BANKING

Banking



Banking

Introduction

This paper analyses the significance of bank runs in today's banking system. The first section researches some of the origins that cause bank runs to take place and its effect it has on the country's economy. It is found that some of the causes have been a result of:

Decline in the terms of trade

Economic growth and inflation rates

Bank-lending booms

Decline in equity prices

Increase in bank liabilities

Importance of Banking

Banking crises have been significant in today's banking sector. According to Lindgren (1996) it has been reported that over the 1980-96 period, at least two-thirds of International Monetary Fund(IMF) member countries has experienced these banking crises.

Caprio and Klingebiel's (1996) research suggested that banking crises in developing countries have been far more severe during the past 15 years than those in industrial countries. Their estimates imply approximately a 10% difference between the developing and industrialized countries. Such of these include - Spain 17%GDP (Industrial) to losses of greater or equal to 25% GDP (Argentina, Chile, and Cote d'Ivoire).

The result of banking crises in developing economies is also costly for industrial countries. The factors behind this implication are that developing countries purchase about 25% of industrial country exports. Thus, a banking crisis will strain the ability to service and to repay private capital inflows, and eventually add to the liabilities of developing country governments.

Banking Operation Process

As banks typically borrow short and lend long, they operate with high leverage (low capital) and on a fractional reserve basis. Thus, according to Goldstein and Turner, if volatility changes the relationship between the values of bank assets and liabilities that are beyond the ex ante protection provided by bank capital, banks can become vulnerable.

It is reputed that terms-of trade deterioration is an external factor that lead to banking crises which has been apparent in small industrial countries and in emerging markets.

(cite)reports that 75% of the developing countries suffered a decline in its terms-of-trade of at least 10% prior to a crisis.

In respect to the domestic factors, both economic growth and inflation rates are often key issues. Goldstein and Turner suggest that credit risk become harder to define when growth and inflation rates fluctuate widely. Thus, a company's credit history under hyperinflation may not be a good guide to its performance in a more stable environment. Caprio and Klingebiel(1996) reported that during 1960-94 there exists a trend in rising inflation and growth rates in countries where banking crises are present while this trend was non-existent for countries experiencing less severe or no banking difficulties.

It is suggestd that bank-lending booms have preceded banking crises over countries in Latin America and even in industrialized countries such as Japan and the United States. But this statement is controversial as Caprio and Klingebiel argue that this link is non-existent outside of Latin America. According to Kaminsky and Reinhart(1995) declines in equity prices are among the best leading indicators of banking crises. The reason for this is that equity prices act as an exogenous trigger that reduces the profitability of bank ...