The Mexican Banking Crisis Of 1995-96: A "Vulnerability-Shocks" Explanation

This dissertation constructs first a paradigm of "vulnerability-shocks" to explain banking crises. Banking crises are due to both vulnerability and shocks. It deals with macro and microeconomic dimensions of these two elements of banking crises and gives the policy implications. Then it gives a "vulnerability-shocks" explanation to the Mexican banking crisis of 1995~96. It details the events that precipitated and followed this crisis and examines how the problems took shape.The bank regulation and supervision had not been strengthened before Mexican financial liberalization. The new owners/managers of the re-privatized banks did not pass the "fit and proper" test. The result of the privatization was, to some extent, to exchange public sector inefficiencies for private sector incompetence and even fraud. The structural reforms and financial liberalization opened opportunities to the banks with weak regulation and supervision. The banks engaged actively in lending booms, which generated vulnerability of the banking system. The year of 1994 saw a crisis. The vulnerable banking sector was submerged by macroeconomic shocks such as peso devaluation, hiking interest rate and inflation, capital flight, slow economic growth and assets price collapses. The governmental rescue of the banking sector prevented successfully a systemic breakdown of the banking and financial system.The Mexican banking crisis of 1995-96 supports the policy implications of the "vulnerability-shocks" paradigm: developing countries should identify the specific causes of their banking systems vulnerability and implement the appropriate financial reforms; fragile banking systems complicate the management of macroeconomic policy in terms of timing, scope, and effectiveness; macroeconomic considerations should play an important role in the design of bank regulatory regimes; effective deposit insurance systems should be established in order to reduce bank runs and moral hazards of both bankers and depositors; considering the apparent role of lending booms in creating vulnerability of banking systems, the authorities should monitor the rate of credit growth, and take measures when it appears to be growing too rapidly.Two conlusions can be drawn. First, a well-developed public financial infrastructure is vital to improve the banking supervision. Second, a balance-of-payments crisis can develop parallel to a banking crisis. A vulnerable banking system limits the authorities's ability to defend the fixed exchange rate regime. A balance-of-payments crisis can speed the outbreak of a banking crisis.