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From systemic banking crises to fiscal costs: risk factors

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The authors find that direct fiscal costs of banking crises are higher in countries where the banking sectors are larger, more leveraged, and more reliant on external funding. However, better institutions – particularly better banking supervision – and broader deposit insurance coverage are associated with lower direct fiscal costs of crises. Hence, countries’ regulatory and supervisory frameworks can help mitigate fiscal risks arising from modern banking systems.

IMF working paper no. 15/166
20 July 2015
Source: International Monetary Fund

Authors:
David Amaglobeli, International Monetary Fund
Nicolas End, International Monetary Fund
Mariusz Jarmuzek, International Monetary Fund
Geremia Palomba, International Monetary Fund

>  From systemic banking crises to fiscal costs: risk factors

Abstract

This paper examines the risk factors associated with fiscal costs of systemic banking crises using cross-country data. We differentiate between immediate direct fiscal costs of government intervention (e.g., recapitalization and asset purchases) and overall fiscal costs of banking crises as proxied by changes in the public debt-to-GDP ratio. We find that both direct and overall fiscal costs of banking crises are high when countries enter the crisis with large banking sectors that rely on external funding, have leveraged non-financial private sectors, and use guarantees on bank liabilities during the crisis. The better quality of banking supervision and the higher coverage of deposit insurance help, however, alleviate the direct fiscal costs. We also identify a possible policy trade-off: costly short-term interventions are not necessarily associated with larger increases in public debt, supporting the thesis that immediate intervention may be actually cost-effective over time.

Conclusions

This paper sheds new light on the fiscal costs of systemic banking crises. Unlike previous research, which focused on direct fiscal costs of banking crises, this paper also examines overall fiscal costs.

We identify risk factors such as precrisis macroeconomic, financial, and institutional conditions that help explain the size of fiscal costs. We explore the impact of policy choices on both direct and overall fiscal costs, and we highlight a possible trade-off between policies that have initial costs but that may reduce later deterioration of fiscal accounts. We find that direct fiscal costs of banking crises are higher in countries where the banking sectors are larger, more leveraged, and more reliant on external funding. However, better institutions – particularly better banking supervision – and broader deposit insurance coverage are associated with lower direct fiscal costs of crises. Hence, countries’ regulatory and supervisory frameworks can help mitigate fiscal risks arising from modern banking systems. Most of these factors matter for overall fiscal costs, but policy responses seem to have a differential impact on fiscal costs of crises. For example, bank guarantees appear to increase both direct and overall fiscal costs, but the correlation is less clear-cut for other policy measures such as recapitalizations and asset purchases. These latter short-term measures carry initial direct costs but do not necessarily add to the overall fiscal costs of crises, as summarized by changes in the public debt-to-GDP ratio. This result suggests that some early policy interventions present a possible trade-off between costly short-term policies and overall increase in public debt.

These findings are important for policymakers. Risks and costs that spill over from the banking sector to the sovereign cannot be entirely eliminated, regardless of the loss-absorbing capacity of banking sectors. Our results suggest governments should identify and monitor specific risk indicators from the banking sector and develop expertise to evaluate the potential impact of banking vulnerabilities on fiscal and debt sustainability. Moreover, governments could benefit by acting early in crises.

Looking forward, several areas merit further research, including developing a more refined measure of the overall fiscal cost and identifying the part of the change in public debt specifically due to banking crises. In addition, it would be useful to study the factors underlying recovery rates and crisis duration, which could help policymakers judge the costs and benefits of their interventions. Finally, it would be interesting to study whether banks’ ownership structure, in particular the presence of foreign or sovereign shareholders, has any bearing on the fiscal costs of banking crises.

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