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 stability-frequently 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.