Abstract
Using a new country-level panel database, we explore effect of capital inflow surges, credit booms and financial fragility on the probability of banking crises. We find that booms increase the probability of a crisis only in relatively fragile financial systems.
Highlights
One potential concern with a high rate of growth in bank lending is that it will exacerbate the moral hazard and adverse selection problems that undermine the stability of the banking system, increasing the probability of a banking crisis (Schularick and Taylor, 2012)
There is a similar concern about high rates of growth in foreign capital inflows, either because these inflows fuel excessive growth in bank lending, or because they generate asset price bubbles (Calvo, 2012)
Caballero finds the effect of a surge in capital inflows to be distinct from that of a lending boom, which is consistent with the asset price mechanisms outlined by Calvo
Summary
One potential concern with a high rate of growth in bank lending is that it will exacerbate the moral hazard and adverse selection problems that undermine the stability of the banking system, increasing the probability of a banking crisis (Schularick and Taylor, 2012). (This is the specification that produces the best fit according to a pseudo-R2 statistic.) Here, the parameter estimates imply that the effect of returns on the probability of a crisis is small and statistically insignificant in the absence of a credit boom, but large and statistically significant in the presence of a boom. To put it another way, a higher level of returns mitigates the effect of a boom. Adding similar interaction terms with FDI-surge does not produce any significant parameter estimates, so these results are not shown
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