Financial development and the occurrence of banking crises

The empirical literature highlighted that variables related to the development of the financial system, and particularly those associated with activity of the banking sector, such as the growth rate of banking credit and the ratio of financial intermediation to GDP, are robust predictors of the occurrence of a banking crisis.

However, no econometric study has so far precisely and systematically tried to analyze the role of financial development in the emergence of the banking crises. Using a wide dataset covering 115 countries for the period 1980-2009, we evaluate in this paper the sources of financial fragility. We explore the effect of the different dimensions of the banking sector on the occurrence of banking crises, by taking a close look at the level, the growth rate and the instability of the size, the activity and the structure of the banking sector.

Our results show that financial development exerts a significant effect on the probability of occurrence of banking crises, through a rather clear pattern. Indeed, the probability of a banking crisis significantly increases with (i) the level of bank assets (as a GDP ratio), (ii) the level of private sector credit (in ratio of both GDP and deposits), and (iii) the volatility of the private sector credit (as a GDP ratio). In addition we show that the higher (iv) the growth rate, and (v) the share, of the relative weight of commercial banks in savings allocation, the higher the banking crisis risk. Finally, our findings emphasize that (vi) the exposure to banking crises significantly differs with the level of economic development (and in particular, low and intermediate per capita income countries are the most vulnerable).

Thus, in the current international environment characterized by the upsurge of financial crises, our study contributes to the current important debate on the relationship between financial development and financial instability, by identifying precisely the components of the banking system that are the most likely to signal the future occurrence of a banking crisis, and thus providing critical insights when it comes to the definition of the prudential control.