The IMF, Domestic Public Sector Banks, and Currency Crises in Developing States

The stabilization programs of the International Monetary Fund (IMF)which are often designed to prevent currency crashes and promote exchange rate stabilityfrequently fail to prevent currency crises in program-recipient developing countries. This leads to the following puzzle: when do IMF programs fail to prevent currency crises in developing states that turn to the Fund for assistance? We suggest that the likelihood that a currency crisis may occur under an IMF program depends on the market concentration of public sector banks in program-participating developing countries: the higher the market concentration of public banks in a program recipient nation, the more likely that the IMF program will be associated with a currency crisis. Specifically, if the market concentration of public banks in a program-participating developing country is high, then banks will compel the government to renege on its commitment to implement banking sector reforms. This induces a financial panic among investors that leads to a currency crisis. Statistical tests from a sample of developing countries provide robust support for our hypothesis.