Domestic Bank Regulation and Financial Crises: Theory and Empirical Evidence from East Asia

UC Santa Cruz Center for International Economics Working Paper No. 02-8

61 Pages Posted: 2 Sep 2002

See all articles by Kenneth M. Kletzer

Kenneth M. Kletzer

University of California at Santa Cruz; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Robert Dekle

University of Southern California - Department of Economics

Multiple version iconThere are 4 versions of this paper

Date Written: April 2001

Abstract

A model of the domestic financial intermediation of foreign capital inflows based on agency costs is developed for studying financial crises in emerging markets. In equilibrium for the model economy, the banking system becomes progressively more fragile under imperfect prudential regulation and public sector loan guarantees until a crisis occurs with an expected reversal of capital flows. The crisis in this model evolves endogenously as the banking system becomes increasingly vulnerable through the renegotiation of firm debts. Firm revenues are subject to idiosyncratic firm-specific technology shocks, but there are no aggregate shocks.

The model generates dynamic relationships between foreign capital inflows, domestic investment, firm debt and the value of firm and bank equity in an endogenous growth model. Prior to crisis, foreign capital inflows and bank debt rise relative to investment and domestic production. The aggregate portfolio of the banking sector deteriorates and the total value of bank equities declines in proportion to that for goods producers progressively. The model's assumptions and implications for the behavior of the economy before and after crisis are compared to the experience of five East Asian economies. The case studies compare three crisis or near-crisis countries, Korea, Thailand and Malaysia, to two non-crisis economies, Taiwan and Singapore, and lend support to the model.

Keywords: currency crises, financial fragility, exchange rate regimes, capital inflows

JEL Classification: F31, F41

Suggested Citation

Kletzer, Kenneth M. and Dekle, Robert, Domestic Bank Regulation and Financial Crises: Theory and Empirical Evidence from East Asia (April 2001). UC Santa Cruz Center for International Economics Working Paper No. 02-8. Available at SSRN: https://ssrn.com/abstract=315859 or http://dx.doi.org/10.2139/ssrn.315859

Kenneth M. Kletzer (Contact Author)

University of California at Santa Cruz ( email )

Santa Cruz, CA 95064
United States
(408) 459-3407 (Phone)
(408) 459-5000 (Fax)

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

Robert Dekle

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States
213-740-8335 (Phone)

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