries. Deleveragingof OECD positions seemed to dominate the patterns of capital flows during the crisis. While high incomecountries on average saw net capital inflows and net portfolio inflows during the crisis quarters, comparedto net outflows for developing economies, the indicators of banking sector stress were higher for highincome economies on average than for developing economies. De-facto openness was associated withgreater capital outflows and greater portfolio outflows. Larger total external debt minus reserves, externalportfolio assets/GDP and external portfolio liabilities/GDP were also associated with greater internalfinancial stress. Countries with better banking supervision and higher bank capital to assets ratio sawsmaller declines in banking sector stock prices. Countries with more concentrated banking sectors alsohad more stable banking sectors in this crisis. Intriguingly, the same was true for more competitive butbetter supervised banking sectors. Central banks also seem to have responded more in countries withgreater de-facto openness.