The Consequences of Banking Crises on Public Debt

The aim of this paper is to assess the consequences of banking crises on public debt. Using an unbalanced panel of 154 countries from 1980 to 2006, the paper shows that banking crises produce a significant and long-lasting increase in government debt. The effect is a function of the severity of the crisis. In particular, we find that for severe crises, comparable to the most recent one in terms of output losses, banking crises are followed by a medium-term increase of about 37 percentage points in the government gross debt-to-GDP ratio. We also find that the debt ratio increased more in smaller countries, with worse initial fiscal positions and with a lower quality of institutions (in terms of political stability and democracy). The increase in government debt is also a function of the size of the fiscal stimulus to counter the economic downturns and varies with the type of banking intervention policy, with liquidity support to banks associated with a larger increase in public debt.