Banking Crises, External Crises and Gross Capital Flows

Abstract

In this paper, we study the relationship between banking crises, external financial crises and gross international capital flows. First, we confirm that banking and external crises are correlated. Then, as we explore the role of gross capital flows, we find that declines of external liabilities in the balance of payments – a proxy for foreign capital repatriation we call gross foreign investment reversals (GIR) – predict banking as well as external crises. Finally, we estimate the effects of GIR-associated banking crises on the risk of currency and sudden stop crises in an instrumental-variables specification. In developing countries, GIR-associated banking crises increase the onset risk for currency and sudden stop crises by 39-50 and 28-30 percentage points per year respectively. For OECD countries, we show an increase in the currency crisis risk by 33-45 percentage points.

JEL Classification: F32, G01, G15, G21