These so-called feedback effects from financial to macro-economic instability underscore the need for the application of the core principles. 7. The second main cause of financial fragility is premature financial liberalisation. It is widely recognised that financial liberalisation promotes competition among banks, thereby improving the efficient allocation of financial resources in the long run.
However, during the transition, bank managers and supervisors often lack the expertise to deal with the higher risks associated with the new activities in which their institutions get involved. This lack of experience increases the probability of banking crises. Moreover, increased competition from foreign banks often encourages domestic banks to finance riskier investments in order to keep up their earnings.