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The persistent effect of banking crises on investment and the role of financial markets

Felix Rioja (Department of Economics, Andrew Young School of Policy Studies, Georgia State University, Atlanta, Georgia, USA)
Fernando Rios-Avila (Department of Economics, Andrew Young School of Policy Studies, Georgia State University, Atlanta, Georgia, USA)
Neven Valev (Department of Economics, Andrew Young School of Policy Studies, Georgia State University, Atlanta, Georgia, USA)

Journal of Financial Economic Policy

ISSN: 1757-6385

Article publication date: 1 April 2014

1674

Abstract

Purpose

While the literature studying the effect of banking crises on real output growth rates has found short-lived effects, recent work has focused on the level effects showing that banking crises can reduce output below its trend for several years. This paper aims to investigate the effect of banking crises on investment finding a prolonged negative effect.

Design/methodology/approach

The authors test to see whether investment declines after a banking crisis and, if it does, for how long and by how much. The paper uses data for 148 countries from 1963 to 2007. Econometrically, the authors test how banking crises episodes affect investment in future years after controlling for other potential determinants.

Findings

The authors find that the investment to GDP ratio is on average about 1.7 percent lower for about eight years following a banking crisis. These results are robust after controlling for credit availability, institutional characteristics, and a host of other factors. Furthermore, the authors find that the size and duration of this adverse effect on investment varies according to the level of financial development of a country. The largest and longer-lasting decrease in investment is found in countries in a middle region of financial development, where finance plays its most important role according to theory.

Originality/value

The authors contribute by finding that banking crisis can have long-term effects on investment of up to nine years. Further, the authors contribute by finding that the level of development of the country's financial markets affects the duration of this decrease in investment.

Keywords

Acknowledgements

JEL classification – G01, E22The authors would like to thank Lawrence Ball, Barry Bosworth, Daniel Leigh, Elizabeth Searing, and Henry Thompson for valuable comments. Useful comments from seminar participants at the Brookings Institution and Auburn University are gratefully acknowledged.

Citation

Rioja, F., Rios-Avila, F. and Valev, N. (2014), "The persistent effect of banking crises on investment and the role of financial markets", Journal of Financial Economic Policy, Vol. 6 No. 1, pp. 64-77. https://doi.org/10.1108/JFEP-08-2013-0035

Publisher

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Emerald Group Publishing Limited

Copyright © 2014, Emerald Group Publishing Limited

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