Crises and bail-outs of banks and countries: Interconnections, analogies, differences

During the last decade or so a number of banking crises has occurred in both industrial and developing countries. Bank unsoundness is the focus of deep concerns for its possible interactions with macroeconomic instability. The potential size and severity of sovereign debt crises in integrated financial markets were highlighted by the outbreak of the Mexican crisis at the end of 1994. Subsequently, in a number of international bodies policy makers have undertaken to consider various avenues and arrangements to prevent, anticipate and resolve sovereign debt crises. In the second half of 1997, East Asia's turmoil testified to the interdependence between currency devaluations, stockmarket crashes, and banks' insolvencies. After a general discussion of financial crises and bank runs, the paper discusses the prototype case of banks for which both established economic doctrine and the practical experience of policy makers and regulators offer clearer indications. Then it turns to countries exploring interactions, analogies and differences with the case of banks. Fundamental differences remain between the cases of financial intermediaries and nations. Ultimately the decision of a sovereign state to default or suspend its debt-service payments is largely a voluntary one and the safeguards against moral hazard built into domestic bankruptcy codes cannot be applied to it. Important consequences follow in terms of international co-ordination and the function of the "lender of last resort".