Controlling the fiscal cost of banking crises

this is an extract taken from Patrick Honohan and Daniela Klingebiels paper on banking crises which was written in 2000, its evidence is based upon the study of c. 40 banking crises throughout the world in both developed and developing economies.

Banking crises hit the budget with outlays that must be absorbed by higher taxes or spending cuts, and they are also costly in terms of forgone economic output (eg: every € invested in a bailout doesn’t go into creating a factory or school or something with a similar societal benefit). Certain crisis management strategies appear to add greatly to fiscal costs

such as:

unlimited deposit guarantees
open ended liquidity support
repeated recapitalizations
debtor bailouts
regulatory forbearance

Ireland is currently engaging in several of these even though their findings favoured a strict rather than accommodating approach to crisis resolution. In fact, an austere solution will (according to the paper) mean that the cost is limited to 1% of GDP, little more than 1/10th of what was actually experienced in most cases, if a country engages in ALL of the options it can cost as much as a whopping 60% of GDP!

Sadly, banking crises are not limited to everywhere but here, in the past every type of nation has had them, by one count there has been 112 episodes of systemic banking crises in 93 countries the late 70’s to 2000 (when the paper was published) and a further 51 borderline cases in 46 countries.

Governments – and ultimately the taxpayer- always seem to foot the bill increasing the dead-weight cost of taxation. Generally it costed about 12.8% of GDP to fix the problem. Having said that, in today’s ultra-leveraged world a mere 12.8% of GDP might seem cheap! In developing countries the cost was generally 40-55% of GDP (eg: Argentina & Chile), the East Asian crisis cost the countries involved (on average) 20-55% of GDP.

Fiscal outlays are only cost, bailing out depositors amounts to a transfer from taxpayers to depositors, this is not a net economic cost at all.

Question: What will the cost be of granting several institutions near monopoly control over the market by ensuring they are the only ones with excess liquidity?

The paper goes on to cover many fascinating areas on the topic of the cost of a Banking Crisis, it is very readable and should help people to come to terms with some of the rationale behind the banking rescue decisions being made, it is also highly appropriate to see Patrick Honohan given the role of Governor of the Central Bank

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