Domestic financial reforms and crisis recoveries

• Author: Hanbo Zou,Shu Lin,Yanke Dai
• DOI: http://doi.org/10.1002/ijfe.1749
• Date: 01 April 2020
• Published date: 01 April 2020

RESEARCH ARTICLE

Domestic financial reforms and crisis recoveries

Yanke Dai

1

| Shu Lin

2

| Hanbo Zou

3

1

School of Business, Shanghai University

of International Business and Economics,

Shanghai, China

2

Department of Economics, Chinese

University of Hong Kong, Sha Tian,

Hong Kong

3

Shanghai, China

Correspondence

Yanke Dai, School of Business, Shanghai

University of International Business and

Economics, 1900 Wenxiang Road,

Songjiang District, Shanghai, China.

Email: dyk_arthas@hotmail.com

Abstract

We examine empirically whether domestic financial reforms lead to faster

recoveries from financial crises. Using a duration analysis approach and finan-

cial reform indicators from Abiad, Detragiache, and Tressel (2010), we find

robust evidence that a higher overall level of domestic financial liberalization

is associated with a significantly shorter duration of recovery. This effect exists

in both the downturn and upturn stages of a crisis but matters only for devel-

oping countries. We also check the effect of each individual dimension of

domestic financial reforms and find they all contribute to significant faster cri-

sis recoveries except for privatization of the banking sector.

KEYWORDS

domestic financial reforms, duration analysis, financial crises, recoveries

JEL CLASSIFICATION

H12; E44; G28

1|INTRODUCTION

Financial crises differ substantially in their durations and

the harm they do to the economy. Although some crises

lead to large and persistent output loss, others are less

harmful and recover fairly quickly (Gourinchas &

Obstfeld, 2012; Laeven & Valencia, 2013). Such heteroge-

neous consequences have drawn attention from both aca-

demic researchers and policymakers. Recent studies have

explored some potential determinants of a country's post

crisis macroeconomic performance. For example,

Spilimbergo, Symansky, Cottarelli, and Blanchard (2009)

show that country's fiscal capacity affects its recovery

from a financial crisis through government spending and

other types of fiscal policies. Reinhart and Rogoff (2009)

find that bank crisis leads to significantly more severe

recessions than other crisis.

In particular, a few studies have examined the role of

financial factors in determining the crisis recovery out-

comes. Claessens, Kose, and Terrones (2012) and

Gourinchas and Obstfeld (2012) report that recoveries

with credit or house price growth are typically associated

with better economic performance. Similarly, Abiad,

Grace, and Dell'Ariccia (2011) and Calvo, Izquierdo, and

Talvi (2006) also show that creditless recoveries are often

associated with weak macroeconomic outcomes as finan-

cial frictions make firms difficult to raise funds externally

for new investment. A deep determinant of a country's

credit growth and financial frictions, however, is the

development of its domestic financial system. The goal of

this study is thus to make the first attempt in the litera-

ture to explore how domestic financial reforms affect

recoveries from financial crises. Another contribution of

our work is that, unlike previous studies that focus

mainly on postcrisis macroeconomic outcomes, we exam-

ine here the effects of domestic financial reforms on the

durations of crises (speed of recovery).

To investigate the impacts of domestic financial

reforms on the durations of financial crises, we employ a

hazard-based duration analysis. Based on a comprehen-

sive sample of 42 economies from 1976 to 2014 and a

series of measures of domestic financial reforms con-

structed by Abiad, Detragiache, and Tressel (2010), we

find that domestic financial reforms significantly increase

Received: 9 February 2017 Revised: 19 December 2018 Accepted: 13 September 2019

DOI: 10.1002/ijfe.1749

Int J Fin Econ. 2019;1–13. wileyonlinelibrary.com/journal/ijfe © 2019 John Wiley & Sons, Ltd. 1

248 © 2019 John Wiley & Sons, Ltd. Int J Fin Econ. 2020;25:248–260.wileyonlinelibrary.com/journal/ijfe