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When Poor People Sneeze, Banks Catch a Cold

When Poor People Sneeze, Banks Catch a Cold

Analysts often borrow from the vocabulary of disease to describe financial crises, using words such as "pandemic" and "contagion" to discuss how economic disturbances spread. But recent research suggests a more literal connection between the two: In poor countries, actual disease can infect the financial system.

In a study for the Journal of Banking & Finance, Patrick Leoni and Thomas Lagoarde-Segot of Kedge Business School in France looked at tuberculosis outbreaks in 80 countries between 1995 and 2009. They found that spikes in infections were correlated with reductions in banking deposits, financial system deposits, and private credit — all key indicators of financial stability.

The problem is that in poor regions, people find medical treatment expensive — and generally an out-of-pocket expense. "Once people get infected, they’re forced to stop working and use their savings to pay for medical care," Leoni says. When infection spreads, a lot of small withdrawals can send ripples through a fragile financial sector. Bankers, fearing literal contagion, are then forced to anticipate further withdrawals and start dumping long-term investments and taking shorter-term positions. Over time, this conservative behavior affects a country’s growth prospects.

The authors note that richer countries with strong social safety nets are more resistant to this phenomenon. But they caution banks in developing countries against knee-jerk responses to health pandemics. Borrowing from the language of medicine, they write that "an essential prophylactic measure is to increase bank reserves, and somewhat reduce long-term risk" when there are signs that a disease outbreak is under way. Saudi bankers, get your MERS reserves ready.