ANTICIPATING BANKING

CRISES AND ASSESSING

THEIR COST
DEFINING A BANKING CRISIS
Insolvency of large proportion of banking
system.
Possible occurrence of bank runs, leading to bank
failures.
Banks encounter financial stress (insolvency), but do
not fail.
Government or Central Bank may inject liquidity into the
system.
Caprio & Klingebiel (2003) definition:
In a systemic banking crisis, the net worth of the
banking system is almost, or entirely, exhausted as
non performing loans use up most or all of the capital
in the system.
CAUSES OF A BANKING CRISIS
Bad Banking
Poor lending decisions;
Excessive risk taking;
Materialization of newly identified credit risk.
BANKING CRISIS IS THE CAUSE OF BROADER ECONOMIC
PROBLEM.
Bad Operating Environment
External shock to the economy.
Sudden stop in capital flows;
Currency crisis.
Change in political environment.
BANKING CRISIS IS A SYMPTOM NOT A CAUSE OF THE
BROADER ECONOMIC PROBLEM.
 LIBERALISATION COMES
BEFORE A FALL
Country Domestic Financial Liberalisation Banking Crisis Lag (years)
Argentina 1977 1980, 1985, 1994 3
Bolivia 1985 1987 2
Brazil 1975 1985, 1994 10
Chile 1974-1976 1981 7
Colombia 1980 1982 2
Denmark Early 1980s 1987 7
Finland 1982-1991 1991 9
Indonesia 1983-1988 1992 9
Israel na 1983 na
Malaysia 1978-1985 1985 7
Mexico 1974, 1991 1982, 1992 8
Norway 1980-1990 1988 8
Peru 1991 1983 -8
Philippines 1980-1984 1981 1
Spain 1974 onwards 1978 4
Sweden 1980-1990 1991 11
Thailand 1989-1990 1979, 1983 -10
Turkey 1987 1991 4
Uruguay 1976-1979 1981 5
Venezula 1989 1993 4

Source: Kaminsky and Reinhart 1996 (so excludes Asian and Russian crises)
 REGIONAL VARIATIONS
Banking Crisis 1974 2003
Average Number Countries with
Region of Crises Per recurrent crises
Country
Latin America 1.25 35%
Latin America & Caribbean 0.90 27%
Eastern Europe & Central Asia 0.89 11%
Sub-Saharan Africa 0.83 13%
Middle East & North Africa 0.40 0
East Asia & Pacific 0.38 8
South Asia 0.38 0
High Income OECD Countries 0.21 0
High Income non-OECD Countries 0.09 0

Source: IDB calculations on date from Caprio & Klingebiel (2003)

 COST OF BANKING CRISES
Banking crises hit the whole economy not just
the banking sector.
Most banking crises are followed by a credit crunch
that slows economic growth.
Most banking crisis undermine international
confidence in a country.
Taxpayers (who are also depositors) usually bear the
cost of any government sponsored bailout.
How do the authorities prevent a re-occurrence
of a banking crisis?
COST OF BANKING CRISES
 COST OF BANKING CRISES
OUTPUT LOSSES
Difference Between Actual and Potential Output Calculated
as the Sum of the Output Gap over a Four-Year Period (as
% of potential output)
Tequila Crisis Cumulative 4-year Output Loss
Argentina 15%
Mexico 30%
Asian Crisis Cumulative 4-year Output Loss
Indonesia 82%
South Korea 27%
Malaysia 39%
Thailand 57%
COST OF BANKING CRISES
OUTPUT LOSSES
 COST OF BANKING CRISIS
Country Crisis Date Real Change In Fiscal Cost (% GDP)
Deposits
Mexico 1994-95 -15% 19.3%
Venezuela 1994-95 -43% 15%
South Korea 1997-2000 -6% 31.2%
Indonesia 1997-2000 +13% 56.8%
Thailand 1997-2000 -2% 43.8%
Ecuador 1998-2001 -24% 21.7%
Turkey 2000-2002 -27% 30.5%
Argentina 2002-2003 -41.8% 11.4%

Source: BIS Papers No 23

 COST OF BANKING CRISES
SOCIAL COSTS
Declining Real Wages & Income
Rising Unemployment Pressures
Falling Living Standards
Escalating Social Safety Net Costs
Unemployment Benefits/Compensation
Food Subsidy Programs
Direct Budgetary Transfers to the Poor
Social Security and Pension Benefits
 RECOVERY I
Does not happen overnight
Are problem firms allowed to continue?
After closure, are old problem loans written off or collected by
special agencies?
Can the country sell banks problem loans to special asset
management companies as part of their bail out?
Is there a change in ownership of banks
Are foreign banks introduced as shareholders?
Are domestic banks re-capitalised to give operational flexibility?
Are all regions of the country affected equally?
 RECOVERY II
Analyse response of bank management to the
problems
Have they learnt from earlier mistakes
Lending decisions will probably become more
prudent
Many banks overshoot in their prudency
Banks will only lend to the very best lending companies
Banks create an effective credit crunch which
slows future economic growth
BANKING CRISIS EXAMPLE:
BULGARIA 1996
BULGARIA BANKING CRISIS I

The communists had been re-elected to power.

This led to cronyism and a back-tracking on
economic reform.
State banks were still involved in politically directed lending.
Private banks were pocket banks for mafia controlled industrial
groups.
Politicians were closely linked with the main
industrial groups.
 BULGARIA BANKING CRISIS II
Data on surviving banks only

Group 1 includes 7 big state-owned banks (67% of the banking system at end-1996).
Group 2 includes17 small and medium size banks (7% of system).
Group 3 includes 7 foreign banks (2% of system).
The remaining 24% of assets are banks in bankruptcy initiated by the BNB and not included in
the table.
Doubtful loans A - in arrears of less than 30 days
Doubtful loans B - in arrears between 30 and 90 days
Uncollectable loans - in arrears of over 90 days
 BULGARIA BANKING CRISIS III
The state had relieved banks of NPLs, but not tightened
lending criteria.
NPLs had again become a problem.
Banks stopped lending to one another in the interbank
market.
Virtually all BGL personal deposits were with the State
Savings Bank which only invested in government
securities.
What is now DSK Bank was then a government department.
Other banks relied on corporate deposits for funding.
 BULGARIA BANKING CRISIS IV

Most banks were insolvent

Liquidity crisis became too severe and State eventually
ordered 18 banks to cease activities
Some of the leading state banks closed
Balkanbank, Economic Bank, Mineralbank
Two largest private sector banks closed
First Private Bank, TS Bank
 BULGARIA BANKING CRISIS V
The Government was removed after popular protests.
Following an interim government, a new government was
appointed in mid 1997.
Agreement signed with IMF.
Currency Board introducing pegging BGL to DEM
Legal status of State Savings Bank changed to that of a state
owned company.
Bulgaria began to privatize state owned banks, but this took
some time.
Privatization of State Owned Banks which survived crisis
Bulgarian Post Bank 1998 EFG Eurobank
Express Bank 1999 Societe Generale
United Bulgarian Bank 2000 National Bank of Greece
Bulbank 2000 UniCredito Italiano
Hebros Bank 2000 Regent Pacific (HVB acquired in 2005)
Commercial Bank Biochim 2002 HVB Group
Bank DSK 2003 OTP Bank
 BULGARIA BANKING CRISIS VII

New lending still severely curtailed until the new century

and arrival of foreign shareholders.
Political economy has been stable since 1997 and
Bulgaria is now on a strong growth and recovery path.
Bulgaria EU accession candidate for 2007.