Financial Stress, Downturns, and Recoveries

This paper examines why some financial stress episodes lead to economic downturns. The paper identifies episodes of financial turmoil using a financial stress index (FSI), and proposes an analytical framework to assess the impact of financial stress-in particular banking distress-on the real economy. It concludes that financial turmoil characterized by banking distress is more likely to be associated with severe and protracted downturns than stress mainly in securities or foreign exchange markets. Economies with more arms-length financial systems appear to be particularly vulnerable to sharp contractions, due to the greater procyclicality of leverage in their banking systems.Financial systems;Banking sector;Banking crisis;Economic recession;Economic recovery;banking, foreign exchange, financial system, stock market, bond, bank assets, financial innovation, financial markets, banking distress, stock market crash, banking systems, banking crises, financial intermediation, bank capital, financial intermediaries, corporate bond, financial institutions, stock market index, financial cycles, banking system, bank asset, stock prices, bond yield, stock index, financial stability, bond yields, currency crises, financial instability, investment bank, bank loans, government bond, bond market, bonds, financial sector, foreign exchange market, banking sector equity, stock price, deposit insurance, bond spreads, bank lending, government bond yields, financial market, bank runs, financial assets, savings bank, junk bond, global bond, financial globalization, interest rate risk, bank intermediation, return on assets, bank lending rates, borderline financial crises, financial economics, dividend discount model, moral hazard, hedge funds, systemic banking crises, bank balance sheet, bank balance sheets, currency crisis, capital base, capital regulation, bank behavior, financial strength, bank data, stock market decline, bank profitability, federal deposit insurance, cooperative bank, credit derivatives, bank failures, hedge, international financial statistics, government bond yield, financial instruments, stock of debt, bank equity