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Banking Crises and Economic Growth

Published online by Cambridge University Press:  26 March 2020

Ray Barrell
Affiliation:
National Institute of Economic and Social ResearchUK
Dawn Holland
Affiliation:
National Institute of Economic and Social ResearchUK

Extract

Over the summer of 2007 problems began to emerge in financial markets as a result of debt defaults, particularly on US housing lending to individuals with low credit ratings. The globalisation of financial markets has meant that such risks are shared across banks throughout the world and a number of European banks suffered major losses as a result of purchasing high yield high risk bundles of these assets. In this note we discuss the possibility of a systemic banking crisis as a result of debt defaults, putting this risk and its impact on the economy into recent historical context. We also look at the vulnerability of the personal and business sectors to increases in borrowing rates, and at the evidence for a risk related rise in borrowing rates. We then use our model, NiGEM, to investigate the impacts of a significant rise in the spread between lending and borrowing rates for both producers and consumers. Such an increase in spreads might arise when banks wish to rebuild their capital after a crisis or reflect significant capital rationing. In either case they represent the immediate impacts of a crisis in the banking sector. The spread between borrowing and lending rates for producers reflects a risk premium in the business sector, and was used in the September EFN report to the European Commission, whilst the spread between consumer lending and borrowing rates is in use for the first time on the model. The debt-to-income ratio has been rising in the personal sector in a number of countries, and especially in the UK, Ireland and Spain, as we can see from figure 1, and this might indicate where problems could arise.

Type
Articles
Copyright
Copyright © 2007 National Institute of Economic and Social Research

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Footnotes

We would like to thank Simon Kirby, Olga Pomerantz and lana Liadze for their input into this note. Some of the issues have been discussed at seminars at the European Commission in Brussels, The IMF in Washington and Kiel Institute meeting in Berlin, all of which took place in Septemeber.

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