![]() ![]() 2 The other set of explanations relates to the policies employed. For instance, banking distress associated with the unravelling of a domestic financial imbalance (eg a housing bubble) may have a very different impact than that stemming from an external event in the absence of such or similar imbalances (eg a crisis imported through cross-border exposures). One relates to the initial economic conditions, notably the macro-financial imbalances with which countries enter a period of distress. There are two interrelated sets of explanations for such variations across countries and episodes. For example, during the Great Financial Crisis (GFC) output fell from peak to trough by 0.16% in Switzerland and by almost 30% in Greece. Output losses are particularly large when distress morphs into a full-scale banking crisis (Laeven and Valencia (2013)). Baron et al (2020) document that after episodes of large bank stock price declines and an abnormal number of bank failures - that is, after distress episodes - real GDP falls by 5.5% on average from peak to trough. The basic reason is the sharp contraction in lending following a breakdown in financial intermediation. 1īanking distress and crises tend to be followed by deep recessions. Our analysis confirms that the recently employed policies have supported the real economy. While, in general, swifter and broader-ranging policy actions mitigate such recessions, central banks' asset purchases and lending are particularly effective when banks have been underperforming or when distress follows abnormally large asset price movements, such as those triggered by the Covid19 crisis. ![]() The depth of recessions following banking distress depends both on the speed with which tools were deployed and their type and on the macro-financial vulnerabilities. We analyse the effectiveness of policy tools for large-scale banking distress and draw lessons for today.
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