Macro-Economic Stability and Bank Soundness
51 Pages Posted: 26 Apr 2003
Date Written: April 4, 2001
Abstract
Macroeconomic and banking stability are inexorably linked. This paper examines the nature of this linkage and makes recommendations for enhancing macroeconomic stability by improving bank stability. Except where governments intervene significantly, bank instability is caused primarily by macro instability, but feeds back to exacerbate the macro instability. Although widely perceived to be highly fragile and prone to frequent breakage, banking appears to be relatively stable when regulated by market forces. However, poorly designed government safety-nets under banks reduce the stability and contribute to macro instability. The paper concludes by deriving lessons for enhancing bank stability from past experiences of different countries. These include recommendations for structuring the safety-net so that regulatory discipline mimics market discipline and reduces fragility, deregulating and liberalizing banking on a sound basis, avoiding freezing deposits at failed banks, privatizing state owned banks, and reducing the leverage of banks as well as nonbanks.
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