Financial liberalizations, booms, and crashes

Maximilian Grimm, Moritz Schularick and Emil Verner

No 2320, Kiel Working Papers from Kiel Institute for the World Economy

Abstract: Financial liberalization is often seen as a way to deepen credit markets and stimulate economic growth, but it may also fuel credit booms that end in crisis. We construct a new cross-country database of banking regulation policies covering 21 regulatory indicators for 18 advanced economies since World War II. We distinguish liberalizations that directly relax constraints on credit supply from broader financial reforms. Liberalizations that directly affect credit supply lead to substantial expansions in private credit. Credit expansion is concentrated in non-tradable sectors and is not accompanied by higher interest rates or credit spreads in the short run, consistent with an outward shift in credit supply. Real GDP rises over the following 2 to 4 years, but the gains are temporary. On average, GDP returns to trend in the medium run, and there is an increase in the risk of financial crisis and worse downside growth outcomes. Only liberalizations that directly expand credit supply generate these boom-bust dynamics. Based on these estimates, financial liberalization is welfare-improving for coefficients of relative risk aversion below 7.2, a moderately high value.

Keywords: banking regulation; financial liberalization; bank lending; growth; banking crises (search for similar items in EconPapers)
JEL-codes: E44 G01 G21 G28 N20 O43 (search for similar items in EconPapers)
Date: 2026
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:ifwkwp:340837

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