Conclusion

The current account deficits and the lending expansion by local banks that are financed by financial capital inflow, a deterioration of financial institutions’  balance sheet, short term debt repaid in foreign currency, and speculative attacks appear the culprits behind financial crises.  The expansionary monetary policy used by advanced industrialized economies in dealing with banking instability or stock market crashes is not a viable option for the central banks of developing economies.  Direct financial capital flow toward direct investment and a way of debt financing combined with the proper amount of regulations for each country capital account and financial institutions may help reduce the recurring financial crises.            

To reduce liquidity problems, the central banks may require high liquid reserve in the form of higher required reserves, low risk assets, and cash.  Higher required reserves would reduce banks’ return on deposits, would reduce the risk of the banking sector and would cause the loss of some of the local deposits to the banks abroad.    Argentina imposed high liquid reserves that protected its banks in 1997-99 but failed to protect its banking sector in the 2001-2002 period.           

Tax on capital inflows to reduce speculations, interest rate ceilings on deposits to reduce competition by risky banks to attract deposits, and limits on the percentage of lending to the real estate sector would reduce the probability of having a financial crisis.  Finally, redirecting financial capital inflows toward direct investment and equity finance and away from debt financing will serve developing countries better in the long run.  Also redirecting finances will reduce liquidity problems and potential financial crisis.