Interest rate liberalization，Financial development and the Likelihood of Financial Crisis

邱丰+魏媛媛

【Abstract】The paper attempt to characterize the effects of interest rate liberalization among 35 countries on OECD banking crises between 1980 and 2015，and get the primary result that interest rate liberalization enhances the stability of economy.The higher the degree of interest rate liberalization，the less probability that financial crisis occurs.

【Key words】Interest rate liberalization；Financial Crisis；Financial development

1 Introduction

This paper tries to find the links between financial development，interest rate liberalization，and financial crisis empirically.We attempt to characterize the effects of interest rate liberalization among 35 countries on OECD banking crises between 1980 and 2015.

2 Literature Review

2.1Interest rate liberalization and financial crisis

A pile of the literature aims at the influence of interest rate liberalization on a crisis.Ranciere et al.（2006） offer evidence of the correlation between financial liberalization and crises，since the easing of financial constraints relates to the undertaking of insolvency risk due to restrictions of risk-taking and systemic bailout guarantees.

Overall，the literature on the financial liberalization-financial crisis relationship does not reach a concrete conclusion.

2.2Financial development and crisis

The development of a countrys financial system can strengthen the ability of the development of a countrys financial system can strengthen the ability of the macroeconomic to weaken the external shocks and stabilize the whole economy through alleviating individual and firms financing constraints and broaden the sharing of risk （Caballero and Krishnamurty，2001）.

2.3Bank crisis and related factors

Following prior study，we choose real liquidity ratio，housing price and economic growth as the control variables of our model.The liquidity condition and loan quality in commercial bank operation may lead to bank crisis.If banks do not have enough liquidity to meet depositors needs，they may face with reputational risk and even bank crisis.Therefore，a relatively simple banking crisis model should include the liquidity ratio as explanatory variables at least.

3 Model Specifications

We adopt the logit model which has been a standard approach for crisis prediction （Demirgüc-Kunt and Detragiache，2005；Davisand Karim，2008；Barrell et al.，2010）.The logit estimates the probability that a banking crisis will occur in a given country with a vector of explanatory variables.The logit model is as followed：

BCi，t=β0+β1Libi，t-1+β2Fdi，t-1+β3Liqi，t-1+β4Housei，t-1

+β5Cai，t-1+β6Gi，t-1+β7M2i，t-1+εi，t

（1）

4 Empirical Results

We first report the effects of interest rate liberalization on banking crises with equation （1） in Section 4.1 and we will estimate the probability of banking crisis in China in the process of financial liberalization.

The empirical results present that interest rate liberalization proxy on banking crises.All independent variables are lagged one year，except that the real house price adjusted by GDP deflator is lagged three years as Barrell et al （2016） indicates.The results show that the coefficient of the interest rate liberalization is negatively significant，which implies that interest rate liberalization can reduce the probability of occurrence of banking crises.A higher degree of interest rate liberalization is less likely to produce a financial crisis，which is similar to the findings of Shehzad and De Hann （2009），Baier et al.（2012）.

5 Conclusion

We attempt to characterize the effects of interest rate liberalization among 35 countries on OECD banking crises between 1980 and 2015，and get the primary result that interest rate liberalization enhances the stability of economy.The higher the degree of interest rate liberalization，the less probability that financial crisis occurs.However，the financial development seems to stimulate the bank crisis in this empirical study.Based on this，a better regulatory system is required to restrain overgrown financial sector.It certainly will lower the degree of interest rate liberalization.Therefore，the central bank may have to balance these two to dampen the probability of financial crisis.

Reference：

[1]Angkinand，A.，Sawangngoenyuang，W.，Wihlborg，C.，2010.Financial liberalization and banking crises：a cross-country analysis.International Review of Finance 10，263-292

[2]Int.Rev.Finance 10，263-292.Barrell，R.，Davis，E.P.，Karim，D.，Liadze，I.，2010.Bank regulation，property pricesand early warning systems for banking crises in OECD countries.Journal of Banking and Finance 34，2455-2464

[3]Barrell，R.，Karim，D.，& Ventouri，A.2016.Interest rate liberalization and capital adequacy in models of financial crises.Journal of Financial Stability