Banking Crises

Fin254f: Spring 2010

Lecture notes 2.2a

Readings: Reinhart and Rogoff(10)

Outline

Bank run theory Location and frequency of runs Crises and financial liberalization Capital flow “bonanzas” Comovements

Equity prices Real estate Capacity

Consequences

Types of Banking Crises

Repressed financial systemsBank runs

Repressed Financial Systems(Emerging markets)

Developing countriesGovernment controls most bankingForce consumers to save at banksForce banks to buy government debtGovernment defaultsWipes out depositors

Bank Runs(Anywhere)

What is a bank?Bank

Borrows short term (deposits) Lends long term (assets/loan portfolio)

Investment banks, Shadow banking, hedge funds …

Classic Bank Run

Depositors lose confidenceWithdraw fundsBanks forced to sell assets (loan

portfolio) “Fire sale”/distressed/low prices

Bank can run out of assets and go bankrupt

Two Cases

Insolvent bank Bank was bankrupt anyway Liabilities>Assets

Solvent bank “liquidity crises” Can’t cover short term debt, but basically has

good loans (assets) Can still be shut down Bad economic disruption

Which one is difficult to tell

One Last Question

What is a bank?

Policies to Stop Runs

Deposit insuranceLarger banks bailout smaller onesClever temporary mergersDirect government assistance

Banks and Recessions

Pretty strong connections Bernanke, 1930s 1/2 of all US banks fail

Credit constrained models, or credit channel models of business cycles

Outline

Bank run theory Location and frequency of runs Crises and financial liberalization Capital flow “bonanzas” Comovements

Equity prices Real estate Capacity

Consequences

Fraction of Time in Banking Crisis (Independence(or 1800)

-> 2008)

Tables 10.1 and 10.2Developing

Kenya 19.6%,Nigeria 10.2, Zambia 2.2, Argentina 8.8, Russia 1.0 Mexico 9.7, China 9.1, Japan, 8.1, Singapore, 2.3, India 8.6

Developed France 11.5, Netherlands 1.9, Germany

6.6, UK 9.2, Canada 8.5, US 13

Frequency of Banking Crises

Developing Nigeria 1, China 10, India 6, Egypt 3,

Japan 8, Singapore 1, Argentina 9, Brazil 11, Chile 7, Mexico 7

Developed Germany 8, Greece 2, UK 12, France 15,

US 13, Canada 8, New Zealand 1

Summary

Both developed and developing countries

All regions

Crises and Liberalization

Figure 10.1Obstfeld-Taylor index of capital mobility

Arbitrary guess at global capital status3 year moving average of countries with

banking crisesBanking crises probabilities higher after

financial liberalization

Capital Flows and Banking Crises

Sustained capital inflow “Capital Bonanza” Three year inflows before crisis Cutoff at 20 percentile (for each country) Over threshold then Bonanza

Banking Crises and Bonanza’s

Table 10.7Prob(Crises) = 0.132Prob(Crises | Bonanza) = 0.184Share of countries where conditional

prob is greater than unconditional = 0.609

Outline

Bank run theory Location and frequency of runs Crises and financial liberalization Capital flow “bonanzas” Comovements

Equity prices Real estate Capacity

Consequences

Comovements: House Prices and Bank CrisesTable 10.8House price cycles coincide with

banking crisis yearsMagnitudes in price declines similar

between developed and developing countries

Comovements:Equity Prices and Bank Crises Figure 10.2 Peak in year t-1 Recovery started by t+2, nearly full recovery

by t+3 Much shorter than real estate Two recent examples of “no crisis” stock

market movements Crash of 87 IT bubble in 2001

Comovements:Equity Prices and Bank CrisesFigure 10.3: Number of banks around

great depression1976-1985: US Financial/GDP = 4.9%1996-2005: US Financial/GDP = 7.5%

Outline

Bank run theory Location and frequency of runs Crises and financial liberalization Capital flow “bonanzas” Comovements

Equity prices Real estate Capacity

Consequences

Bailout Costs

Difficult to measure See table 10.9 Argentina (High 55, Low 4 ) % of GDP Some types of bailouts payoff eventually

GDP growth Figure 10.4

Central government revenue Figure 10.6, 10.8

Government Debt

Government debt levels, fig 10.10 Increase in Debt (100 = start) Average 3 year increase to 186.3 Ignores state level debt

Summary

Crisis are not limited to The past Emerging markets

Pretty commonPatterns similar