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The Market’s View on the Probability of Banking Sector Failure: Cross-Country Comparisons

  • Byström, Hans


    (Department of Economics, Lund University)

Considering the increasingly international banks of today, the health ofa country’s banking sector is crucial not only to the country’s growthand prosperity but also to the rest of the international financialcommunity. Early warning signals of a banking sector in trouble or apending banking crisis would therefore be of great value to both banks,investors and banking regulators/supervisors world wide. Di.erentwarning signals exist and in this paper we investigate how the stockmarket can provide a market-based indicator of banking sector health.Hall and Miles (1990) suggests an approach of estimating defaultprobabilities of individual banks using only their stock marketvaluations and volatilities. In this paper we apply an aggregatedversion of their approach to banking sectors around the world in bothdeveloped and emerging economies and study the market’s assessment ofthe probability of systemic banking crises in these countries over thelast decade, including the Asian Crisis 1997-98. In addition, weinvestigate whether there is a relationship between the probability ofbanking sector failure and institutional/structural features of theactual banking sector. The quality of governance and the degree of lawand order in a country is found to be significantly negatively relatedto the market based failure probabilities as is an explicit depositinsurance during periods of crisis. Keywords: banking sector; bankingcrisis; default probability; market discipline

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Paper provided by Lund University, Department of Economics in its series Working Papers with number 2003:2.

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Length: 27 pages
Date of creation: 11 Mar 2003
Date of revision:
Publication status: Published in Journal of International Financial Markets, Institutions and Money, 2004, pages 419-438.
Handle: RePEc:hhs:lunewp:2003_002
Contact details of provider: Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
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  1. Beck, Thorsten & Demirguc-Kunt, Asli & Levine, Ross, 1999. "A new database on financial development and structure," Policy Research Working Paper Series 2146, The World Bank.
  2. Andrew Clare & Richard Priestley, . "Calculating the probability of failure of the Norwegian banking sector," CERF Discussion Paper Series 97-02, Economics and Finance Section, School of Social Sciences, Brunel University.
  3. Asli Demirgüç-Kunt & Enrica Detragiache, 2000. "Does Deposit Insurance Increase Banking System Stability?," IMF Working Papers 00/3, International Monetary Fund.
  4. Pettway, Richard H., 1980. "Potential Insolvency, Market Efficiency, and Bank Regulation of Large Commercial Banks," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(01), pages 219-236, March.
  5. Demirguc-Kunt, Asli & Levine, Ross, 1999. "Bank-based and market-based financial systems - cross-country comparisons," Policy Research Working Paper Series 2143, The World Bank.
  6. La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei & Vishny, Robert W., 1998. "Law and Finance," Scholarly Articles 3451310, Harvard University Department of Economics.
  7. Demirguc-Kunt, Asli & Detragiache, Enrica, 2002. "Does deposit insurance increase banking system stability? An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1373-1406, October.
  8. Barth, James R. & Caprio, Gerard & Levine, Ross, 2000. "Banking systems around the globe : do regulation and ownership affect the performance and stability?," Policy Research Working Paper Series 2325, The World Bank.
  9. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
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