The Real Effect of Banking Crises*

Banking crises are usually followed by a decline in credit and growth. Is this because crises tend to take place during economic downturns, or do banking sector problems have independent negative effects on the economy? To answer this question we examine industrial sectors with differing needs for financing. If banking crises have an exogenous detrimental effect on real activity, then sectors more dependent on external finance should perform relatively worse during banking crises. The evidence in this paper supports this view. In addition, differential effects are stronger in developing countries, in countries with less access to foreign finance, and where banking crises are more severe. We examine a number of government interventions during crises, and find that blanket guarantees and regulatory forbearance work best in limiting the effect of banking crises on real activity. * We wish to thank Eisuke Okada for outstanding research assistance. This paper should not be reported as representing the views of the IMF. The views expressed are those of the author and do not necessarily reflect the views of the IMF or IMF policy.