We develop a model in which financial crises in emerging markets may occur
when domestic banks are internationally illiquid. Runs on domestic deposits
may interact with foreign creditor panics, depending on the maturity of th
e foreign debt and the possibility of international default. Financial libe
ralization and increased inflows of foreign capital, especially if short te
rm, can aggravate the illiquidity of banks and increase their vulnerability
. The primary role of illiquidity is consistent with the existence of asset
price booms and crashes and of government distortions.