The odds of a country suffering a banking crisis are 2.5 times higher if it is affected by a conflict, according to research from the International Monetary Fund (IMF).
IMF economist Rasmane Ouedrago and senior resident representative in South Africa Montfort Mlachila found that while the economic effects of conflict and political instability have been analysed extensively, much less attention has been paid to how banks are affected.
In addition, the odds of suffering a banking crisis in the afflicted country, the research found conflicts and political instability in neighboring countries will also increase the likelihood of banking crises.
"The probability of experiencing a banking crisis is 25% when the conflict lasts 10 years, against 16.4% when it lasts two years," the report said.
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The report looked at the example of during the Sierra Leone civil war (1991-2002), where more than 40% of banking system loans were non-performing and the licence of one bank was suspended in 1994.
In Central African Republic, bank non-performing loans increased to more than one-third of total loans and some banks became undercapitalised following the outbreak of the conflict in 2013.
"The primary channel of transmission is the occurrence of fiscal crises following a conflict or political instability," it said.
"Conflicts and political instability can have a negative impact on the productive capacity of a country and this in turn can reduce government revenue and increase unproductive spending, including military expenditures, leading to fiscal crises.
"This can also lead to government dysfunctionality and weakening of institutions."
Ouedrago and Mlachila said governments facing conflict and/or political instability need to address their root causes and try to mitigate their negative effects with the appropriate design and implementation of economic policies.
"Creating adequate fiscal space in normal times can reduce the likelihood of fiscal crises and in turn lower the probability of systemic banking crises," they said.
"Our findings also suggest that policymakers should pay attention to conflicts in neighboring countries even if they themselves are not conflict-afflicted as their banking systems may suffer negative spillovers from their neighbors given that banks operate across borders."