A Framework for the Analysis of Financial Reforms and the Cost of Official Safety Nets

This paper builds a multiperiod, general equilibrium framework for analyzing the macroeconomic effects of financial reforms in developing countries and the costs of maintaining official safety nets under the financial system during such reforms.While a financial liberalization yields efficiency gains adverse macroeconomic effects can arise if the creditworthiness of the nonfinancial sector is weak. In this situation financial liberalization may also increase the authorities` expected deposit insurance funding obligations even with strong prudential supervision. Moreover given the distortions in a repressed financial system an increase in the required bank capital-asset ratio may increase the funding obligations associated with deposit insurance particularly when the debt-servicing capacity of nonfinancial firms is low