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Financial Liberalization, Risky Bank Lending, and Market Discipline: An Empirical Examination of Six Countries Financial Liberalization, Risky Bank Lending, and Market Discipline: An Empirical Examination of Six Countries William C. Gruben Jahyeong Koo Robert R. Moore Federal Reserve Bank of Dallas

Approach n Consider six countries n look for market discipline n look for heightened Approach n Consider six countries n look for market discipline n look for heightened risk postliberalization n see whether market discipline and heightened risk are related

Deposit Insurance, Bank Risk, and Financial Crises: A Puzzle? n Martinez Peria and Schmukler Deposit Insurance, Bank Risk, and Financial Crises: A Puzzle? n Martinez Peria and Schmukler JF 2001 n n Demirgüç-Kunt and Detragiache JME 2002 n n deposit insurance does not diminish market discipline deposit insurance increases the likelihood of financial crises Barth, Caprio, and Levine 2001 n regulatory restrictions make financial crises more likely

Financial Crises and Financial Institution Risk n Sources of financial crises n n n Financial Crises and Financial Institution Risk n Sources of financial crises n n n force majeure heightened risk taking by financial institutions When will financial institutions take on heightened risk?

Market Discipline n Deposit flows and bank characteristics n Behavior in wake of shocks Market Discipline n Deposit flows and bank characteristics n Behavior in wake of shocks

Deposit Growth and Bank Characteristics Constant term not shown Deposit Growth and Bank Characteristics Constant term not shown

Risk Taking n Ex post problems? n Aggressive growth strategy/market share struggle increased quantity Risk Taking n Ex post problems? n Aggressive growth strategy/market share struggle increased quantity n change in focus n n Liberalization/privatization

Bank Interest Rates: Argentina Bank Interest Rates: Argentina

Bank Interest Rates: Canada Bank Interest Rates: Canada

Bank Interest Rates: Mexico Bank Interest Rates: Mexico

Bank Interest Rates: Norway Bank Interest Rates: Norway

Bank Interest Rates: Singapore Bank Interest Rates: Singapore

Interest Rates: Texas S&L Interest Rates: Texas S&L

Measuring Preemptive Investment Shaffer 1993 n Perceived MR n MRp=P + λh(Q, Y, α) Measuring Preemptive Investment Shaffer 1993 n Perceived MR n MRp=P + λh(Q, Y, α) n λ=0 perfect competition n λ>0 market power & underproduction n λ<0 “supercompetition” and overproduction n

Estimation n Q = α 0 + α 1 P + α 2 Y Estimation n Q = α 0 + α 1 P + α 2 Y + α 3 PZ + α 4 Z + α 5 PY +α 6 YZ + ε n P = -λQ/(α 1 +α 3 Z + α 5 Y) + (C/Q)(ß 1 + ß 2 ln Q + ß 3 ln W 1 + ß 4 ln W 2) + ξ n P = -λQ/(α 1 +α 3 Z + α 5 Y) + (C/Q)(ß 1 + ß 2 ln Q + ß 3 ln W 1 + ß 4 ln W 2)- ß 5 DQ/(α 1 +α 3 Z + α 5 Y) + ξ

Estimation Results for Bank Risk Model Estimation Results for Bank Risk Model

Depositor Discipline Limits Risk-Taking After Liberalization Depositor Discipline Limits Risk-Taking After Liberalization

Conclusion n Financial liberalization need not increase risk n Market discipline constrains risk taking Conclusion n Financial liberalization need not increase risk n Market discipline constrains risk taking n Financial liberalization need not precipitate financial crises