Abstract
The Q&A in this issue features seven questions about emerging markets and the financial crisis (by Ayhan Kose); the research summaries are "Tax Revenue Response to the Business Cycle" (by Cemile Sancak, Ricardo Velloso, and Jing Xing) and "Banking Crisis Resolution: Was this Time Different?" (by Luc Laeven and Fabian Valencia). The issue also lists the contents of the second issue of the IMF Economic Review, Volume 58 Number 2; visiting scholars at the IMF during October-December 2010; and recent IMF Working Papers and Staff Position Notes.
While there are commonalities between the recent financial crisis and past crises both in terms of underlying causes and policy responses, the scale and scope of interventions differ. Direct fiscal costs to support the financial sector were smaller this time as a consequence of swift policy action and significant indirect support from expansionary monetary and fiscal policy, the widespread use of guarantees on liabilities, and direct purchases of assets. While these policies have reduced the real impact of the current crisis, they have increased the burden of public debt and the size of government contingent liabilities, raising concerns about fiscal sustainability in some countries.
The global financial crisis that started in the United States in 2007 has resulted in systemically important banking crises and large output losses in a number of countries despite extraordinary policy interventions.
With the recovery from this crisis under way, questions about its causes, consequences, and resolution naturally arise.
The underlying causes of the recent crisis are still being debated, though there appears to be broad agreement that financial innovation in the form of asset securitization, government policies to increase home ownership, global imbalances, and lax monetary policy were all contributing factors to the buildup of vulnerabilities and the unfolding of the crisis (De Nicoló and others, 2010; Keys and others, 2010; Obstfeld and Rogoff, 2009; and Taylor, 2009).
A number of papers have documented stylized facts about banking crises. Caprio and others (2005) present a database on systemic and nonsystemic banking distress episodes, focusing on the costs of the crises; Duttagupta and Cashin (2008) analyze factors that generally precede a banking crisis; Laeven and Valencia (2008) improve upon existing data by adding detailed information on policy responses during systemic banking crises; and Reinhart and Rogoff (2009) present an analysis of the stages of financial crises (banking, currency, and sovereign) with data going back to the 1800s. Laeven and Valencia (2010) present new and comprehensive data on the starting dates and characteristics of systemic banking crises over the period from 1970–2009, including detailed information on policy interventions. An uncontroversial definition of a systemic banking crisis is a situation where a large fraction of banking system capital has been depleted (Caprio and others, 2005; Laeven and Valencia, 2008; and Reinhart and Rogoff, 2009). However, implementing this definition implies relying on qualitative information, given the difficulty in measuring economic losses. Laeven and Valencia (2010) propose a crisis definition based on the range and scale of policy interventions that improves upon this qualitative strategy.
Laeven and Valencia (2010)’s definition requires the fulfillment of two conditions: significant signs of financial distress in the banking system (i.e., significant bank runs, losses, and liquidations) and significant banking policy intervention measures in response to losses in the banking system, where the last component is satisfied when at least three of six conditions are met: significant liquidity support, guarantees on bank liabilities, asset purchases, nationalizations, restructuring costs, and deposit freezes and bank holidays (see Laeven and Valencia, 2010, for definitions). The year that both criteria are met marks the beginning of a systemic banking crisis.
Based on this definition, 13 countries experienced a systemic banking crisis during 2007–09: Austria, Belgium, Denmark, Germany, Iceland, Ireland, Latvia, Luxembourg, Mongolia, the Netherlands, Ukraine, United Kingdom, and the United States. Ten additional countries are listed as borderline cases, representing episodes where the definition is almost met: France, Greece, Hungary, Kazakhstan, Portugal, Russia, Slovenia, Spain, Sweden, and Switzerland. Several other countries also announced policy packages in response to the crisis, but usage of those packages was small or policy actions were not significant enough to meet the criteria. Some of the borderline cases (notably Greece) have since taken systemic proportions.
Containing and Resolving Banking Crises: Past and Present
Using the database collected by Laeven and Valencia (2010), one can compare the policy responses and costs between the current crisis and past banking crises. A first difference between the current crisis and previous ones is the predominance of high-income countries, while past crises affected mainly emerging and low-income economies. The large international networks and cross-border exposures of financial institutions in high-income countries helped propagate the crisis to other countries. Failure of any of these large financial institutions could have resulted in the failure of other systemically important institutions, either directly by imposing large losses through counterparty exposures or indirectly by causing a panic and bank runs. This prompted large-scale government interventions in the financial sector, including preemptive measures in some countries.
The policy responses during 2007–09 were qualitatively similar to those in the past. First, liquidity pressures were contained through liquidity support and guarantees on bank liabilities, and often were followed by the announcement of recapitalization packages. Quantitatively, however, liquidity support was notably lower this time around, while overall monetary expansion was substantially larger. For the current crisis, the median of liquidity support reached 5.5 percent, while the historical median is about 10 percent of deposits and foreign liabilities in the system. Lower liquidity support can in part be explained by larger financial systems this time around. Monetary expansion has been six times the median in previous crises of 1 percent—measured as the change in the ratio of the money base to GDP. The concentration of past crises among emerging and low-income countries, generally with less space to expand monetary policy without the concern of a currency crisis, explains this finding. (Jacome (2008) presents stylized facts showing a correlation between monetary expansion and currency crises in Latin America.)
We have no records of the use of bank holidays during the recent wave of crises, while a deposit freeze was used only in the case of Latvia for deposits in Parex Bank. All resolution policies used in the current crisis (notably bank recapitalizations) were also used in past crises, although they were put in place quicker in the recent crisis. The median difference between the time it took to implement public recapitalization programs and the time that liquidity support became extensive (that is, when liquidity support exceeded 5 percent) is no months for the recent crisis compared to 12 months for past crises.
What Is the Damage?
The economic cost of the recent crisis is on average much larger than that of past crises, both in terms of output losses and increases in public debt. The median output loss for the current crisis is 25 percent, exceeding the historical median by about 5 percent. Similarly, we estimate the median increase in public debt for the recent crisis at 24 percent, while the historical median is 16 percent. Direct fiscal costs to support the financial sector (such as those arising from recapitalizations) were smaller this time at 5 percent of GDP, compared to 10 percent for past crises. These differences in part reflect differences in the size of the initial shock to the financial system, an increase in the size of financial systems over time, and the fact that the recent crisis was concentrated in high-income countries, with better financing options to expand fiscal policy and allow automatic stabilizers to operate. The capacity to conduct expansionary monetary policy, combined with relatively swift policy action regarding bank recapitalization, the widespread use of guarantees on liabilities, and asset purchases that helped sustain asset prices, allowed countries to keep direct outlays in support to the financial sector relatively low. Of course, the crisis is not over yet, and the final tab will have to be recomputed in the years ahead.
An additional consequence of the crisis has been a reorganization of the world financial map, with large players becoming significantly smaller, allowing new players to gain importance. Countries with a systemic banking crisis in 2007–09 had dominated the banking arena in 2006, with a share of close to 60 percent of the total, of which two-thirds corresponded to U.S. banks. Today, however, U.S. banks’ participation reaches only 21 percent and Australia, China, Brazil, and Sweden appear now on the top-30 list.
To summarize, we first find that, unlike past crises, the recent crisis was concentrated in advanced economies, in particular those with large financial systems. Second, the speed of intervention was faster and the range of policy measures broader. Third, the costs of the recent crisis are higher in terms of output losses and increases in public debt, though direct fiscal costs associated with financial sector interventions are lower. The bias toward high-income countries during the recent crisis, with greater institutional quality, made possible a broader menu of policy options, including unconventional monetary policy, asset purchases and guarantees, and significant fiscal stimulus packages. These large-scale interventions, together with faster implementation of recapitalization programs, help explain the lower fiscal costs.
Notwithstanding the role of a large-scale policy intervention in avoiding a Great Depression, the burden of public debt and the size of government contingent liabilities increased substantially, raising concerns about fiscal sustainability in a number of countries. Moreover, the crisis is ongoing in several countries and its ultimate impact will have to be reassessed in the future.
References
Caprio, Gerard, Daniela Klingebiel, Luc Laeven, and Guillermo Noguera, 2005, “Banking Crisis Database,” in Systemic Financial Crises: Containment and Resolution, ed. by Patrick Honohan and Luc Laeven (Cambridge, U.K.: Cambridge University Press).
De Nicoló, Gianni, Giovanni Dell’Ariccia, Luc Laeven, and Fabian Valencia, 2010, “Monetary Policy and Bank Risk Taking,” IMF Staff Position Note 09/10.
Duttagupta, Rupa, and Paul Cashin, 2008, “Anatomy of Banking Crises,” IMF Working Paper 08/93.
Honohan, Patrick, and Luc Laeven (eds.), 2005, Systemic Financial Crises: Containment and Resolution (Cambridge, U.K.: Cambridge University Press).
Jacome, Luis, 2008, “Central Bank Involvement in Banking Crises in Latin America,” IMF Working Paper 08/135.
Keys, Benjamin, Tanmoy Mukherjee, Amit Seru, and Vikrant Vig, 2010. “Did Securitization Lead to Lax Screening? Evidence from Subprime Loans,” Quarterly Journal of Economics, Vol. 125, No. 125, pp. 307–62.
Laeven, Luc, and Fabian Valencia, 2008, “Systemic Banking Crises: A New Database,” IMF Working Paper 08/224.
Laeven, Luc, and Fabian Valencia, 2010, “Resolution of Banking Crises: The Good, the Bad, and the Ugly” IMF Working Paper 10/146.
Obstfeld, Maurice, and Kenneth Rogoff, 2009, “Global Imbalances and the Financial Crisis: Products of Common Causes” (unpublished; Harvard University).
Reinhart, Carmen, and Kenneth Rogoff, 2009, This Time is Different: Eight Centuries of Financial Folly (Princeton, NJ: Princeton University Press).
Taylor, John, 2009, Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis (Stanford, CA: Hoover Press).