Transcript Econnet 2011-Cesar Calderon

DOES FINANCIAL OPENNESS LEAD
TO DEEPER DOMESTIC FINANCIAL
MARKETS?
César Calderón
Megumi Kubota
IDB ECONNET Seminar Series
The World Bank – March 5, 2011
MOTIVATION
 Salient
features of the global economy:
Rapid integration of advanced countries and emerging
market economies (EMs) to world capital markets.
 Important changes in the patterns of saving and
investment across the world.
 Deepening of financial markets across industrial
countries and EMs.

MOTIVATION
Rapid increase in financial openness (FO) and domestic
financial development (DFD) over the last 25 years
MOTIVATION
Rapid increase in financial openness (FO) and domestic
financial development (DFD) over the last 25 years
Industrial Countries
5.5
5.0
4.7
4.0
4.5
3.0
4.3
Developing Countries
3.5
5.3
5.1
3.0
2.5
4.9
4.7
2.0
4.5
2.0
4.1
1.5
4.3
1.0
4.1
3.9
1.0
3.9
0.0
3.7
-1.0
3.5
0.5
3.7
3.5
1977
1982
1987
Financial Openness
1992
1997
2002
Stock Market Capitalization (RHS)
0.0
1977
1982
1987
Financial Openness
1992
1997
2002
Stock Market Capitalization (RHS)
MOTIVATION
More financially open countries tend to show deeper banks
and stock markets
De Facto Financial Openness vs. Private Credit
6
6
5
5
Stock market capitalization (% GDP, logs)
Private Credit (% GDP, logs)
De Facto Financial Openness and Stock Market
Capitalization
4
3
2
1
4
3
2
1
0
2
3
4
5
-1
0
2.0
3.0
4.0
5.0
6.0
Foreign Liabilities (% GDP, logs)
7.0
8.0
-2
Foreign Liabilities (% GDP, logs)
6
7
8
MOTIVATION

FO leads to faster DFD through different channels:
Eliminating financial repression and shifting interest
rates to clearing-market competitive levels (Baldwin
and Forslid, 2000)
 Raising the degree of bank competition –i.e. adoption
of more sophisticated banking techniques (Levine,
1996; Caprio and Honohan, 1999).
 Displacing inefficient financial intermediaries and
creating pressures for a financial reform agenda
(Stulz, 1999; Stiglitz, 2000; Claessens et al. 2001; Chinn
and Ito, 2006).

MOTIVATION

FO, on the other hand, may lead to:

Risky behavior by banks and trigger boom-bust cycles (Allen and
Gale, 1999; Schneider and Tornell, 2004; Tornell and
Westermann, 2005)

Agency problems (Allen and Gale 2000).
Buy risky assets during lending booms
 Bubbles may burst into banking crisis and recessions


Financial liberalization may generate short-run tensions
(Kaminsky and Schmukler, 2008)
MOTIVATION
 The

effect of FO on DFD is theoretically ambiguous.
It becomes an empirical issue!
 It
may require a minimum threshold in some
structural areas.
 Prior: The effect of FO on DFD depends on some
structural features of the economy.
Institutional framework
 Legal infrastructure

GOAL
 Goal
of the paper: Test the nexus between FO and
the development of domestic financial markets



Depth of banking and non-banking intermediaries
Stability
Volatility and crisis
 FO
may have an impact on DFD once certain
thresholds are surpassed



Institutional quality,
Investor protection, and
Trade openness
CONTRIBUTION
 Contribution


to the literature:
First paper to evaluate the effects on DFD of FO using
“outcome” measures of cross-border asset trade
rather than indicators of the lack of restrictions to
perform cross-border trade
Complements existing evidence that more intense
financial linkages may lead to deeper domestic
financial markets after controlling for the legal and
institutional framework of the country
MAIN FINDINGS, I

Rising FO enhances DFD



It deepens the activity of banking intermediaries

Creation of credit

Expanded balance sheets

Raises banking leverage
It deepens the activity of non-banking intermediaries

Higher stock market capitalization

Raises stock market total value traded

Increasing private bond market capitalization
It heightens financial volatility and likelihood of crisis

Raises volatility of credit and stock prices

Higher likelihood of banking crisis
MAIN FINDINGS, II

Is there any role played by the structure of foreign assets
and liabilities?

Emerging markets –as opposed to advanced nations:


Accumulates equity-related liabilities (gross and net) more
than loan-related ones.

Savings exporters and FDI importers
Main findings:

Depth of intermediaries (along with stability and volatility)
affected by loan-related foreign liabilities

Depth of non-banking intermediaries (stock markets) affected
by equity-related liabilities
MAIN FINDINGS, III



Response of DFD to higher FO depends upon:

The level of institutional quality (IQ)

The degree of investor protection (IP)

International trade linkages of the domestic country (TO)
DFD enhanced by FO in countries with moderate to
higher levels of IQ, IP, TO

Bank size and activity (credit and assets)

Bank Leverage
Impact of FO on financial volatility and likelihood of
crisis countries is weaker in with strong institutional
environment
THE DATA
 Sample
of 145 countries (24 industrial economies)
 Annual information, 1974-2007 (unbalanced panel)
 Domestic financial development (B-DK-L, 2009)

Depth and stability of financial intermediaries
Domestic credit to the private sector
 Bank Assets
 Leverage


Depth of non-banking intermediaries
Stock Market Capitalization and Total Value Traded
 Private and Public Bond Market Capitalization


Volatility and Crisis
Credit volatility
 Stock price volatility
 Banking Crisis

THE DATA
 Financial
openness
Outcome measures: Foreign assets and liabilities (Lane and
Milesi-Ferretti, 2001, 2007)
 Policy measure: Index of financial openness (Chinn-Ito, 2007)


Intensity of financial openness?
 Control



variables
PPP-adjusted real GDP
Inflation
Exchange rate regimes: dual and freely falling (Reinhart and
Rogoff, 2004; Ilzetzki, Reinhart and Rogoff, 2008)
BASELINE REGRESSIONS: LEAST SQUARES
DEPTH OF FINANCIAL INTERMEDIARIES
Control variables
Financial
Income
Trade
CPI
Openness
per capita
Openness
Inflation
Exchange rate regimes
Falling
Dual
Nobs.
R**2
1. Depth and stability of banking intermediaries
Private credit by deposit money
0.1164 **
0.6575 **
0.3270 **
-0.2173 **
-0.1399 **
-0.1718 **
(0.022)
(0.046)
(0.042)
(0.041)
(0.037)
(0.066)
0.0770 **
0.4756 **
0.3401 **
-0.1631 **
-0.1045 **
-0.0644
(0.019)
(0.040)
(0.036)
(0.035)
(0.036)
(0.050)
0.0758 **
0.3474 **
0.2077 **
-0.0148
-0.0733 **
0.0436
(0.018)
(0.034)
(0.030)
(0.034)
(0.031)
(0.058)
0.2348 **
0.7568 **
0.3159 *
-0.4489 **
-0.2367 **
-0.1055
(0.072)
(0.146)
(0.174)
(0.141)
(0.115)
(0.217)
0.1492
0.9781 **
0.1242
-0.1882 *
0.0953
-0.7387 **
(0.109)
(0.210)
(0.226)
(0.120)
(0.164)
(0.218)
Private bond market capitalization
(% GDP, logs )
-0.2522 *
1.3522 **
0.2424
-1.0377 **
0.8089
0.5346 **
(0.145)
(0.283)
(0.348)
(0.316)
(0.570)
(0.237)
Public bond market capitalization
(% GDP, logs )
-0.2116 **
-1.0365 **
0.6784 **
-0.3394 *
0.0300
0.6956 **
(0.101)
(0.372)
(0.252)
(0.222)
(0.223)
(0.168)
banks (% GDP, logs )
Bank Assets
(% GDP, logs )
Bank leverage
(Credit-Deposit ratio, logs )
2916
0.861
2930
0.886
3268
0.659
1579
0.838
1631
0.839
629
0.905
730
0.800
2. Depth of non-banking intermediaries
Stock market capitalization
(% GDP, logs )
Stock market total value traded
(% GDP, logs )
Numbers in parenthesis are robust standard errors. * (**) implies significance at the 10 (5) percent level.
BASELINE REGRESSIONS: LEAST SQUARES
FINANCIAL VOLATILITY
Control variables
Financial
Income
Trade
CPI
Openness
per capita
Openness
Inflation
Exchange rate regimes
Falling
Dual
Nobs.
R**2
3. Financial Volatility
Volatility of growth in credit per capita
(3-year std. dev. )
Volatility of growth in Credit-GDP ratio
(3-year std. dev. )
Volatility of MoM % changes in real
stock prices (std. dev. within the year )
Volatility of YoY % changes in real
stock prices (std. dev. within the year )
0.0957 **
-0.3653 **
0.0570
0.3587 **
0.0638
0.4855 **
(0.036)
(0.065)
(0.054)
(0.050)
(0.054)
(0.157)
0.0857 **
-0.4157 **
-0.0054
0.3608 **
0.0891 *
0.4506 **
(0.034)
(0.067)
(0.054)
(0.050)
(0.054)
(0.161)
0.1075 **
0.1701
-0.4135 **
0.2925 **
0.1150
-0.0154
(0.046)
(0.121)
(0.115)
(0.055)
(0.100)
(0.105)
0.0649
0.2875 *
-0.3494 **
0.2314 **
0.1448
0.2646 *
(0.058)
(0.156)
(0.144)
(0.074)
(0.104)
(0.167)
Numbers in parenthesis are robust standard errors. * (**) implies significance at the 10 (5) percent level.
3161
0.474
3170
0.496
1340
0.529
1289
0.457
METHODOLOGY
 Challenges


Presence of unobserved period- and country-specific effects
Most explanatory variables are likely endogenous. Need to
control for reverse causality.
 Method:

IV estimation
Need: Control reverse causation in financial openness


of panel data estimation
DFD may affect cross-border asset holdings.
Instruments for FO (Faria et al. 2007):
Institutional quality (summary index: rule of law, corruption,
bureaucratic quality, and democratic accountability)
 Legal origin of the country (La Porta et al. 1998)
 Natural resource abundance, and area of the country
 Initial size of the country

BASELINE REGRESSIONS: IV ESTIMATION
DEPTH OF FINANCIAL INTERMEDIARIES
Control variables
Financial
Income
Trade
CPI
Openness
per capita
Openness
Inflation
Exchange rate regimes
Falling
Dual
Nobs.
R**2
1. Depth and stability of banking intermediaries
Private credit by deposit money
banks (% GDP, logs )
0.0941 **
0.6406 **
0.2875 **
-0.2324 **
-0.1915 **
-0.1433 *
(0.028)
(0.050)
(0.049)
(0.047)
(0.040)
(0.075)
0.0520 **
0.4607 **
0.2893 **
-0.1662 **
-0.1376 **
-0.0428
(0.024)
(0.042)
(0.040)
(0.039)
(0.038)
(0.056)
0.0919 **
0.3242 **
0.1239 **
0.0382
-0.1072 **
0.0080
(0.023)
(0.038)
(0.035)
(0.038)
(0.033)
(0.068)
0.3495 **
1.0480 **
0.2084
-0.2230 **
-0.3174 **
-0.2190
(0.087)
(0.170)
(0.186)
(0.061)
(0.114)
(0.189)
0.4342 **
1.2462 **
0.0054
-0.0685
0.1092
-0.7878 **
(0.138)
(0.242)
(0.248)
(0.117)
(0.182)
(0.229)
Private bond market capitalization
(% GDP, logs )
-0.3538 **
1.3672 **
0.2057
-1.0405 **
0.8352
0.5293 **
(0.157)
(0.304)
(0.376)
(0.314)
(0.566)
(0.245)
Public bond market capitalization
(% GDP, logs )
-0.2720 **
-1.2503 **
0.6531 **
-0.1016
-0.0631
0.6074 **
(0.108)
(0.394)
(0.256)
(0.129)
(0.201)
(0.156)
Bank Assets
(% GDP, logs )
Bank leverage
(Credit-Deposit ratio, logs )
2441
0.857
2453
0.883
2596
0.643
1380
0.851
1419
0.846
593
0.904
675
0.806
2. Depth of non-banking intermediaries
Stock market capitalization
(% GDP, logs )
Stock market total value traded
(% GDP, logs )
Note: To control for reverse causality and likely endogeneity of financial openness (FO), we use the following instruments: lagged financial openness,
lagged real GDP, lagged level of institutions, lagged level of natural resource abundance, surface area of the country (logs), and dummies of legal
origin (British common law, French civil code, German civil code, and Scandinavian civil code). Numbers in parenthesis are robust standard errors.
Finally, note that * (**) implies significance at the 10 (5) percent level.
BASELINE REGRESSIONS: IV ESTIMATION
FINANCIAL VOLATILITY
Control variables
Financial
Income
Trade
CPI
Openness
per capita
Openness
Inflation
Exchange rate regimes
Falling
Dual
Nobs.
R**2
3. Financial Volatility
Volatility of growth in credit per capita
(3-year std. dev. )
Volatility of growth in Credit-GDP ratio
(3-year std. dev. )
Volatility of MoM % changes in real
stock prices (std. dev. within the year )
Volatility of YoY % changes in real
stock prices (std. dev. within the year )
0.2023 **
-0.5006 **
0.0544
0.4145 **
0.0328
0.4997 **
(0.050)
(0.076)
(0.067)
(0.067)
(0.059)
(0.195)
0.2112 **
-0.5061 **
-0.0334
0.4265 **
0.0405
0.5080 **
(0.049)
(0.082)
(0.066)
(0.066)
(0.059)
(0.199)
0.2087 **
0.3492 **
-0.4913 **
0.2955 **
0.0492
-0.0100
(0.054)
(0.157)
(0.133)
(0.052)
(0.106)
(0.104)
0.2058 **
0.4909 **
-0.4177 **
0.2490 **
0.0806
0.2835 *
(0.071)
(0.204)
(0.162)
(0.074)
(0.114)
(0.169)
2528
0.454
2533
0.486
1164
0.548
1123
0.489
Note: To control for reverse causality and likely endogeneity of financial openness (FO), we use the following instruments: lagged financial openness,
lagged real GDP, lagged level of institutions, lagged level of natural resource abundance, surface area of the country (logs), and dummies of legal
origin (British common law, French civil code, German civil code, and Scandinavian civil code). Numbers in parenthesis are robust standard errors.
Finally, note that * (**) implies significance at the 10 (5) percent level.
ROBUSTNESS ANALYSIS, I
DROPPING SHARP VARIATIONS IN FINANCIAL MARKETS
Control variables
Financial
Income
Trade
CPI
Openness
per capita
Openness
Inflation
Exchange rate regimes
Falling
Dual
Nobs.
R**2
1. Depth and stability of banking intermediaries
Private credit by deposit money
banks (% GDP, logs )
Bank leverage
(Credit-Deposit ratio, logs )
0.0975 **
0.6482 **
0.2526 **
-0.1981 **
-0.1706 **
-0.1139 *
(0.029)
(0.050)
(0.050)
(0.061)
(0.042)
(0.073)
0.1034 **
0.3414 **
0.1144 **
0.0101
-0.1003 **
-0.0061
(0.022)
(0.037)
(0.035)
(0.048)
(0.033)
(0.066)
2326
0.865
2503
0.658
1264
0.864
521
0.942
614
0.839
2411
0.461
1091
0.617
2. Depth of non-banking intermediaries
Stock market capitalization
(% GDP, logs )
0.3870 **
1.0490 **
0.2872 *
-0.2224 **
-0.1875 *
-0.3228 *
(0.086)
(0.166)
(0.180)
(0.058)
(0.105)
(0.177)
Private bond market capitalization
(% GDP, logs )
-0.1684
1.2268 **
0.4304
0.0170
0.0595
0.3318 *
(0.131)
(0.257)
(0.326)
(0.098)
(0.241)
(0.203)
Public bond market capitalization
(% GDP, logs )
-0.3763 **
-0.9809 **
0.7718 **
-0.4424 **
0.3115 *
0.7099 **
(0.098)
(0.392)
(0.255)
(0.135)
(0.194)
(0.146)
0.1834 **
-0.4505 **
-0.0741
0.3448 **
0.0585
0.4192 **
(0.044)
(0.078)
(0.065)
(0.082)
(0.058)
(0.205)
0.2493 **
0.3816 **
-0.3366 **
0.2672 *
0.0361
-0.0480
(0.039)
(0.108)
(0.092)
(0.166)
(0.082)
(0.064)
3. Financial Volatility
Volatility of growth in Credit-GDP ratio
(3-year std. dev. )
Volatility of YoY % changes in real
stock prices (std. dev. within the year )
Note: We eliminated those observations where absolute variations in the financial indicators exceeded two standard deviations. Our regressions were
conducted using IV estimation techniques. To control for reverse causality and likely endogeneity of financial openness (FO), we use the following
instruments: lagged financial openness, lagged real GDP, lagged level of institutions, lagged level of natural resource abundance, surface area of the
country (logs), and dummies of legal origin (British common law, French civil code, German civil code, and Scandinavian civil code). Numbers in
parenthesis are robust standard errors. Finally, note that * (**) implies significance at the 10 (5) percent level.
ROBUSTNESS ANALYSIS, II
 Does
the structure of external assets and liabilities
matter for financial development?
 Emerging markets have become net creditors in debtrelated assets and net debtors in equity-related assets

Exporting savings and importing FDI
 What
are the implications for depth, stability and
volatility in domestic financial markets?


Any implications for countries with high debt-equity ratios?
Distinguish between equity-related liabilities (FDI, Portfolio
equity holdings) and loan-related liabilities (Portfolio debt and
Other investment holdings)
STRUCTURE OF FOREIGN LIABILITIES – IV REGRESSION
DEPTH OF FINANCIAL INTERMEDIARIES
Financial Openness
Control variables
Equity-related
Loan-related
Income
Trade
CPI
Liabilities
Liabilities
per capita
Openness
Inflation
Exchange rate regimes
Falling
Dual
Nobs.
R**2
1. Depth and stability of banking intermediaries
Private credit by deposit money
banks (% GDP, logs )
0.0216
0.0825 **
0.6474 **
0.2865 **
-0.2315 **
-0.1954 **
-0.1523 **
(0.014)
(0.024)
(0.051)
(0.049)
(0.047)
(0.040)
(0.074)
0.0040
0.0561 **
0.4712 **
0.2902 **
-0.1684 **
-0.1416 **
-0.0482
(0.014)
(0.020)
(0.044)
(0.039)
(0.039)
(0.037)
(0.054)
0.0141
0.0755 **
0.3344 **
0.1277 **
0.0397
-0.1090 **
-0.0013
(0.011)
(0.020)
(0.039)
(0.035)
(0.038)
(0.033)
(0.067)
0.6231 **
0.0554
1.0444 **
-0.0500
-0.1416 **
-0.2945 **
-0.1356
(0.077)
(0.065)
(0.177)
(0.189)
(0.061)
(0.108)
(0.207)
0.9973 **
0.0457
1.2824 **
-0.5130 **
0.0971
0.0742
-0.6950 **
(0.119)
(0.105)
(0.243)
(0.247)
(0.102)
(0.172)
(0.267)
Private bond market capitalization
(% GDP, logs )
-0.0402
-0.2635 **
1.3042 **
0.1603
-1.0381 **
0.8419
0.5823 **
(0.126)
(0.126)
(0.309)
(0.410)
(0.316)
(0.569)
(0.254)
Public bond market capitalization
(% GDP, logs )
0.0388
-0.3481 **
-1.2919 **
0.5216 **
-0.1027
-0.0088
0.6901 **
(0.119)
(0.081)
(0.372)
(0.255)
(0.133)
(0.212)
(0.173)
Bank Assets
(% GDP, logs )
Bank leverage
(Credit-Deposit ratio, logs )
2441
0.858
2453
0.884
2596
0.643
1381
0.859
1420
0.858
593
0.904
675
0.813
2. Depth of non-banking intermediaries
Stock market capitalization
(% GDP, logs )
Stock market total value traded
(% GDP, logs )
Note: To control for reverse causality and likely endogeneity of financial openness (FO), we use the following instruments: lagged financial openness,
lagged real GDP, lagged level of institutions, lagged level of natural resource abundance, surface area of the country (logs), and dummies of legal
origin (British common law, French civil code, German civil code, and Scandinavian civil code). Numbers in parenthesis are robust standard errors.
Finally, note that * (**) implies significance at the 10 (5) percent level.
STRUCTURE OF FOREIGN LIABILITIES – IV REGRESSION
FINANCIAL VOLATILITY
Financial Openness
Control variables
Equity-related
Loan-related
Income
Trade
CPI
Liabilities
Liabilities
per capita
Openness
Inflation
Exchange rate regimes
Falling
Dual
Nobs.
R**2
3. Financial Volatility
Volatility of growth in credit per capita
(3-year std. dev. )
-0.0048
0.1719 **
-0.4714 **
0.0881
0.4176 **
0.0288
0.4698 **
(0.024)
(0.043)
(0.078)
(0.067)
(0.066)
(0.059)
(0.196)
Volatility of growth in Credit-GDP ratio
(3-year std. dev. )
-0.0224
0.1818 **
-0.4685 **
0.0103
0.4280 **
0.0369
0.4736 **
(0.023)
(0.042)
(0.083)
(0.067)
(0.065)
(0.058)
(0.199)
Volatility of MoM % changes in real
stock prices (std. dev. within the year )
0.2117 **
0.0613
0.2853 *
-0.5652 **
0.3172 **
0.0784
0.0517
(0.045)
(0.041)
(0.151)
(0.135)
(0.052)
(0.105)
(0.110)
0.1921 **
0.0478
0.4162 **
-0.4726 **
0.2684 **
0.1066
0.3327 *
(0.050)
(0.056)
(0.195)
(0.164)
(0.070)
(0.112)
(0.172)
Volatility of YoY % changes in real
stock prices (std. dev. within the year )
Note: To control for reverse causality and likely endogeneity of financial openness (FO), we use the following instruments: lagged financial openness,
lagged real GDP, lagged level of institutions, lagged level of natural resource abundance, surface area of the country (logs), and dummies of legal
origin (British common law, French civil code, German civil code, and Scandinavian civil code). Numbers in parenthesis are robust standard errors.
Finally, note that * (**) implies significance at the 10 (5) percent level.
2530 0.453
2535 0.485
1164 0.556
1123 0.496
ROLE OF STRUCTURAL FEATURES
 Test
whether the impact of FO on DFD depends
upon:



Degree of institutional quality (IQ)
Investor protection (IP)
Extent of international trade integration (TO)
 We
model the coefficient it as:
FDit
 it 
  0   1 IQit   1 IPit   1TOit
FOit
 Prior: 1, 2, 3 >0
ROLE OF STRUCTURAL FEATURES – IV REGRESSIONS
DEPTH OF FINANCIAL INTERMEDIARIES
Financial Openness
Control variables
Foreign
FL x
FL x Investor
FL x Trade
Income
Trade
CPI
Liabilities (FL)
Institutions
Protection
Openness
per capita
Openness
Inflation
Exchange rate regimes
Falling
Dual
Nobs. R**2
2395 0.864
1. Depth and stability of banking intermediaries
Private credit by deposit money
banks (% GDP, logs )
-2.3691 **
0.2662 **
1.4088 **
0.1592 **
0.4555 ** -0.3268 ** -0.1600 ** -0.1880 **
0.0117
(0.316)
(0.027)
(0.226)
(0.030)
(0.058)
(0.055)
Private credit by financial system
(% GDP, logs )
-2.3337 **
0.2730 **
1.4540 **
0.1347 **
0.5330 ** -0.2501 ** -0.1213 ** -0.2017 ** -0.0133
(0.321)
(0.027)
(0.228)
(0.031)
(0.059)
Bank Assets
(% GDP, logs )
-1.7468 **
0.1923 **
0.9858 **
0.1244 **
0.3227 ** -0.1840 *
-0.1141 ** -0.1363 **
0.0670
(0.252)
(0.022)
(0.182)
(0.025)
(0.050)
(0.039)
(0.039)
(0.053)
Bank leverage
(Credit-Deposit ratio, logs )
-0.7037 **
0.0672 **
0.7317 **
0.0394 *
0.2559 ** -0.0417
0.0573 *
-0.1087 **
0.0728
(0.195)
(0.017)
(0.130)
(0.021)
(0.038)
(0.037)
(0.032)
(0.068)
-0.2590
0.0885
-0.3381
0.0883
1.0282 ** -0.1133
-0.2377 ** -0.3029 ** -0.2216
(1.057)
(0.068)
(0.859)
(0.097)
(0.196)
(0.416)
(0.068)
(0.121)
(0.123)
(0.100)
(0.087)
(0.044)
(0.047)
(0.040)
(0.042)
2404 0.872
(0.081)
2407 0.883
2549 0.670
2. Depth of non-banking intermediaries
Stock market capitalization
(% GDP, logs )
Stock market total value traded
(% GDP, logs )
Private bond market capitalization
(% GDP, logs )
Public bond market capitalization
(% GDP, logs )
(0.118)
(0.192)
1375 0.852
0.3092
0.1244
-1.6464
0.1054
1.3541 ** -0.3914
-0.0694
0.1062
-0.8580 ** 1412 0.848
(1.583)
(0.120)
(1.170)
(0.140)
(0.293)
(0.581)
(0.126)
(0.191)
(0.249)
-6.7533 **
0.6850 **
2.4006 **
0.4191 **
0.2146
-1.6134 *
-1.3220 **
1.1170 **
0.7893 **
(2.278)
(0.228)
(1.034)
(0.205)
(0.487)
(0.960)
(0.356)
(0.570)
(0.383)
3.4308 **
-0.3294 **
-2.5383 **
-0.1814 *
-0.4565
1.2664 **
0.0245
-0.1438
0.4234 **
(1.140)
(0.101)
(0.577)
(0.120)
(0.376)
(0.462)
(0.131)
(0.211)
(0.158)
Note: To control for reverse causality and likely endogeneity of financial openness (FO), we use the following instruments: lagged financial openness,
lagged real GDP, lagged level of institutions, lagged level of natural resource abundance, surface area of the country (logs), and dummies of legal origin
(British common law, French civil code, German civil code, and Scandinavian civil code). Numbers in parenthesis are robust standard errors. Finally, note
that * (**) implies significance at the 10 (5) percent level.
593 0.890
675 0.816
ROLE OF STRUCTURAL FEATURES – IV REGRESSIONS
FINANCIAL VOLATILITY
Financial Openness
Control variables
Foreign
FL x
FL x Investor
FL x Trade
Income
Trade
CPI
Liabilities (FL)
Institutions
Protection
Openness
per capita
Openness
Inflation
Exchange rate regimes
Falling
Dual
Nobs. R**2
3. Financial Volatility
Volatility of growth in credit per capita
(3-year std. dev.)
Volatility of growth in Credit-GDP ratio
(3-year std. dev.)
Volatility of Mom % changes in real
stock prices (std. dev. within the year)
Volatility of YoY % changes in real
stock prices (std. dev. within the year)
1.4772 **
-0.1555 **
-0.9239 **
-0.0458
-0.4918 ** 0.2626
0.3849 ** 0.0265
0.3675 * 2486 0.451
(0.460)
(0.038)
(0.345)
(0.047)
(0.078)
(0.069)
(0.200)
1.6572 **
-0.1643 **
-0.7852 **
-0.1012 ** -0.5238 ** 0.3798 ** 0.3967 ** 0.0401
0.3856 * 2491 0.479
(0.462)
(0.038)
(0.346)
(0.048)
(0.084)
(0.057)
(0.207)
0.0752
0.1493 **
-0.6293 *
-0.0374
0.4055 ** -0.4068 *
0.3123 ** 0.0328
-0.0237
(0.613)
(0.065)
(0.380)
(0.046)
(0.163)
(0.053)
(0.105)
(0.112)
1.2783 *
-0.0076
-1.1804 **
-0.1106 ** 0.5702 ** 0.0239
0.2846 ** 0.0786
0.2038
(0.705)
(0.076)
(0.439)
(0.054)
(0.081)
(0.185)
(0.216)
(0.189)
(0.192)
(0.231)
(0.275)
(0.070)
(0.057)
(0.112)
1157 0.559
1116 0.490
Note: To control for reverse causality and likely endogeneity of financial openness (FO), we use the following instruments: lagged financial openness,
lagged real GDP, lagged level of institutions, lagged level of natural resource abundance, surface area of the country (logs), and dummies of legal origin
(British common law, French civil code, German civil code, and Scandinavian civil code). Numbers in parenthesis are robust standard errors. Finally, note
that * (**) implies significance at the 10 (5) percent level.
ROLE OF STRUCTURAL FACTORS: A SCORECARD
The Role of Structural Characteristics: Conditional response of domestic financial development to an increase in financial openness
(Response to doubling our measure of financial openness )
Depth and Stability of
Banking Intermediaries
Bank
Bank
Bank
Credit
Assets
Leverage
Institutions
Low (L)
Medium
High (H)
H1: H > L
Depth of Non-Banking
Intermediaries
Stock Market
Bond Market Cap
Capitalization Value traded
Private
Public
[0]
[+]
[+]
(0.0072)
[0]
[+]
[+]
(0.0193)
[+]
[+]
[+]
(0.3518)
[+]
[+]
[+]
(0.7781)
[+]
[+]
[+]
(0.8139)
[-]
[-]
[-]
(0.5286)
[0]
[0]
[0]
(0.5507)
Investor Protection
Low (L)
[0]
Medium
[+]
High (H)
[+]
H1: H > L
(0.0000)
[0]
[+]
[+]
(0.0000)
[0]
[+]
[+]
(0.0002)
[+]
[+]
[+]
(0.7372)
[+]
[+]
[+]
(0.2936)
[-]
[-]
[-]
(0.3819)
[+]
[0]
[0]
(0.0725)
Trade Openness
Low (L)
Medium
High (H)
H1: H > L
[0]
[+]
[+]
(0.0046)
[+]
[+]
[+]
(0.3088)
[+]
[+]
[+]
(0.6057)
[+]
[+]
[+]
(0.7070)
[-]
[-]
[-]
(0.4528)
[0]
[0]
[0]
(0.5294)
[0]
[+]
[+]
(0.0027)
Notes: Low (L) and high (H) levels of structural variables are computed as the 25th and 75th percentile of the distribution of the corresponding dimensions (with the other
dimensions being evaluated at their medians). The p-value tests the null of equality in the effects whereas the alternative tests whether H is greater than L effect.
ROLE OF STRUCTURAL FACTORS: A SCORECARD
The Role of Structural Characteristics: Conditional response of domestic financial development to an increase in financial openness
(Response to doubling our measure of financial openness )
Volatility of Real Credit
(3-year standard deviation)
Credit per
Credit-GDP
capita
ratio
Stock Price Volatility
(3-year standard deviation)
MoM
YoY
% Change
% Change
Institutions
Low (L)
Medium
High (H)
H1: H > L
[+]
[+]
[+]
(0.3448)
[+]
[+]
[+]
(0.3053)
[+]
[+]
[+]
(0.4703)
[+]
[+]
[+]
(0.9770)
Investor Protection
Low (L)
Medium
High (H)
H1: H > L
[+]
[+]
[+]
(0.0486)
[+]
[+]
[+]
(0.0874)
[+]
[+]
[+]
(0.2717)
[+]
[+]
[+]
(0.0987)
Trade Openness
Low (L)
Medium
High (H)
H1: H > L
[+]
[+]
[+]
(0.6014)
[+]
[+]
[+]
(0.2379)
[+]
[+]
[+]
(0.7233)
[+]
[+]
[+]
(0.4118)
Notes: Low (L) and high (H) levels of structural variables are computed as the 25th and 75th percentile of the distribution of the corresponding dimensions (with the other
dimensions being evaluated at their medians). The p-value tests the null of equality in the effects whereas the alternative tests whether H is greater than L effect.
CONDITIONAL RESPONSE: BANK INTERMEDIARIES
0.15
0.12
0.10
0.10
0.05
0.08
0.00
0.06
1
10
20
30
40
50
60
70
80
Response of bank leverage conditional to institutional
quality
0.14
Response of private credit conditional to institutional
quality
0.20
90
99
-0.05
0.04
-0.10
0.02
-0.15
0.00
1
-0.20
-0.02
Institutional Quality (selected percentiles)
Response of Private Credit conditional to Investor
Protection
0.8
10
20
30
40
50
60
70
80
90
99
90
99
Institutional quality (selected percentiles)
Response of bank leverage conditional to investor
protection
0.4
0.6
0.3
0.4
0.2
0.2
0.1
0.0
1
10
20
30
40
50
60
70
80
90
99
0.0
-0.2
1
-0.4
-0.6
10
20
30
40
50
60
70
80
-0.1
Investor Protection (selected percentiles)
-0.2
Investor Protection (selected percentiles)
Notes: Responses evaluated at different percentiles of the corresponding variables while the other dimensions are evaluated at their medians. Note that the dotted red lines
represent the 95% confidence interval.
CONDITIONAL RESPONSE: NON-BANK INTERMEDIARIES
Response of stock market capitalization conditional to
institutional quality
0.4
Response of private bond market capitalization
conditional to institutional quality
0.00
0.4
1
-0.20
0.3
10
20
30
40
50
60
70
80
90
99
-0.40
0.3
-0.60
0.2
-0.80
-1.00
0.2
-1.20
0.1
-1.40
0.1
-1.60
0.0
1
10
-0.1
20
30
40
50
60
70
80
90
99
-2.00
Percentiles of the distribution of Institutions
Response of stock market capitalization conditional on
investor protection
1.0
-1.80
Institutional quality (selected percentiles)
Response of private bond market capitalization
conditional to investor protection
1.0
0.8
0.5
0.6
0.0
1
0.4
-0.5
0.2
-1.0
0.0
1
10
20
30
40
50
60
70
80
-0.2
-0.4
90
99
10
20
30
40
50
60
70
80
90
99
-1.5
-2.0
Percentiles of the distribution of Investor Protection
-2.5
Investor Protection (selected percentiles)
Notes: Responses evaluated at different percentiles of the corresponding variables while the other dimensions are evaluated at their medians. Note that the dotted red lines
represent the 95% confidence interval.
CONDITIONAL RESPONSE: FINANCIAL VOLATILITY
Response of credit volatility conditional to institutional
quality
0.35
Response of stock price volatility conditional to
institutional quality
0.30
0.25
0.30
0.20
0.25
0.15
0.20
0.10
0.15
0.05
0.10
0.00
0.05
1
10
20
30
40
50
60
70
80
90
99
-0.05
0.00
1
10
20
30
40
50
60
70
80
90
99
Institutional Quality (selected percentiles)
Response of credit volatility conditional to investor
protection
0.6
-0.10
Institutional Quality (selected percentiles)
Response of stock price volatility conditional on investor
protection
0.6
0.5
0.5
0.4
0.4
0.3
0.3
0.2
0.2
0.1
0.1
0.0
1
10
20
30
40
50
60
70
-0.1
90
99
0.0
1
10
20
30
40
50
60
70
80
90
99
-0.1
-0.2
-0.2
-0.3
-0.4
80
Investor Protection (selected percentiles)
-0.3
Investor Protection (Selected percentiles)
Notes: Responses evaluated at different percentiles of the corresponding variables while the other dimensions are evaluated at their medians. Note that the dotted red lines
represent the 95% confidence interval.
ROBUSTNESS ANALYSIS III
 The
estimates of our “augmented” model are robust
to:


Excluding sharp variations in financial variables (associated to
lending booms, equity bubbles, etc.)
Changes in the measure of institutional quality


Political institutions, quality of institutions, socio-economic
environment, conflict
Changes in the measure of investor protection

Disclosure index, director liability, and shareholder suits
BANKING CRISIS
 Demirgüç-Kunt
and Detragiache (1998a,b): Assess the
determinants of banking crisis
Macroeconomic environment
 Characteristics of the banking sector
 Financial liberalization

 Domac
& Martinez Peria (2003): Linkages between
banking crises and exchange rate regimes. Is the
likelihood of banking crisis under fixed regimes affected
by:
Unhedged liabilities?
 M2 backed by reserves?
 Illiquidity of banking system?
 Higher exposure to external shocks?

BANKING CRISIS



Goal: Does financial openness increases the likelihood of banking crisis
Financial openness may raise the vulnerability to financial shocks
Approach:
Reduced form not derived from specific structural model
 Correlations, not causal links


Prior (Demirgüç-Kunt and Detragiache, 1998b):
Banking crisis more likely to take place in financially open countries
 Weaker impact in countries with strong institutional environment


Determinants:
Macro environment: GDP growth, CPI inflation, real interest rate,
M2/Reserves
 Bank and monetary characteristics: Bank liquid reserves to asset ratio, Growth
in Real Credit
 Institutions: ICRG index of political risk (sub-indices), rule of law, investor
protection.
 Financial Openness (Variable of interest)

FINANCIAL OPENNESS AND THE LIKELIHOOD OF
BANKING CRISIS - PROBIT ANALYSIS
ALL Countries
[2]
[1]
Control Variables
Income per capita
Real GDP growth
CPI Inflation
Real interest rate
Bank reserves to asset
Terms of trade
M2/ Reserves
Growth in real credit
Institutional quality
Financial Openness
Foreign liabilities (FL)
(% GDP, logs - lagged)
Equity-related foreign
liabilities (% GDP, logs)
Loan-related foreign
liabilities (% GDP, logs)
FL x Institutional quality
(lagged value)
FL x Investor protection
(lagged value)
FL x Trade openness
(lagged value)
No. Countries
No. Observations
-0.0779
-2.7648
0.4868
0.6474
-1.1219
-0.1537
0.0003
-0.4652
-0.2623
**
**
**
*
**
0.8375 **
(0.147)
..
0.2521
-2.7893
0.3664
0.5554
-1.3143
-0.1284
0.0003
-0.4646
-0.0144
**
*
*
**
**
..
..
-0.0494
(0.083)
0.8471 **
(0.139)
..
..
..
..
..
..
94
1744
94
1746
[3]
0.1387
-2.6324
0.4390
0.7877
-1.1841
-0.0622
0.0003
-0.4489
4.7436
**
*
**
**
*
**
DEVELOPING Countries
[4]
[5]
[6]
-0.0571
-2.5622
0.4817
0.5775
-1.1144
-0.0154
0.0003
-0.4755
-0.0407
0.1098
-2.4325
0.4125
0.7626
-1.2256
0.1206
0.0004
-0.5134
9.4648
**
**
*
*
**
0.3481
-2.5856
0.3388
0.4744
-1.3394
0.0112
0.0003
-0.4854
0.3332
**
*
**
**
6.1672 **
(1.795)
..
0.7520 **
(0.164)
..
..
..
-1.1623 **
(0.429)
-0.4419
(0.359)
-0.0667
(0.052)
..
-0.1360 *
(0.089)
0.8038 **
(0.151)
..
..
..
..
..
92
1695
84
1452
..
84
1454
Numbers in parenthesis are robust standard errors. Finally, note that * (**) implies significance at the 10 (5) percent level.
**
*
**
**
**
**
10.0831 **
(2.261)
-2.1994 **
(0.561)
-0.4270
(0.404)
-0.0560
(0.056)
82
1409
CONCLUSIONS, I
 World
economy characterized by:
Rising financial globalization
 Rapid increase in cross-border asset trade
 Deepening of local financial markets

 How
does FO affect DFD?
Theoretically ambiguous
 Empirical issue
 Possible to determine causal impact?

CONCLUSIONS, II
 Rising
FO appears to enhance DFD by:
Expansion of bank credit and balance sheets of banking
intermediaries
 Enhances the depth of non-banking intermediaries (stock market
capitalization and total value traded)

 Rising


FO also:
Raises financial volatility
Increase the likelihood of banking crisis
 Impact
of FO on the expansion of banking intermediaries
requires a minimum threshold in terms of institutional
quality, investor protection, and openness to traded.
 Impact of FO on financial volatility and crisis is weaker in
countries with strong institutions.