Financial Liberalization and Banking Crises: A Cross-Country Analysis

30 Pages Posted: 4 Jun 2010

See all articles by Apanard Penny Prabha

Apanard Penny Prabha

University of Illinois at Springfield

Wanvimol Sawangngoenyuang

Claremont Colleges - Claremont Graduate University

Clas Wihlborg

Chapman University; University West

Abstract

Several studies indicate that financial liberalization contributes to the likelihood of a financial crisis. We focus on banking crises and argue that they are most likely to occur after an intermediate degree of liberalization. Using a recently updated dataset for financial reforms in 48 countries between 1973 and 2005, we find an inverted U-shaped relationship between liberalization and the likelihood of crisis. We ask whether the relationship remains when institutional characteristics of countries and dynamic effects of liberalization are considered. The empirical results indicate that the relationship between liberalization and banking crises depends strongly on the strength of capital regulation and supervision. With very weak regulation and supervision, the probability of banking crises is increasing with liberalization but this relationship is reversed as regulation and supervision become stricter. The most important type of liberalization in relation to banking crises seems to be behavioral (a relaxation of interest and credit controls). A policy implication is that positive growth effects of liberalization can be achieved without increasing the risk of a banking crisis if appropriate institutions are developed.

Suggested Citation

Prabha, Apanard Penny and Sawangngoenyuang, Wanvimol and Wihlborg, Clas, Financial Liberalization and Banking Crises: A Cross-Country Analysis. International Review of Finance, Vol. 10, No. 2, pp. 263-292, June 2010, Available at SSRN: https://ssrn.com/abstract=1611979 or http://dx.doi.org/10.1111/j.1468-2443.2010.01114.x

Apanard Penny Prabha (Contact Author)

University of Illinois at Springfield ( email )

Springfield, IL 62703
United States

Wanvimol Sawangngoenyuang

Claremont Colleges - Claremont Graduate University ( email )

150 E. Tenth Street
Claremont, CA 91711
United States

Clas Wihlborg

Chapman University ( email )

333 N. Glassell
Orange, CA 92866
United States
+17147447630 (Phone)

University West ( email )

Trollhättan, 46186
Sweden

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