Do financial crises discipline future credit growth?

Abstract

This paper tests one aspect of whether financial markets can provide strong discipline over domestic macroeconomic policies by looking at the behavior of credit markets following financial crises. While financial markets often fail to give strong warning signals before a crisis, at times they might still provide a secondary form of discipline by helping to force needed economic adjustments once a crisis has broken out, as witnessed by the euro crisis. In this paper we present a test of this hypothesis with respect to the rate of credit growth, a frequent contributor to financial crises. Using a sample 58 banking crisis episodes from 1977 to 2010,we find that after banking crises on average rates of credit expansion fall substantially and financial regulation and supervision is strengthened. However, there is a substantial degree of regional and within-region differences in these discipline effects and for a sizeable minority of cases there is no evidence of discipline effects. We also find that both democracy and the presence of post crisis IMF programs are associated with larger drops in the rate of credit creation from pre to post crisis periods.

Uncovering Effects of Hot Potatoes in Banking System: Arresting Die-Hard Issues

“…The authors have attempted to arrest the system’s behavior, as bolstered in literature, Figures 1 and 2, and demonstrated it in Figure 3. The variables: networth (noted as NW ), networth of firms, a network of banks, and networth of households are duly plotted on the y- axis, whereas variable “difference of interest” in structure and operational behavior of collapsing CBM (Allen & Gale, 2000; Amri et al, 2017; Borio, 2014; Carlson & Rose, 2015; Chapra, 2007; Driga, 2004; Festić et al, 2009; Zarrouk & Ayachi, 2009) on the x- axis. The difference of principle in structure and operational behavior of CBM has been treated as an exogenous variable.…”

“…There are countless studies on the failure of the banking system and financial crises (Akinsola, 2018; Amri et al, 2017; Ba, 2021; Tailab, 2020). The scope of the study review of literature is limited to highly relevant studies concerning the economic/financial/banking systems, loans, defaults, crises, and attempts made to address the issue.…”

“…The studies on the contagion of financial crises have become increasingly exciting, and empirical results of these studies enlighten upon many dimensions (Amri et al, 2017; Paas & Kuusk, 2012; Park & Shin, 2020; Sun, 2020). The financial crisis is not one dip, at any one point of time, but it lasts around 10 years, and the risk of contagion of crisis has increased over the period (Anari et al, 2005; Chan-Lau et al, 2012; Huynh et al, 2020).…”

“…(i) Difference/mismatch between actual payments and contractual commitments of interest (Allen & Gale, 2000;Amri et al, 2017;Borio, 2014;Chapra, 2007;Driga, 2004;Festić et al, 2009;Zarrouk & Ayachi, 2009). (ii) Continuous focus on economic efficiency contradicting the principle of resilience (Lietaer et al, 2010).…”

“…(i) Difference/mismatch between actual payments and contractual commitments of interest (Allen & Gale, 2000; Amri et al, 2017; Borio, 2014; Chapra, 2007; Driga, 2004; Festić et al, 2009; Zarrouk & Ayachi, 2009).…”