Banking Policy and Macroeconomic Stability: An Exploration

37 Pages Posted: 20 Apr 2016

See all articles by Gerard Caprio

Gerard Caprio

Williams College

Patrick Honohan

Trinity College Dublin - Department of Economics; Peter G. Peterson Institute for International Economics; Centre for Economic Policy Research (CEPR)

Date Written: June 2002


Whether and when does banking serve to stabilize the economy? Caprio and Honohan view the banking system as a filter through which foreign and domestic shocks feed through to the domestic economy. The filter can dampen or amplify the shocks through various credit market channels, including credit growth, import of foreign capital, and possibly interest rates. The question is whether the prudential quality of banking, as proxied by measures of regulatory quality and openness to foreign banking, amplify or dampen these shocks.

The authors find that many of the regulatory characteristics that have been found to deepen a financial system and make it more robust to crises - notably those which empower the private sector - also appear to reduce the sector's ability to provide short-term insulation to the macroeconomy. It is as if prudent bankers are reluctant to absorb short-term risks that, if neglected, might cause solvency and growth problems in the longer run. Forbearance might dampen short-term volatility, but at the expense of the longer run health of the banking sector and the economy. One way to avoid this apparent tradeoff is evident: banking systems which have a higher share of foreign-owned banks, a feature already associated with financial deepening and lowered risk of crisis, also seem to score well in terms of short-term macroeconomic insulation.

This paper - a joint product of Finance, Development Research Group, and the Financial Sector Strategy and Policy Department - is part of a larger effort in the Bank to analyze bank regulation and supervision. The authors may be contacted at or

Suggested Citation

Caprio, Gerard and Honohan, Patrick, Banking Policy and Macroeconomic Stability: An Exploration (June 2002). World Bank Policy Research Working Paper No. 2856. Available at SSRN:

Gerard Caprio (Contact Author)

Williams College ( email )

Williamstown, MA 01267
United States
413-597-2465 (Phone)
413-597-4045 (Fax)

Patrick Honohan

Trinity College Dublin - Department of Economics ( email )

Dublin 2

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

Centre for Economic Policy Research (CEPR)

33 Great Sutton St,
London, EC1V 0DX
United Kingdom

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