Banking Crises and Exchange Rate Regimes : Is There a Link?

Pursuing a policy of exchange rate stability reduces the probability of banking crises, particularly in developing countries.Domaccedil; and Peria investigate the links between banking crises and exchange rate regimes, using a comprehensive data set that includes developed and developing countries over the last two decades.In particular, they examine whether the choice of exchange rate regime affects the likelihood, cost, and duration of banking crises.Empirical results indicate that adopting a fixed exchange rate diminishes the likelihood of a banking crisis in developing countries. But once a banking crisis occurs, its real costs in terms of forgone output growth - are higher for countries with more stringent exchange rate requirements.The duration of crises seems not to be affected by exchange rate policy. Instead, it is influenced mainly by the size of the credit boom before the crisis.This paper - a joint product of the Poverty Reduction and Economic Management Sector Unit, Europe and Central Asia Region, and Finance, Development Research Group - is part of a larger effort in the Bank to understand the causes of banking crises. The authors may be contacted at idomac@worldbank.org or mmartinezperia@worldbank.org