Introduction

The frequency of severe banking crisis has increased significantly over the last few decades, with the current global crisis likely to be the most costly so far. A banking crisis occurs when a large number of banks fail to meet regulatory capital requirements, are illiquid, or even insolvent. There are at least four empirical facts concerning banking crises which are important from a macroeconomic perspective.

First, banking crises are most often caused by economic downturns. In differentiating between the sunspot view and the business cycle view of banking crises, Gorton (1988) shows in a seminal empirical investigation that bank panics are systematically linked to business cycles. Subsequent work by Demirgüç-Kunt and Detragiache (1998), González-Hermosillo et al. (1997) and Kaminsky and Reinhart (1999) identify a number of factors causing financial fragilities which may ultimately lead to a systemic banking crisis. These results suggest that banking crises tend to occur when the macroeconomic environment is weak, particularly when output growth is low.