Transparency, Liberalization, and Financial Crisis

32 Pages Posted: 27 Mar 2001

See all articles by Gil Mehrez

Gil Mehrez

International Monetary Fund (IMF)

Daniel Kaufmann

Natural Resource Governance Institute (NRGI); The Brookings Institution

Date Written: February 2000


Lack of transparency increases the probability of a banking crisis following financial liberalization. In a country where government policy is not transparent, banks may tend to increase credit above the optimal level.

Mehrez and Kaufmann investigate how transparency affects the probability of a financial crisis.

They construct a model in which banks cannot distinguish between aggregate shocks and government policy, on the one hand, and firms' quality, on the other. Banks may therefore overestimate firms' returns and increase credit above the level that would be optimal given the firms' returns.

Once banks discover their large exposure, they are likely to roll over loans rather than declare their losses. This delays the crisis but increases its magnitude.

The empirical evidence, based on data for 56 countries in 1977-97, supports this theoretical model. The authors find that lack of transparency increases the probability of a crisis following financial liberalization. This implies that countries should focus on increasing transparency of economic activity and government policy, as well as increasing transparency in the financial sector, particularly during a period of transition such as financial liberalization.

This paper - a product of Governance, Regulation, and Finance, World Bank Institute - is part of a larger effort in the institute to research governance and transparency and apply the findings in learning and operational programs. (For details, visit The authors may be contacted at or

JEL Classification: E6, F02, F30, F4, G00, G14, G15, G18, G38, H0

Suggested Citation

Mehrez, Gil and Kaufmann, Daniel, Transparency, Liberalization, and Financial Crisis (February 2000). World Bank Policy Research Working Paper No. 2286. Available at SSRN:

Gil Mehrez (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Daniel Kaufmann

Natural Resource Governance Institute (NRGI) ( email )

80 Broad Street
New York, NY 10004
United States


The Brookings Institution ( email )

1775 Massachusetts Avenue, NW
Washington, DC 20036
United States


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