Financial Crisis in Developing Countries and Structural Weaknesses of the Financial System

Abstract

This paper examines the generation of financial crises in developing economies and shows that the microeconomic structure of the financial sector is a crucial factor in creating the conditions for a crisis. Structural problems of the financial system in developing countries, including implicit insurance on bank liabilities, limitations of capital markets, and lack of appropriate regulations, are sources of financial fragility. The paper concludes that the intervention of a supervisory agency is needed to eliminate these distortions, and the optimal intervention consists of charging a fair insurance premium on bank liabilities or imposing an adjustable bankruptcy penalty on banking activity.