What Is An International Banking Crisis

In many industries, competition has become increasingly global over the past two decades. Banking and financial services are no exception. Rapidly falling costs of transaction due to technological innovation and the removal of capital controls, in the industrial countries in the late 1970s and early 1980s and in many developing countries thereafter, have together led to a huge increase in the volume of short-term international financial flows. Core investment and commercial banking services - syndicated lending or underwriting of bond and equity issues to give just two examples - are now worldwide markets centred on the major international financial centres. Many of the world's largest banks are looking to cross-border market penetration and cross-border acquisition as a means to achieving significant revenue growth in products such as mortgages, credit cards, personal lending and corporate banking services. On top of all this the 'internet revolution' is having an impact on many aspects of banking and promises to accelerate the trend towards internationalization of banking.

This internationalization raises new concerns about financial stability. Might financial problems, perhaps originating in some obscure part of the globe far from the major financial centres, lead to major solvency problems among the world's banks and threaten the functioning of the world's financial markets? The objective of this chapter is to examine whether globalization of banking does indeed bring with it increased risks of an international banking crisis of this kind.

Addressing this issue requires first a clarification of what constitutes a banking crisis and, in particular, of what constitutes an international banking crisis. As we note in Section 2, where we discuss the theory and history of banking crises, it is advisable to restrict the term 'banking crisis' to cases where widespread bank failure threatens the stability of the banking system and the operation of the payments system. Banking crises are thus to be distinguished from other financial problems by their severity and their impact on the functioning of the financial system as a whole. Financial losses, collapse of asset prices, even a series of bank failures, do not necessarily constitute a banking crisis. Only where the integrity of the banking system is threatened do we have a banking crisis and only then is there an obvious case for intervention to protect failing institutions. Banking crises, thus defined, have at least in developed countries been relatively rare occurrences, even in recent years, when the rate of bank failures has risen sharply in comparison to the early post-war decades. By this standard, in recent years among developed countries only Spain in the early 1980s, and Scandinavia and perhaps also Japan in the 1990s, can be said to have experienced a domestic banking crisis. Banking crises have been more widespread in emerging markets, including the well-known problems of Venezuela, Mexico and Thailand.

This strict definition of a banking crisis is appropriate and widely accepted. What then can we mean by an international banking crisis?1 A natural definition, based on this definition of a banking crisis, is a situation where financial problems are transmitted internationally and trigger banking crises in a number of different countries. We might also classify as an international banking crisis a case where international transmission of financial problems triggers a banking crisis in a single country, although such an occurrence would be primarily of domestic rather than international concern.

On either of these definitions international banking crises have been rarer even than domestic banking crises - indeed it does not seem possible to point to a single example of a genuine international banking crisis ever having taken place. What the record reveals is a number of near, or sometimes not so near, misses - episodes where losses or liquidity problems on international exposures appeared, at least at the time, to threaten domestic banking crises in other countries. These cases include the failure of Credit Anstalt in the 1930s, the Herstatt failure of 1974, the losses on sovereign lending in the early 1980s, and most recently problems in emerging markets in 1997 and 1998.2 Otherwise even major international financial problems, such as the collapse of Bretton Woods, problems in the European Exchange Rate Mechanism (ERM) in 1992 and 1993, and stock market collapses of 1929 and 1987, did not threaten to trigger banking crises in other countries.

This then is what we mean by an international banking crisis. The way we address our central question - whether or not the risks of an international banking crisis are increased by the internationalization of banking -is historical and comparative. Section 2 examines the theory and history of banking crises. Section 3 then looks at the origins and transmission of banking crises, discusses their international transmission, assesses whether the likelihood of an international banking crisis has increased or reduced in recent years. Finally, Section 4 considers and dismisses the case for an international lender of last resort to cope with international banking crisis, should one emerge. Section 5 summarizes and concludes.

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Financial End Game

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