Liberalization and Banking Crises: The Role of Capital Inflows and Lack of Transparency
42 Pages Posted: 14 Jun 2004
Date Written: April 2005
Previous literature has stressed that financial liberalizations may cause banking crises because they spur competition. I show that also another aspect of financial liberalization may be important for bank stability in emerging markets: the liberalization of capital inflows. After financial liberalization, international investors initially provide large amounts of funds at low cost, if they have incomplete information on the quality of bank assets. This enables insolvent banks to accumulate bad loans. In equilibrium, investors rationally stop funding domestic banks and bank defaults occur only after a substantial amount of losses has been accumulated.
Keywords: Banking crises, Capital inflows, Transparency, Capital requirements
JEL Classification: G21, G28, F34
Suggested Citation: Suggested Citation