Information and incentive problems lie at the root of many recent financial crises in Asian and Latin American economies. Effective regulation is also important: The economies with the most conservative regulatory environments weathered the crises best.
What has caused the epidemic of financial crises in the past 20 years? And what steps can be taken—perhaps are being taken—to minimize financial vulnerability?
Caprio summarizes both basic and proximate factors behind financial crises, arguing that although a variety of factors contribute to the crises, the basic causes are information and incentive problems.
Caprio develops a scoring system for the broad regulatory environment for a dozen Asian and Latin American financial systems in 1997. The Asian economies in crisis score the lowest. Economies with high scores felt relatively little impact from the crises.
The scoring system may serve as a guide for how countries might assign priorities to improvements in their regulatory environment, although further research is needed to sort out more important factors from less important factors.
Caprio stresses one conclusion: Given the information problems inherent in finance, regulatory systems that allow "multiple eyes" to oversee the financial system should perform best. Bank owners, markets, and supervisors must all be given clear incentives and adequate information to monitor banks.
This paper—a product of Finance, Development Research Group—is part of a larger effort in the group to examine the role of incentives in the financial sector. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye, room MC3-422, telephone 202-473-8526, fax 202-522-1155, Internet address psintimaboagye@worldbank.org. The author may be contacted at gcaprio@worldbank.org. (32 pages)
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