Governance and Financial Fragility: Evidence from a Cross-Section of Countries

Michael Francis ()

Staff Working Papers from Bank of Canada

Abstract: The author explores the role of governance mechanisms as a means of reducing financial fragility. First, he develops a simple theoretical general-equilibrium model in which instability arises due to an agency problem resulting from a conflict of interest between the borrower and lender. In particular, when governance is weak and transaction costs are high, the share of capital assets that creditors can claim as collateral is highly sensitive to shocks. As a result, there is financial fragility, in that the willingness of agents to finance productive investments is sensitive to shocks. Second, using a data set that contains over 90 industrialized and developing economies, the author tests the hypothesis that governance is important in explaining financial fragility (measured as the likelihood of a banking crisis and investment volatility). His results show that institutions, rules, and laws that govern the financial environment are of first-order importance for the stability of financial systems. The author finds that, while better legal systems are particularly important, so are democratic institutions that limit the power of the executive.

JEL-codes: G0 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2003
New Economics Papers: this item is included in nep-fin and nep-mfd
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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