POLICY RESEARCH WORKING PAPER 2431 Inside the Crisis Contemporary banking crises are not accompanied by declines in aggregate bank An Empirical Analysis of Banking deposits, and credit does not Systems in Distress fall relative to output, but the growth of both deposits and credit does slow down Ashi Demirgii -Kunt substantially. Output recovery Enrica Detragiache begins the second year after Poonam Gupta 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. The World Bank Development Research Group Finance and International Monetaty Fund Research Department August 2000 H Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure Authorized POLICY RESEARCH WORKING PAPER 2431 Summary findings Much of the substantial literature on banking crises The authors find that contemporary banking crises are focuses on early warning indicators. Demirgiiu-Kunt, not accompanied by declines in aggregate bank deposits, Detragiache, and Gupta look at what happens to the and credit does not fall relative to output, but the growth economy and the banking sector after a banking crisis of both deposits and credit does slow down substantially. breaks out. Output recovery begins the second year after the crisis Much of the theory of banking crises assigns a central and is not led by a resumption of credit growth. Instead, role to depositor runs., with vulnerability to runs viewed banks (including the stronger banks) reallocate their asset as a basic characteristic of banks as financial portfolio away from loans. intermediaries. But banking systems can be financially This suggests that protecting deposits during a banking distressed even when dlepositors do not withdraw their crisis may not be enough to protect bank credit, as lack deposits, if other bank creditors rush for the exit or if of usable collateral and poor borrower creditworthiness banks become insolvent. discourage banks from lending. However, protecting Are contemporary banking crises characterized by bank credit may not be a priority right after a crisis, as large declines in deposits? 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. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Kari Labrie, room MC3-456, telephone 202-473-1001, fax 202-522-1155, email address klabrie@worldbank.org. Policy Research Working Papers are also posted on the Web at www.worldbank.org/:research/workingpapers. The authors may be contacted at ademirguckunt@worldbank.org, edetragiache@imf.org, or pgupta@imf.org. August 2000. (36 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Produced by the Policy Research Dissemination Center Inside the Crisis: An Empirical Analysis of Banking Systems in Distress by Aslh Demirgiiu-Kunt, Enrica Detragiache, and Poonam Gupta* * Demirgiiu-Kunt: Development Research Group, The World Bank. Detragiache and Gupta: Research Department, International Monetary Fund. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the World Bank, the IMF, their Executive Directors, or the countries they represent. The paper has benefited from very helpfil comments from Jerry Caprio, Stijn Claessens, Paolo Mauro, Miguel Savastano, Peter Wickham, and participants to the joint Bank- Fund seminar. We wish to thank Carlos Arteta and Anqing Shi for excellent research assistance. [...]... valueof the variablein the year and the country-specific averageof the value of the variablein the two pre-crisisyears Table 7 containsthe regressionresults.Returnson averageassets and profitsare below the pre-crisislevel in the year of the crisis, and moremarkedlyso in the first post-crisisyear, while in T+2 the difference no longersignificant.Non-performing is loans and loan loss reservesrise substantially... lending interestrate and the spreadrise significantlyin the crisis year,possibly reflectingan increasein defaultrisk premiums F Inflation ,the ExchangeRate,and the GovernmentBalance Bankingcrises are accompaniedby a substantialincrease in inflationthat peaks in the year after the crisis at almost28 percentagepoints abovethe pre-crisislevel, and persists throughoutthe aftermathperiod The increase in the. .. responseto the bankingcrisis differed in countriesthat increasedthe real interestrate in the year of the crisis In Table 6, a positive sign for the interactionterm meansthat the responseto the crisis of the particularvariablewas larger in countriesthat increasedinterestrates The first observationis that where interestrates declined central banks steppedup lendingto the bankingsystemrelativeto the pre-crisisperiod... percentageof banks in the Bankscopedatabasestoppedreportingdata in the year of the crisis or in the two subsequentyears.This figure,whichprovidesan upper boundto the fractionof banksthat closedbecauseof the crisis, is 10.7percent B The variablesof interest in The informationfromBankscopeallows us to examineseveralbank characteristics measuredby gross and net the aftermathof a bankingcrisis The first... substantially beginningin the crisis year, whileby T+2 they are back to their precrisis level,probablybecauseat that stagebanks begin gettingbad assets off their books.Thus, 7 the bankingcrises were accompanied a decline in bank profitabilityand asset quality.' by The crisis is also followedby a significantdeclinein liquidityand by a reductionin both operatingcosts andthe interestmargin.Thus, financialdifficultiesseemto... centralrole in the theoreticalliteratureon banking crises ,in practicethey seemto be a sideshowat best Furthermore,while banklendinginterest rates and spreadsrise in the wake of a crisis, we find no evidenceof increaseddepositinterest rates A plausibleinterpretation these findingsis that bank safetynets have succeededin of keeping depositorsfrom fleeingdespitewidespreadinsolvencyin the bankingsystem Of course,to... increasedliquidityrequirements.Domac and Ferri (1999)present evidencesuggestinga similar phenomenonin Korea,Malaysia, andthe Philippinesin 1998 .In Thailand,large banks benefitingfrom deposit flight from small banks in the immediateaftermathof the crisis increasedtheir liquidityinstead of expandingtheir loan portfolio (Ito and Pereirada Silva, 1999) - 21 - lending The reductionin bank lending activitymay also help explainthe reductionin... quintileof banks both credit and depositsdecelerate substantiallyboth in T and T+l The decline in the rate of growthof these variablesare of the order of 1 5-2 0percentagepoints, so they are quite substantial.Thus, while on averagethere is The portfolioshift away from lending is more marked in countrieswith deposit insurance, and so is the declinein overheadcosts 20 -2 2 - no evidenceof a strongdecline in. .. rate of depreciationof the exchangerate is even more markedthan that of inflation,even if only eight countriesin the samplehad a full - 1 0- 7 blown currencycrisis in the year of the bankingcrisis This loss of monetarycontrol,however, doesnot seem to be driven by centralbank lendingto the bankingsystem,as centralbank credit doesnot significantlyincreaseas a share of bank assetsin the samplecountries .The. .. a fall in bank lending,so we examinethe growthrate of total assets and of credit, and the breakdownof bank assets betweenloans and otherearningassets Finally,we look at the evolutionof equity over assetsto determinewhethercrises were accompaniedby an erosionof bank capital - 1 8- C Estimationresults To characterize bank behaviorin the aftermathof a crisis we employthe same methodologyusedfor the macrovariables,exceptthat, . WORKING PAPER 2431 Inside the Crisis Contemporary banking crises are not accompanied by declines in aggregate bank An Empirical Analysis of Banking. Dissemination Center Inside the Crisis: An Empirical Analysis of Banking Systems in Distress by Aslh Demirgiiu-Kunt, Enrica Detragiache, and Poonam