The Determinants of Banking Crises: Evidence from Industrial and Developing Countries

Abstract

Vulnerability to crises in the banking sector appears to be associated with these factors: a weak macroeconomic environment characterized by slow GDP growth and high inflation, vulnerability to sudden capital outflows, low liquidity in the banking sector, a high share of credit to the private sector, past credit growth, the existence of explicit deposit insurance, and weak institutions.

In the 1980s and 1990s several countries experienced banking crises. Demirgüç-Kunt and Detragiache try to identify features of the economic environment that tend to breed problems in the banking sector.

They do so by econometrically estimating the probability of a systemic crisis, applying a multivariate logit model to data from a large panel of countries, both industrial and developing, for the period 1980-94.

Included in the panel as controls are countries that never experienced banking problems.

The authors find that crises tend to occur in a weak macroeconomic environment characterized by slow GDP growth and high inflation. When these effects are controlled for, neither the rate of currency depreciation nor the fiscal deficit are significant.

Also associated with a higher probability of crisis are vulnerability to sudden capital outflows, low liquidity in the banking sector, a high share of credit to the private sector, and past credit growth.

Another factor significantly (and robustly) associated with increased vulnerability in the banking sector is the presence of explicit deposit insurance, suggesting that moral hazard has played a major role.

Finally, countries with weak institutions (as measured by a law and order index) are more likely to experience crises.

This paper-a product of the Development Research Group, World Bank, and the Research Department, International Monetary Fund-is part of a larger effort to understand the causes of banking crises.