Inequality as a Cause of Systemic Banking Crises ̶ Some New Theory and Evidence

Abstract: The thesis argues that systemic banking crises and inequality go hand in hand, with inequality in front. Through showing how factors commonly found to influence banking crises, such as household and business debt levels, asset prices, default ratios, and credit growth (all important in Minsky-type bubbles) theoretically can be attributed to decreasing relative wages of households, and/or concentration of wealth among "hoarders" it sheds light on a potentially strong link between inequality and banking crises. It proposes a simple theoretical model formalizing this link through a capitalist spirit utility function and Minsky-type asset inflation, and tests the effect of inequality on the probability of suffering a systemic banking crisis through a multivariate logit approach. The results are conclusive in favor of growing inequality being a significant factor increasing the probability of suffering a systemic banking crisis in the future. Reducing income inequality is argued to be a first-best policy option for reducing financial fragility.