Banking crises and sudden stops: What could IMF do to assist?

Abstract

Along the studies suggesting IMF to promote private capital flows, this paper sheds light on the links of banking crisis and sudden stops and provides suggestions which are flexible and more specific for countries in various situations of sudden stops. In this overlapping generation framework in an open economy with international credit markets, both the default risks of firms’ loan repayment, and the possibilities of bank runs are considered. As a result, there are good and bad equilibriums, depending on whether bank runs would occur in the lifetime. In the four bad equilibrium discussed in the paper, sudden stops may be unnecessary or unavoidable coinside with the expectation of bank runs, which may or may not occur as expected. There are bad equilibriums in which sudden stops are unnecessary. These are the cases when IMF’s assistance could prevent sudden stops, and the repayment to IMF’s short-term lending facilities can be guaranteed. In the bad equilibriums when bank runs are unavoidable and when sudden stops cannot be prevented and may last for a long period of time, it could be very costly to assist countries in such equilibrium without certain policies becoming effective. Assisting several countries under this circumstances all together could jeopardize IMF’s situation. These findings are consistent with those in [Eichengreen, Guptam and Mody (2006)], and the suggestions for countries in various situations are more specific.