Inside the Crisis: An Empirical Analysis of Banking Systems in Distress

Abstract

Contemporary banking crises are not accompanied by declines in aggregate bank deposits, and credit does not fall relative to output, but the growth of both deposits and credit does slow down substantially. Output recovery begins the second year after the crisis and is not led by a resumption of credit growth. Instead, banks (including the stronger banks) reallocate their asset portfolio away from loans.

Much of the substantial literature on banking crises focuses on early warning indicators. Demirguc-Kunt, Detragiache, and Gupta look at what happens to the economy and the banking sector after a banking crisis breaks out.

Much of the theory of banking crises assigns a central role to depositor runs, with vulnerability to runs viewed as a basic characteristic of banks as financial intermediaries. But banking systems can be financially distressed even when depositors do not withdraw their deposits, if other bank creditors rush for the exit or if banks become insolvent.

Are contemporary banking crises characterized by large declines in deposits?

The authors find that contemporary banking crises are not accompanied by declines in aggregate bank deposits, and credit does not fall relative to output, but the growth of both deposits and credit does slow down substantially. Output recovery begins the second year after the crisis and is not led by a resumption of credit growth. Instead, banks (including the stronger banks) reallocate their asset portfolio away from loans.

This suggests that protecting deposits during a banking crisis may not be enough to protect bank credit, as lack of usable collateral and poor borrower creditworthiness discourage banks from lending. However, protecting bank credit may not be a priority right after a crisis, as the real economy can rebound without it, at least while there is substantial underused capacity.

This paper - a joint product of Finance, Development Research Group, and the Research Department, International Monetary Fund - is part of a larger effort to study banking crises. The authors may be contacted at [e-mail], [e-mail], or [e-mail].

JEL Classification: G21, E44