Managing banking crises in emerging market economies

Since the Great Financial Crisis, emerging market economies (EMEs) have made much progress on enhancing their frameworks to manage banking crises. Yet significant challenges remain. Banking sectors and bank ownership are more concentrated in EMEs than in advanced ecomonies (AEs), and banks fund themselves predominantly through deposits, rather than by tapping capital markets. Banks in EMEs therefore have lower levels of debt that can reliably absorb losses, and are less likely to increase loss-absorbing capacity as capital markets are much less developed in EMEs than in AEs. However, if banks were required to issue more loss-absorbing debt, that may stretch their funding models and aggravate existing vulnerabilities. As a result of that predicament, risks for public finances are usually greater in EMEs than in AEs. Analysing a sample of 11 EMEs, we find that authorities may increase their options to manage banking crises if frameworks are enhanced to facilitate the use of transfer and recapitalisation tools and, importantly, secure broader sources of funding. While this will mitigate risks for public finances, it does not eliminate the need for public backstops. The key is to maximise recoveries if backstops are used. We also propose ways to reduce the cost of crisis management by planning and increasing crisis preparedness.

JEL classification: G01, G18, G21, G33, H63.

Keywords: banking crisis, bank resolution, crisis management, deposit insurance.