Working Paper No. 644
By Ambrogio Cesa-Bianchi, Fernando Eguren Martin and Gregory Thwaites
This paper provides novel empirical evidence showing that foreign financial developments are a powerful predictor of domestic banking crises. Using a new data set for 38 advanced and emerging economies over 1970–2011, we show that credit growth in the rest of the world has a large positive effect on the probability of banking crises taking place at home, even when controlling for domestic credit growth. Our results suggest that this effect is larger for financially open economies, and is consistent with transmission via cross-border capital flows and market sentiment. Direct contagion from foreign crises plays an important role, but does not account for the whole effect.