Costs of Banking System Instability: Some Empirical Evidence

Abstract

This paper assesses the cross-country 'stylised facts' on empirical measures of the losses incurred during periods of banking crises. Firstly, the direct resolution costs to the government are considered, and then the broader costs to the welfare of the economy (proxied by losses in GDP). The cumulative output losses incurred during crisis periods are found to be large, roughly 15%-20% of annual GDP, on average. In contrast to previous research, it is also found that output losses incurred during crises in developed countries are as high, or higher, on average, than those in emerging market economies. Moreover, output losses during crisis periods in developed countries also appear to be significantly larger - 10%-15% - than in neighbouring countries that did not at the time experience severe banking problems. In emerging market economies, by contrast, banking crises appear to be costly only when accompanied by a currency crisis. These results seem robust to allowing for macroeconomic conditions at the outset of crisis - in particular low and declining output growth - that have also contributed to future output losses during episodes.