The Relationship between Macroeconomic Conditions and Banking Crises.

Abstract

What conditions and factors lead to systemic banking crises, and how do they affect macroeconomic conditions? What explains the causal relationships between systemic banking crises and the cyclical behaviour of the business cycle? What are the causal relationships between banks’ cross-border transactions and systemic banking crises? Can economic crises in financial counterparty economies instigate systemic banking crises in partners’ economies? What are the implications for the macroeconomy? Prior inquiries into the causal relationships between systemic banking crises and the macroeconomic conditions have been limited by differing conceptualizations and characterizations of systemic banking crises and the tilted attention towards individual bank failure properties. However, with the advent of Laeven & Valencia's (2018) in-depth crisis dating for countries, a new research frontier into panel analysis of the causal relationship between systemic banking crises and economic conditions will empower stakeholders and enrich risk management. This paper analysed the relationship between macroeconomic conditions and systemic banking crises using Laeven & Valencia's (2018) crisis dating and applying panel VAR and other techniques.

The findings show that systemic banking crises negatively affect macroeconomic conditions directly and indirectly. The indirect impacts are through the contractionary impact on sectoral and expenditure components of aggregate output and worsening macro-financial indicators. The manufacturing sector witnessed a severe loss in output. More so, the persistent contractionary effect of banking crises on liquidity means that consumption, investment, and import expenditure are also hampered. On the causal and reactivity between the business cycle and systemic banking crises. Banking crises reinforce and contract the business cycle for about two years, while the business cycle instigated three categories of banking crises. Firstly, banking crises are induced by intense liquidity demand pressure during economic expansion. These findings have significant implications for policymakers and risk management strategies. Secondly, banking crises that were caused by excessive leverage(boom and bust), while the last category is banking crises caused by economic downturns. More so, banking crises are part and parcel of the business cycle, and the causal factors vary depending on the business cycle phase. They start with output distortion and are prolonged further by credit/liquidity distortion. Regarding banking crises and cross-border positions, contagions are channelled directly through interbank exposures, global liquidity shocks, foreign banking, and currency crises, especially from liability counterparties. Finally, these cross-border contagions cause systemic banking crises and hurt the real sector. The effect becomes more severe when the named countries are liable to counterparties abroad. The results are robust to alternative model specifications and techniques.

This thesis contributed to the literature as the first-panel analysis to examine the relationship between macroeconomic conditions and banking crises using Laeven & Valencia's (2018) crisis dating and the panel Vector Autoregressive (pVAR) model. Secondly, this thesis contributes to the analytical disaggregation of the banking industry indicators into banking depth, stability, and efficiency, as well as GDP disaggregation into expenditures and sectoral units and the causal relationships with banking crises. Thirdly, the thesis contributes to works on the economic cost of banking crises by documenting relationships between banking crises and real output gaps. In addition, this is the first study to measure and categorise the six phases of the business cycle and their influence on the causal relationship between banking crises and macro-financial variables. It discovered that banking crises' causes, features, and impacts differ across the six business cycle phases, improving the limitations of past literature. More so, the paper contributed to the literature on early warning indicators of banking crises.

Finally, the study connects banks' cross-border activities with macroprudential risks by exploring the cross-border contagion of banking crises among financially linked economies, with networks of cross-border inter-banking systems, and exposure to global liquidity volatility. The study, therefore, also joined the classes of literature that contribute to the cross-border contagion of systemic banking crises.

Date of Award	11 Dec 2024
Original language	English
Awarding Institution	University of Bath
Supervisor	Andreas Krause (Supervisor) & Stylianos Asimakopoulos (Supervisor)