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Growth expectations and banking system fragility in developing economies

  • Proto, Eugenio

    ()

    (University of Warwick, Department of Economics)

The likelihood of a banking crisis appears to be higher in fast-developing countries. An explanation is provided in a Diamond and Dybvig framework, where banks are vehicles of consumption-smoothing, offering insurance against shocks to the consumption path of consumers. The theoretical model shows that the higher consumer growth expectations, the higher the optimal level of illiquidity insurance — even if it implies higher exposure bank runs. Empirical evidence supports this result and suggests that the effect of deposit interest rates on the probability of crisis is stronger after a period of high, uniterrupted growth. Policies of providing bail-outs or deposit insurance are demonstrated to be efficient even when they increase the fragility of the banking system.

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File URL: http://www.suomenpankki.fi/bofit_en/tutkimus/tutkimusjulkaisut/dp/Documents/dp1305.pdf
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Paper provided by Bank of Finland, Institute for Economies in Transition in its series BOFIT Discussion Papers with number 13/2005.

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Length: 32 pages
Date of creation: 07 Nov 2005
Date of revision:
Handle: RePEc:hhs:bofitp:2005_013
Contact details of provider: Postal: Bank of Finland, BOFIT, P.O. Box 160, FI-00101 Helsinki, Finland
Phone: + 358 10 831 2268
Fax: + 358 10 831 2294
Web page: http://www.suomenpankki.fi/bofit_en/
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  13. Edward J. Green & Ping Lin, 2000. "Diamond and Dybvig's classic theory of financial intermediation : what's missing?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-13.
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