Banking Crises Fin254f: Spring 2010 Lecture notes 2.2a Readings: Reinhart and Rogoff(10)

Outline Bank run theory Location and frequency of runs Crises and financial liberalization Capital flow bonanzas Comovements Equity prices Real estate Capacity Consequences

Types of Banking Crises Repressed financial systems Bank runs

Repressed Financial Systems (Emerging markets) Developing countries Government controls most banking Force consumers to save at banks Force banks to buy government debt Government defaults Wipes out depositors

Bank Runs (Anywhere) What is a bank? Bank Borrows short term (deposits) Lends long term (assets/loan portfolio) Investment banks, Shadow banking, hedge funds …

Classic Bank Run Depositors lose confidence Withdraw funds Banks forced to sell assets (loan portfolio) Fire sale/distressed/low prices Bank can run out of assets and go bankrupt

Two Cases Insolvent bank Bank was bankrupt anyway Liabilities>Assets Solvent bank liquidity crises Cant cover short term debt, but basically has good loans (assets) Can still be shut down Bad economic disruption Which one is difficult to tell

One Last Question What is a bank?

Policies to Stop Runs Deposit insurance Larger banks bailout smaller ones Clever temporary mergers Direct government assistance

Banks and Recessions Pretty strong connections Bernanke, 1930s 1/2 of all US banks fail Credit constrained models, or credit channel models of business cycles

Outline Bank run theory Location and frequency of runs Crises and financial liberalization Capital flow bonanzas Comovements Equity prices Real estate Capacity Consequences

Fraction of Time in Banking Crisis (Independence(or 1800) -> 2008) Tables 10.1 and 10.2 Developing Kenya 19.6%,Nigeria 10.2, Zambia 2.2, Argentina 8.8, Russia 1.0 Mexico 9.7, China 9.1, Japan, 8.1, Singapore, 2.3, India 8.6 Developed France 11.5, Netherlands 1.9, Germany 6.6, UK 9.2, Canada 8.5, US 13

Frequency of Banking Crises Developing Nigeria 1, China 10, India 6, Egypt 3, Japan 8, Singapore 1, Argentina 9, Brazil 11, Chile 7, Mexico 7 Developed Germany 8, Greece 2, UK 12, France 15, US 13, Canada 8, New Zealand 1

Summary Both developed and developing countries All regions

Crises and Liberalization Figure 10.1 Obstfeld-Taylor index of capital mobility Arbitrary guess at global capital status 3 year moving average of countries with banking crises Banking crises probabilities higher after financial liberalization

Capital Flows and Banking Crises Sustained capital inflow Capital Bonanza Three year inflows before crisis Cutoff at 20 percentile (for each country) Over threshold then Bonanza

Banking Crises and Bonanzas Table 10.7 Prob(Crises) = Prob(Crises | Bonanza) = Share of countries where conditional prob is greater than unconditional = 0.609

Outline Bank run theory Location and frequency of runs Crises and financial liberalization Capital flow bonanzas Comovements Equity prices Real estate Capacity Consequences

Comovements: House Prices and Bank Crises Table 10.8 House price cycles coincide with banking crisis years Magnitudes in price declines similar between developed and developing countries

Comovements: Equity Prices and Bank Crises Figure 10.2 Peak in year t-1 Recovery started by t+2, nearly full recovery by t+3 Much shorter than real estate Two recent examples of no crisis stock market movements Crash of 87 IT bubble in 2001

Comovements: Equity Prices and Bank Crises Figure 10.3: Number of banks around great depression : US Financial/GDP = 4.9% : US Financial/GDP = 7.5%

Outline Bank run theory Location and frequency of runs Crises and financial liberalization Capital flow bonanzas Comovements Equity prices Real estate Capacity Consequences

Bailout Costs Difficult to measure See table 10.9 Argentina (High 55, Low 4 ) % of GDP Some types of bailouts payoff eventually GDP growth Figure 10.4 Central government revenue Figure 10.6, 10.8

Government Debt Government debt levels, fig Increase in Debt (100 = start) Average 3 year increase to Ignores state level debt

Summary Crisis are not limited to The past Emerging markets Pretty common Patterns similar