Financial Institutions, Contagious Risks, and Financial Crises

44 Pages Posted: 29 Apr 2002

See all articles by Haizhou Huang

Haizhou Huang

International Monetary Fund (IMF)

Chenggang Xu

University of Hong Kong

Date Written: November 2001

Abstract

In this paper contagious risks and financial crises are endogenized through the interactions among corporations, banks, and the interbank market. We show that the lack of financial discipline in a single-bank-financing economy generates informational problems and thus the malfunction of the interbank market, which constitutes a mechanism of financial contagion and may lead to a financial crisis. In contrast, financial discipline in an economy with diversified financial institutions leads to timely information disclosure from firms to banks and improves the informational environment of the interbank market. With symmetric information in the interbank market, bank runs are contained to insolvent banks and financial crises are prevented. Our theory sheds light on the causes and timing of the East Asian crisis; it also has important policy implications for the lender of last resort and banking reform.

Keywords: financial institutions, contagious risks, financial crises

Suggested Citation

Huang, Haizhou and Xu, Chenggang, Financial Institutions, Contagious Risks, and Financial Crises (November 2001). Available at SSRN: https://ssrn.com/abstract=307103 or http://dx.doi.org/10.2139/ssrn.307103

Haizhou Huang (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Chenggang Xu

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

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