Assessing Banking and Currency Crisis Risk in Small States: An application to the Eastern Caribbean Currency Union

By Carlo Pizzinelli, Kotaro Ishi, Tariq Khan

November 19, 2021

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Carlo Pizzinelli, Kotaro Ishi, and Tariq Khan. Assessing Banking and Currency Crisis Risk in Small States: An application to the Eastern Caribbean Currency Union, (USA: International Monetary Fund, 2021) accessed December 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

To complement the early warning signals literature, we study the determinants of banking and currency crises for small states and currency boards. Building on the crisis dataset by Laeven and Valencia (2020), we estimate a binominal logit model to identify the determinants of crises, and as a case study, we apply our models to the Eastern Caribbean Currency Union (ECCU). Our findings largely confirm past studies’ results that both external and domestic fundamentals matter in predicting crisis likelihood, but we find that small states and fixed exchange rate regimes are more sensitive to these fundamentals, compared to larger economies. Our empirical results also suggest that for currency board economies, keeping a high level of the foreign reserve cover—the “backing ratio” defined as official foreign reserves as a share of central bank demand liabilities—is critical to reduce the likelihood of both banking and currency crises. The backing ratio is particularly important during years of global economic downturn.

Subject: Banking crises, Conventional peg, Currency crises, Economic and financial statistics, Financial crises, Financial statistics, Foreign exchange

Keywords: Banking crises, Banking crises, Banking crisis, Caribbean, Conventional peg, Crisis likelihood, Currency board, Currency boards, Currency crises, Currency crises, Early warning signals, Financial statistics, Global, Modeling banking, Risk in small states, Small states

Publication Details

Pages:

34
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2021/276
Stock No:

WPIEA2021276
ISBN:

9781513599861
ISSN:

1018-5941

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