Financial Crisis, Economy Recovery and Banking Development in Russia
Posted: 23 May 2001
Date Written: February 26, 2001
This paper builds a model that provides a unified explanation for the onset of the financial crisis in 1998 and the striking economic recovery in Russia afterwards. We argue that before the crisis, the banking sector in Russia was stuck in a banking development trap due to firms incentives to raise liquidity through barter trade and due to the government over issuing of bonds to finance the budget. The banking development trap arises due to an externality that barter trade generates on the lending rates of banks. It is sustained by high yields of government bonds which induces banks to invest in treasury bills rather than to lend to firms. The financial crisis in August 1998 reversed this process and thus acted as a trigger to get out of this trap. This has led to the strong economic recovery and provided initial conditions for banking development. We provide empirical evidence for the banking development trap with firm level data from Ukraine in 1997 and for the financial crisis as a trigger for banking development with country level data for transition conomies.
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