Impact of Trans Border Liquidity Shocks: Case of a Developing Economy

Abstract

This dissertation examines the impact of trans border liquidity shocks on emerging economies. The resilience of the financial sector of a country during a crisis has been a topic of interest in finance literature in recent years. Events such as the Latin American Crisis in the 1980s, the Asian currency crisis of 1997, and the Global financial crisis in 2008 have exposed the vulnerability of the financial sectors of not only the countries where the crisis originated but also indicated the spillover effects of the crisis on other countries that were not the originators of the crisis (See Frankel & George, 2012; Fidrmuc & Likka 2010). The 2010 study talks about the implications of the global crisis on the financial sector of countries that were not the originators of the crisis. If the spillover effects of the crisis occur in a country, then policymakers need to have measures in place to ensure smooth functioning of the financial institutions. There are three critical problems investigated in this study, all of which can have dire implications if left unchecked: 1. Do liquidity shocks impact performance efficiency of the banking sector of a non-shock originating country (i.e., a country where the shock did not originate)? 2. Do these liquidity shocks impact the lending ability of a non-shock originating country banking sector? and 3. Do these shocks impact the interbank market relations amongst banks in the non-crisis originating country? The questions mentioned above are answered using a three-pronged approach that starts with investigating the effects on the banking sector performance efficiency by using data envelopment analysis using the Malmquist index approach. Next, the lending ability of the banking sector is studied by using the firm fixed effects methodology. Further, the study looks at the effects of a financial shock to the interbank market relationships by looking at changes in the lender preference index (LPI) and borrower preference index (BPI). The findings of this study are that: II 1. Performance efficiency of the banking sector was also affected due to global financial crisis in a non-crisis originating country. 2. The lending to firms by banks was reduced as a result of the financial crisis in non-crisis originating country and 3. Interbank market relationships remained robust even after a financial crisis. The findings of this study provide regulators with insights about the consequences to the domestic market if such a crises were to occur in the future so that they may formulate contingency actions accordingly.