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Asl1 Demirgüç–Kunt is a Senior Economist in the Development Research Group, The World Bank. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the World Bank, the International Monetary Fund, their Executive Directors, or the countries they represent. The authors are indebted to Jerry Caprio, Stijn Claessens, George Clarke, Steve Cosslett, Harry Huizinga, Ed Kane, Ross Levine, Miguel Savastano, Mary Shirley, Dimitri Vittas, and Peter Wickham for helpful comments, and to Anqing Shi for excellent research assistance.
Some of these studies also review the strategies adopted to rescue the banking system, a topic that we do not address in this paper.
While this approach provides numerous interesting insights, it is open to the criticism that the criteria used to establish which variables are useful signals are somewhat arbitrary.
Economies in transition are excluded from our study even though they have experienced some of the worst banking crises. We believe that some of the banking problems in these economies are due to the process of transforming a centrally planned economy into a market economy, and are therefore of a distinctive nature.
It should be pointed out, however, that without a theory of how beliefs are formed in rational expectations models with multiple equilibria, this evidence cannot rule out that crises have a self-fulfilling component, since pessimistic, self-fulfilling beliefs may tend to emerge when macroeconomic fundamentals are weak.
The amount of risk that bank managers choose to take on, however, is likely to exceed what is socially optimal because of limited liability (Stiglitz, 1972). Hence the need for bank regulators to impose minimum capital requirements and other restrictions. When bank deposits are insured, incentives to take on excessive risk are even stronger (see below). On the theory of bank prudential regulation, see Dewatripont and Tirole (1994).
According to Mishkin (1996), most banking panics in the United States were preceded by an increase in short-term interest rates.
On the determinants of high interest rates in developing and transition economies see Brock (1995).
This mechanism seems to have been at work in Argentina in 1995: following the Mexican devaluation in December 1994, confidence in the Argentinean peso plunged, and the banking system lost 16 percent of its deposits in the first quarter of 1995 (IMF, 1996).
Recently, banking sector difficulties in Brazil and Russia have been explained in this way (Lindgren et al., 1996).
Not surprisingly, when the three outlier countries are left in the sample inflation and the real interest rate lose significance.
Due to lack of data, for some countries the observations included in the panel do not cover the entire 1980–94 period.
An alternative strategy would be to estimate a probit model with random effects, since such a methodology would be compatible with using the entire data set. However, this model produces unbiased estimates only if the random effects are uncorrelated with the regressors, which is unlikely to be true in practice (Judge et al., 1985, p. 527).
We also estimated the model using a more restrictive and a less restrictive definition of a crisis (ratio of nonperforming loans to bank assets above 15 percent and/or cost of crises above 3 percent of GDP, and ratio of nonperforming loans to bank assets above 5 percent and/or cost of crises above 1 percent of GDP). The results remain essentially unchanged.
We explored the possibility of constructing a financial liberalization dummy using country by country information on the timing of liberalization; however, we abandoned the idea because for most countries in our panel the transition to a more liberalized regime was a very gradual process, sometimes taking a decade or more. Kaminsky and Reinhart (1996) find that a financial liberalization dummy variable tends to predict the occurrence of banking crises in their sample of 20 countries.
The GDP growth variable remains strongly significant even if the deviation of the growth rate from its country mean is used.
Recall that our panels exclude years in which banking crises are under way, so periods in which growth is likely to be negatively affected by the decline in credit due to the crisis are not in the sample.
When inflation is excluded from the regression, the coefficient of the rate of depreciation becomes significant and negative in most of the specifications.
Other measures of external vulnerability such as the ratio of foreign exchange liabilities (gross and net) of the banking sector to reserves and the capital account surplus are less significant than the M2–to–reserves ratio.
On the design and implementation of deposit insurance schemes, see Garcia (1995)