Financial Liberalization and Banking Crises: The Role of Capital Inflows and Lack of Transparency

51 Pages Posted: 9 Dec 2005 Last revised: 31 Oct 2018

See all articles by Mariassunta Giannetti

Mariassunta Giannetti

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Swedish House of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2005

Abstract

This paper shows that the liberalization of capital inflows may undermine bank stability in emerging markets. After financial liberalization, uninformed international investors rationally provide large amounts of funds at low cost. This enables insolvent banks to accumulate bad loans. In equilibrium, when a substantial amount of losses may have been accumulated, solvent banks do not find it any longer optimal to issue debt at the interest rate that would compensate investors for risk. Investors anticipate this and stop holding bank debt. When the market for bank liabilities breaks down, insolvent banks default. I show that, because of wasteful investment, the liberalization of capital inflows may decrease aggregate welfare.

Keywords: Banking crises, Capital inflows, Transparency, Capital requirements

JEL Classification: G21, G28, F34

Suggested Citation

Giannetti, Mariassunta, Financial Liberalization and Banking Crises: The Role of Capital Inflows and Lack of Transparency (December 1, 2005). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 109/2005. Available at SSRN: https://ssrn.com/abstract=869388 or http://dx.doi.org/10.2139/ssrn.869388

Mariassunta Giannetti (Contact Author)

Stockholm School of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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European Corporate Governance Institute (ECGI)

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HOME PAGE: http://www.ecgi.org

Swedish House of Finance ( email )

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