An Investigation on Causes of Banking Crises from Asymmetric Knowledge Framework: A Microeconomic Approach

The main aim of this paper is to investigate on banking crises which stemming from asymmetric knowledge problems in financial system. Asymmetric information and its related problems have a great influence on the functioning of financial markets. Finance literature underlines that banking firms are special intermediaries due to systemic risk concerns. In post liberalization interest rate tends to rise and moral hazard and adverse selection problem exist at firm level in banking business because of lack of adequate supervision. As is typically argued, unless liberalization is accompanied by sufficient prudential supervision of the banking sector, it will result in excessive risk taking by financial intermediaries and a subsequent crisis. In this paper excessive risk taking behavior of banking firms analyze with using a theoretical framework of New Keynesian that the “credit rationing model” offers, and moral hazard, adverse selections problems causing bank failure are discussed.