Determinants of financial stress and recovery during the great recession

In this article, we explore the link between stress in the domestic financial sector and the capital flight faced by countries in the 2008-2009 global crisis. Both the timing of emergence of internal financial stress in developing economies and the size of the peak-trough declines in the stock price indices were comparable with that in high-income countries, indicating that there was no decoupling, even before Lehman Brothers' demise. Deleveraging of Organisation for Economic Co-operation and Development (OECD) positions seemed to dominate the patterns of capital flows during the crisis. Although high-income countries on average saw net capital inflows and net portfolio inflows during the crisis quarters, compared with net outflows for developing economies, the indicators of banking sector stress were higher for high-income economies on average than those for developing economies. Internal and external distress during crisis was closely interlinked with common underlying causes of both the severity of stress during the crisis and the recovery. External vulnerabilities were important in both phases, and higher international reserves did not insulate countries from stress.