Exchange rate stability and financial stability

Historical evidence reveals no monocausal explanation for banking crises, i ncluding one which would emphasize the maintenance of a currency peg. To so me extent this follows from the standard textbook wisdom: whether fixed or flexible exchange rates are preferable depends on the source of disturbance s. If threats to the stability of the banking system come from the "outside ," there is a case for exchange rate flexibility to discourage the banks fr om relying excessively an external sources of finance and to enhance the ca pacity of the domestic authorities to act as lenders of last resort. Conver sely, if the main threats to the stability of the banking system emanate fr om "inside" (e.g., erratic monetary policies at home), there is an argument for attempting to peg the exchange rate in order to discipline domestic po licymakers and vent shocks via the external sector. From this point of view , it is no surprise that there is no simple correlation between the exchang e rate regime and the prevalence of banking crises.