Twin Crises in Emerging Markets: The Role of Liability Dollarization and Imperfect Competition in Banking (original) (raw)

Recent currency crises in emerging markets have been accompanied by banking crises, with concentration in the market for bank credit increasing after large devaluations. In this paper we study the role of imperfect competition and liability dollarization in banking in shaping the real effects of twin crises. We do so by introducing currency mismatches in a modified version of the Schargrodsky and Sturzenegger (2000) model of imperfect competition in the banking industry with endogenous product differentiation, and then embedding it in an otherwise standard general equilibrium model of a small open economy. We show that both imperfections-currency mismatches and imperfect competition in banking-can generate a banking crisis in the presence of an exogenous currency crisis. We then discuss the contribution of each distortion to the magnitude of crises.