Financial liberalization, exchange‐rate regime, and banking crisis likelihood

• DOI: http://doi.org/10.1002/ijfe.1705
• Date: 01 July 2019
• Author: Greg M. Richey
• Published date: 01 July 2019

RESEARCH ARTICLE

Financial liberalization, exchange‐rate regime, and banking

crisis likelihood

Greg M. Richey

University of California, Riverside, School

of Business, Riverside, CA, USA

Correspondence

Greg M. Richey, University of California,

Riverside, School of Business, Riverside,

CA, USA.

Email: greg.richey@ucr.edu

JEL Classification: G15; G21; G28; E44;

F31

Abstract

This paper provides empirical evidence of the impact that financial liberaliza-

tion plays, within various exchange rate regimes, on the likelihood of systemic

banking crisis. Using a sample of 50 banking crisis episodes over the period of

1985–2005, I investigate the impact of financial liberalization and exchange‐

rate regime on the likelihood of systemic banking crisis. When interacted with

an overall financial liberalization measure, exchange‐rate regime was signifi-

cant and positive under a flexible regime. Other empirical results show that

when interacted with financial liberalization dimensions, exchange‐rate regime

variables produced significant results under intermediate and flexible

exchange‐rate regimes.

KEYWORDS

banking crisis, exchange rate regime, financial liberalization, panel data

1|INTRODUCTION

Numerous papers have analysed the effectiveness of finan-

cial liberalization programs as a means of promoting finan-

cial and economic growth. Some researchers have found

that nations benefit from financial liberalization (Baier

et al., 2012; Beck et al., 2013; Klein & Olivei, 2008; Quinn

& Toyoda, 2008; Shehzad & De Haan, 2009). On the con-

trary, several studies have found financial liberalization

to be a major factor in the occurrence of banking crises or

the weakening of economic growth (Demirgüç‐Kunt &

Detragiache, 2001; Noy, 2004), whereas others have found

mixed results on financial crisis likelihood from liberaliza-

tion policies (Joyce, 2011).

To shed light on this issue, this paper examines 50

banking crisis episodes from 71 least‐developed, emerging,

and advanced economies over the period of 1985–2005 to

measure the roles of financial liberalization and

exchange‐rate regime play on the likelihood of systemic

banking crisis occurrence. I also utilize the financial liber-

alization data to breakdown the financial liberalization

data into dimensions to test each of their impact on the

likelihood of banking crisis onset. I also employ banking

crisis, financial liberalization, and exchange‐rate regime

data to create an interaction term between financial liber-

alization and exchange‐rate regime in order to test the

impact of financial liberalization, conditional upon

exchange‐rate regime, on the probability of banking crisis

occurrence.

My empirical results indicate that the choice of

exchange‐rate regime, ceteris paribus, has an insignificant

effect on the likelihood of banking crisis. These results

hold when I run the exchange‐rate regime variable with

the aggregated financial liberalization variable as well as

in individual regressions with the dimensions of financial

liberalization. However, I find that when interacted with

financial liberalization, exchange‐rate regime becomes a

statistically significant indicator of banking crisis likeli-

hood under flexible exchange‐rate regimes. When

interacted with particular financial liberalization dimen-

sions, intermediate and flexible exchange‐rate regimes

produce statistically significant results. However, when

interacted with financial liberalization (in whole or with

various liberalization dimensions), fixed exchange‐rate

Received: 23 January 2018 Revised: 12 July 2018 Accepted: 9 September 2018

DOI: 10.1002/ijfe.1705

1066 © 2018 John Wiley & Sons, Ltd. Int J Fin Econ. 2019;24:1066–1078.wileyonlinelibrary.com/journal/ijfe