International Capital Mobility and Financial Fragility - Part 3. How Do Structural Policies Affect Financial Crisis Risk?

This paper examines how structural policies can influence a country's risk of suffering financial turmoil. Using a panel of 184 developed and emerging economies from 1970 to 2009, the empirical analysis examines which structural policies can affect financial stability by either shaping the financial account structure, by reducing the risk of international financial contagion, or by directly reducing the risk of financial crises. Differentiated capital controls are found to affect financial stability via the structure of the financial account. Moreover, a number of structural policies including regulatory burdens on foreign direct investment, strict product market regulation, or tax systems which favour debt over equity finance are found to bias external financing towards debt, thereby increasing financial crisis risk. By contrast, more stringent domestic capital adequacy requirements for banks, greater reliance of a domestic banking system on deposits, controls on credit market inflows, and openness to foreign bank entry are found to reduce the vulnerability to financial contagion. Finally, vulnerability to international bank balance-sheet shocks is found to be lower in situations of abundant global liquidity, underlining the importance of adequate central bank reactions in situations of financial turmoil.