 Financial liberalization and banking crises in emerging economiesBetty Daniel () and John Jones No 2001-03, Pacific Basin Working Paper Series from Federal Reserve Bank of San Francisco Abstract: In this paper, we provide a theoretical explanation of why financial liberalization is likely to generate financial crises in emerging market economies. We first show that under financial repression the aggregate capital stock and bank net worth are both likely to be low. This leads a newly liberalized bank to be highly levered, because the marginal product of capitaland thus loan interest ratesare high. The high returns on capital, however, also make default unlikely, and they encourage the bank to retain all of its earnings. As the banks net worth grows, aggregate capital rises, the marginal product of capital falls, and a banking crisis becomes more likely. Although the bank faces conflicting incentives toward risk-taking, as net worth continues to grow the bank will become increasingly cautious. Numerical results suggest that the bank will reduce its risk, by reducing its leverage, before issuing dividends. We also find that government bailouts, which allow defaulting banks to continue running, induce significantly more risk-taking than the liability limits associated with standard bankruptcy. Keywords: Developing countries; Financial crises (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:fip:fedfpb:2001-03 Ordering information: This working paper can be ordered from Access Statistics for this paper More papers in Pacific Basin Working Paper Series from Federal Reserve Bank of San Francisco Contact information at EDIRC. |
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