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

Posted: 19 Apr 2006

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

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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. Journal of Financial Intermediation, Forthcoming. Available at SSRN: https://ssrn.com/abstract=896938

Mariassunta Giannetti (Contact Author)

Stockholm School of Economics ( email )

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Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

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B-1050 Brussels
Belgium

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

Swedish House of Finance ( email )

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111 60 Stockholm
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