Causes of Banking Crises: Deregulation, Credit Booms and Asset Bubbles, Then and Now

Abstract

We examine similarities in the run-up to banking crises using two essential criteria for their predictability: i) the percentage of a specified number of years prior to a crisis correctly called; and ii) the percentage of true alarms of total alarms for a crisis. Using panel logit models we find that a banking crisis will be sparked by the collapse of a real asset bubble. While such bubbles are associated with popular stories of a new era and an increasingly deregulated financial system, in most cases, this would occur even in the absence of sustained surges of capital inflow, accumulation of public debt, central banks’ low interest rate policies, or structural shocks retarding growth. We also find that a protracted increase in income inequality in the US and other countries helped to inflate the recent housing bubble.