Impact of Conflict and Political Instability on Banking Crises in Developing Economies
IMF Blog, July 29, 2020
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- Impact of Conflict and Political Instability on Banking Crises in Developing Economies
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Bibliographic details
- Authors: Montfort Mlachila, Rasmane Ouedraogo
- Published: July 29, 2020
Scope and data
- Study covers systemic banking crisis occurrence in 92 developing countries over the period 1970-2016.
- Focus: whether rising conflict and political instability globally over the past several decades has led to more banking crises in developing countries.
Key quantitative findings
- The odds of a banking crisis are 2.5 times greater when a country is affected by a conflict.
- The probability of experiencing a banking crisis is 25 percent when the conflict lasts 10 years, against 16.4 percent when it lasts two years.
- Major waves of conflict tend to be associated with a higher rate of occurrence of banking crises (as illustrated by the study’s chart relating number of countries in banking crises and in conflict).
Empirical examples
- Sierra Leone civil war (1991-2002): more than 40 percent of banking system loans were nonperforming and the license of one bank was suspended in 1994.
- Central African Republic (outbreak of conflict in 2013): bank nonperforming loans increased to more than one-third of total loans and some banks became undercapitalized.
Transmission channels and mechanisms
- Primary channel of transmission: occurrence of fiscal crises following a conflict or political instability.
- Mechanisms described:
- Conflicts and political instability negatively affect the productive capacity of a country.
- Reduced productive capacity can reduce government revenue.
- Increased unproductive spending, including military expenditures, can follow.
- Resulting fiscal crises can lead to government dysfunctionality and weakening of institutions, increasing banking system vulnerability.
- Cross-border spillovers: conflicts and political instability in neighboring countries increase the likelihood of banking crises in a given country.
Policy implications and recommendations
- Governments facing conflict and/or political instability need to address their root causes and try to mitigate their negative effects with the appropriate design and implementation of economic policies.
- Creating adequate fiscal space in normal times can reduce the likelihood of fiscal crises and in turn lower the probability of systemic banking crises.
- Policymakers should pay attention to conflicts in neighboring countries even if they themselves are not conflict-afflicted, since their banking systems may suffer negative spillovers from neighbors given that banks operate across borders.
Impact of Conflict and Political Instability on Banking Crises in Developing Economies — Montfort Mlachila, Rasmane Ouedraogo; July 29, 2020 (IMFBlog)