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Introduction
This study analyzes and provides empirical tests of early warning indica-
tors of banking and currency crises in emerging economies. The aim is
to identify key empirical regularities in the run-up to banking and cur-
rency crises that would enable officials and private market participants
to recognize vulnerability to financial crises at an earlier stage. This, in
turn, should make it easier to motivate the corrective policy actions that
would prevent such crises from actually taking place. Interest in identify-
ing early warning indicators of financial crises has soared of late, stoked
primarily by two factors: the high cost to countries in the throes of crisis
and an increasing awareness of the insufficiency of the most closely
watched market indicators.
There is increasing recognition that banking and currency crises can
be extremely costly to the countries in which they originate. In addition,
these crises often spill over via a variety of channels to increase the
vulnerability of other countries to financial crisis.
According to one recent study, there have been more than 65 develop-
ing-country episodes during 1980-95, when the banking system’s capital
pletely or nearly exhausted;1 the public-sector bailout costs of
resolving banking crises in developing countries during this period have
1. See Caprio and Klingebiel (1996b). Other identifications of banking crises over this period
can be found in Demirgu¨ c¸-Kunt and Detragiache (1998), Eichengreen and Rose (1998), IMF
(1998c), Kaminsky and Reinhart (1999), and Lindgren et al. (1996).
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Institute for International Economics |
been estimated at around $250 In more than a dozen of these
banking crises, the public-sector resolution costs amounted to 10 percent
or more of the country’s In the latest additions to the list of severe
banking crises, the cost of bank recapitalization for the countries most
affected in the ongoing Asian financial crisis