TAILIEUCHUNG - Deposit interest rates, asset risk and bank failure in Croatia

In addition, we only provide data at maturities where we think the curve can be fitted so that it is stable and meaningful. Instability arises when small movements in bond prices lead to unrealistically large moves in the estimated yield curves, essentially because there is not enough information from observed prices at a given maturity to allow us to fit that segment of the curve. This is usually a problem at short maturities where we require more information because we expect the short end of the yield curve to exhibit the greatest amount of structure. This is because expectations about the future path of. | Deposit interest rates asset risk and bank failure in Croatia Evan Kraft Advisor to the Governor Croatian National Bank Trg hrvatskih velikana 3 10000 Zagreb Croatia tel 3851 4564-858 fax 3851 4564-784 email Tomislav Galac Director Financial Stability Department Croatian National Bank Trg hrvatskih velikana 3 10000 Zagreb Croatia tel 3851 4564-842 fax 3851 4564-784 email 1 Abstract During the 1980 s and 1990 s financial liberalization became an almost universally-accepted policy prescription. Large numbers of countries eased licensing deregulated interest rates and dismantled systems of directed lending. However banking system crises first in the southern cone of Latin America in the early 1980 s and later in the . Scandinavian countries and a large set of emerging market economies raised questions about the links between financial liberalization and instability. In particular Hellman Murdoch and Stiglitz 2000 question the wisdom of complete deregulation of deposit interest rates arguing that this can facilitate purchasing market share to fund gambling. The transition countries of Central and Eastern Europe provide an interesting laboratory to test these arguments. Starting in the early 1990 s these countries rapidly liberalized their banking markets removing restrictions on entry asset composition and interest rates. For this reason the experience of such countries may help confirm whether the . experience of the 1980 s was typical. In this paper we examine the experience of Croatia which liberalized its banking regulations in the early 1990 s. After the end of the wars surrounding the break-up of former Yugoslavia Croatia experienced rapid growth in the number of banks strong deposit growth and substantial increases in deposit interest rates in the period 1995-98. This buoyant period was punctuated by the failures of numerous medium-sized banks in 1998 and 1999. Our argument is that high deposit interest rates helped

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