Banking crises and financial instability: Empirical and historical lessons

  • Received November 23, 2021;
    Accepted December 7, 2021;
    Published December 21, 2021
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  • Article Info
    Volume 16 2021 , Issue #4, pp. 179-192
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    2 articles

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The paper examines the importance of financial instability for the development of four Norwegian banking crises. The crises are the Post First World War Crisis during the early 1920s, the mid 1920s Monetary Crisis, the Great Depression in the 1930s, and the Scandinavian Banking Crisis of 1987–1993.
The paper first offers a description of the financial instability hypothesis applied by Minsky and Kindleberger, and in a recent dynamic financial crisis model. Financial instability is defined as a lack of financial markets and institutions that provide capital and liquidity at a sustainable level under stress. Financial instability basically evolves during times of overheating, overspending and extended credit granting. This is most common during significant booms. The process has devastating effects after markets have turned into a state of negative development.
The paper tests the validity of the financial instability hypothesis using a quantitative structural time series model. It reveals upheaval of 10 financial and macroeconomic indicators prior to all the four crises, resulting in a state of economic overheating and asset bubble creation. This is basically explained by huge growth in debts. The overheating caused the following banking crises.
Finally, the paper discusses the four crises qualitatively. Again, the conclusion is that a significant increase in money supply and debt caused overheating, asset bubbles, and thereafter, financial and banking crises, which in turn spread to other markets and industries and caused huge slumps in the real economy.

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    • Figure 1. Credit cycle during financial instability
    • Figure 2. Seven-stage dynamic financial crisis model
    • Figure 3. GDP per capita in 2015 USD (left scale) and consumer price index (CPI), 1913 = 100 (right scale)
    • Figure 4. Norwegian domestic credit by source, in billion NOK 1910–1940.
    • Figure 5. Stock market indices Jan-1926 – Sept-1935 (Jan-1926 = 100)
    • Figure 6. Annual relative changes in total credits for Norway 1970-2014 in current and real prices (2015=100)
    • Figure 7. Norwegian real interest rates after tax, 1970–1995
    • Figure 8. Bank losses as a percentage of total bank assets in Scandinavia
    • Table 1. Cycle values of financial and key macroeconomic variables as percentages connected to financial crises
    • Conceptualization
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