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Transparency, Liberalization and Financial Crises

  • Gil Mehrez

    (IMF)

  • Daniel Kaufmann

    (The World Bank)

We investigate the effect of financial liberalization on the probability of a banking crises in economies with poor transparency We construct a model with imperfect information where banks cannot distinguish between aggregate shocks on the one hand, and government’s policy and firms’ quality, on the other. Thus, a sequence of positive shocks or non- transparent policy causes banks to increase their credit above the optimal level given the underlying value of the firms. Once banks discover their large exposure, they are likely to roll-over bad loans rather than declare their losses. This delays the crisis, but increasing its magnitude. Empirical investigation using data on 56 countries from 1977 to 1997 supports the theoretical model. We find that the probability of a crisis is higher in the period following financial liberalization, significantly so in countries with poor transparency.

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Paper provided by EconWPA in its series Finance with number 0308008.

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Length: 32 pages
Date of creation: 26 Aug 2003
Date of revision:
Handle: RePEc:wpa:wuwpfi:0308008
Note: Type of Document - Acrobat PDF; pages: 32
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Laura E. Kodres & Matthew Pritsker, 1998. "A rational expectations model of financial contagion," Finance and Economics Discussion Series 1998-48, Board of Governors of the Federal Reserve System (U.S.).
  2. Enrica Detragiache & Asli Demirgüç-Kunt, 1998. "Financial Liberalization and Financial Fragility," IMF Working Papers 98/83, International Monetary Fund.
  3. Philippe Aghion & Philippe Bacchetta & Abhijit Banerjee, 1999. "Capital Markets and the Instability of Open Economies," Working Papers 99.01, Swiss National Bank, Study Center Gerzensee.
  4. Joseph Zeira, 2000. "Informational overshooting, booms and crashes," Proceedings, Federal Reserve Bank of San Francisco, issue Apr.
  5. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
  6. Burkhard Drees & Ceyla Pazarbasioglu, 1995. "The Nordic Banking Crises; Pitfalls in Financial Liberalization?," IMF Working Papers 95/61, International Monetary Fund.
  7. 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.
  8. George Kopits & J. D. Craig, 1998. "Transparency in Government Operations," IMF Occasional Papers 158, International Monetary Fund.
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