Friend or Foe? Cross-Border Links, Contagious Banking Crises, and Joint Use of Macroprudential Policies

Abstract

In this study, we examine whether the joint use of macroprudential policies by countries that have strong financial or trade links can help slow the spread of a banking crisis from country to country. Research has shown that a financial crisis in one country is more likely to be “contagious” if that country has strong connections with other countries through trade or financial linkages. While macroprudential policies can be used to mitigate the risk of a financial crisis domestically, we find that the implementation of tighter macroprudential policies in closely linked countries can additionally help to lower the increases in real credit growth and house prices (known precursors to a crisis). As well, it can also lower the probability of a domestic banking crisis, even after controlling for these precursors, although this effect could take a couple of years to materialize. This paper sheds light on the potential for coordinated usage of macroprudential policies to help promote global financial stability.