Banking crises are worse

The latest from the IMF World Economic Outlook


In a study covering 17 developed economies over three decades, the IMF came up with three findings of particular relevance.

First, recessions preceded by a financial crisis tend to be deeper and longer than others. The banking system matters. The extension of credit across an economy has wide ranging effect while non-financial shocks may be localized. Credit issues affect the consumer who is still the main driver of the economy.

Second, they tend to be worse again if the crisis is in banking, rather than in securities markets or foreign exchange. Generally, the banking system is more important in most economies. If there is a crisis in the securities markets, borrowers will turn to the banking system for funds.

And third, the countries hardest hit are those with so-called arm’s length financial systems, such as the US or UK. If banks are free to innovate, they tend to build up more pro-cyclical leverage. This is the Minsky argument that banks as profit driven firms are driven to speculative excess when risk declines. The historical record here is spotty but more complex lending structures are more specialized and harder to repackage to other investors.

In practical terms, the IMF found that recessions linked to banking crises lasted twice as long on average as those not linked to any financial crisis, and the cumulative loss of output was about four times as great.

The global economy is in big trouble if this research holds currently.