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Assessing Banking and Currency Crisis Risk in Small States: An application to the Eastern Caribbean Currency Union
Author:
Carlo Pizzinellinull

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,
Kotaro Ishi
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, and
Tariq Khan
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Series:
IMF Working Papers
Volume/Issue:
Volume 2021: Issue 276
Language:
English
Publication Date:
19 Nov 2021
DOI:
https://doi.org/10.5089/9781513599861.001
ISBN:
9781513599861
ISSN:
1018-5941
Pages:
34
Keywords:
Banking crises; currency crises; early warning signals; currency boards; small states; risk in small states; currency board; crisis likelihood; modeling banking; banking crisis; Currency crises; Banking crises; Conventional peg; Financial statistics; Global; Caribbean
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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To complement the early warning signals literature, we study the determinants of banking and currency crises for small states and currency boards. Building on the crisis dataset by Laeven and Valencia (2020), we estimate a binominal logit model to identify the determinants of crises, and as a case study, we apply our models to the Eastern Caribbean Currency Union (ECCU). Our findings largely confirm past studies’ results that both external and domestic fundamentals matter in predicting crisis likelihood, but we find that small states and fixed exchange rate regimes are more sensitive to these fundamentals, compared to larger economies. Our empirical results also suggest that for currency board economies, keeping a high level of the foreign reserve cover—the “backing ratio” defined as official foreign reserves as a share of central bank demand liabilities—is critical to reduce the likelihood of both banking and currency crises. The backing ratio is particularly important during years of global economic downturn.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund
Volume 2021: Issue 276