Banks, financial liberalisation and financial crises in emerging markets

Abstract

The East Asian financial crisis has raised a series of important issues. Amongst them is the question of the role of the banking sector and financial liberalisation in contributing to financial crises. How do weaknesses in the domestic banking sector, when combined with both domestic and international financial liberalisation, engender currency crises? What is lacking in the literature is a simple conceptual framework within which these connections can be conceptualised and drawn out and in which the role of banks is explicitly discussed. This paper seeks to provide just such a framework. Within it, international financial liberalisation can be seen as fuelling a boom in domestic credit, which leads to acute balance sheet problems for domestic banks, and exposes the country concerned to a currency crisis in the event of a sudden reversal of capital inflows, which banking weakness may itself trigger.