20211118-IMF-Assessing_Banking_and_Currency_Crisis_Risk_in_Small_States_An_application_to_the_Eastern_Caribbean_Currency_Union_34页_1mb

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

The study examines the determinants of banking and currency crises in small states, with a case study on the Eastern Caribbean Currency Union (ECCU). Key findings include:

1. Crisis Predictors: External and domestic fundamentals matter for crisis likelihood, with small states and fixed exchange rate regimes being more sensitive to these factors.

2. Backing Ratio Importance: A high foreign reserve cover (backing ratio) is critical in reducing crisis risk, especially during global downturns. The ECCU maintained high backing ratios, limiting crisis probability despite economic shocks.

3. Empirical Models: Using binomial logit models, the study confirms that global conditions interact with country-specific factors, increasing vulnerability during recessions with lower backing ratios.

4. ECCU Case: The ECCU’s high backing ratio mitigated crisis risk during periods like the 2008 GFC and the COVID-19 pandemic, supporting currency and financial stability. However, risks emerge in slow global growth and fiscal mismanagement.

Implications: The research underscores the need for sustained fiscal discipline and robust monetary reserves in small open economies to enhance resilience against external and domestic macroeconomic shocks.