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Recessions after Systemic Banking Crises: Does it matter how Governments intervene?

Listed author(s):
  • Sweder van Wijnbergen

    (University of Amsterdam)

  • Timotej Homar

    (University of Amsterdam)

Systemic banking crises often continue into recessions with large output losses (Reinhart & Rogoff 2009a). In this paper we ask whether the way Governments intervene in the financial sector has an impact on the economy's subsequent performance. Our theoretical analysis focuses on bank incentives to manage bad loans. We show that interventions involving bank restructuring provide banks with incentives to restructure bad loans and free up resources for new economic activity. Other interventions lead banks to roll over bad loans, tying up resources in distressed firms. Our analysis suggests that zombie banks are a drag on economic recovery. We then analyze 65 systemic banking crises from the period 1980-2012, of which 25 are part of the recent global financial crisis, to answer the question: how effective are intervention measures from the macro perspective, in particular how do they affect recession duration? We find that bank restructuring, which includes bank recapitalizations, significantly reduces recession duration. The effect of liquidity support on the probability of recovery is positive but smaller. Blanket guarantees on bank liabilities and monetary policy do not have a significant effect.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 13-039/VI/DSF54.

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Date of creation: 04 Mar 2013
Date of revision: 21 Nov 2013
Handle: RePEc:tin:wpaper:20130039
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