Asian Financial crises

Chapter 47 Conference Summary

International Monetary Fund
Published Date:
January 2001
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I also had the honor of summarizing last year’s conference on “Preventing Bank Crises,” which the Federal Reserve Bank of Chicago co-sponsored with the World Bank and the proceedings of which were just published (Caprio et al., 1998). I found that conference considerably easier to summarize. There was far less disagreement than at this year’s conference. Last year’s conference took place just before the outbreak of the Korean and South East Asian crises and focused primarily on the problems in Latin America in 1994-1995 and in the transition economies of Eastern Europe and the former USSR. Even before the current crises, the IMF had reported banking crises in some 130 of its 180-plus member countries. There was almost a universal agreement among the participants at last year’s conference on the causes and solutions of these banking crises. I might repeat these conclusions as they were pretty much noted again this year and by now appear old hat and almost a mandatory mantra:

  • Encourage market discipline to supplement regulatory discipline;

  • Increase the accuracy and timeliness of reporting;

  • Improve transparency;

  • Make bank regulation independent of political influence;

  • Require sufficient bank capital to absorb both regular losses and adverse macroeconomic shocks;

  • Privatize state-owned banks and reduce or remove altogether government influence from state-controlled banks;

  • Permit foreign ownership of banks;

  • Improve the legal system, particularly bankruptcy and property rights laws; and

  • Improve bank infrastructure, including increasing the sophistication of both bankers and bank regulators and supervisors.

Even if these conditions were satisfied, there would still be market failures, but exit would be orderly. What these conditions should prevent is disorderly exit. There appeared to be far less agreement among this year’s participants on “now what,” particularly as the new crises are both banking and currency (balance of payments) crises, and on “where do we go from here,” particularly with respect to the form and shape of the design of any new architecture for the international financial system.

Nevertheless, there appeared to be some underlying agreement on a number of issues:

  • Fragility and insolvency of banking and financial systems were a major cause of the current crises in East Asia and most of these systems require appropriate recapitalization, including the use of public funds to reduce any negative net worth’s, as soon as possible to both speed recovery from the current crisis and to prevent future crises. Some individual institutions may not be worth recapitalizing and should be merged or liquidated, but the banking system as a whole needs to regain economic solvency.

  • Although we cannot identify the precise straw that broke the camel’s back or the last card that brought the house down, we can recognize, particularly ex-post and also to some extent, in the case of unduly fragile banking systems combined with fixed exchange rates, ex-ante, underlying conditions that are likely to cause crises and represent “accidents waiting to happen.” Unfortunately, reliable early warning systems directed at predicting the precise timing of the breakdowns have not been successfully developed, either among researchers or private credit rating agencies, and the necessary research is still in its infancy. As a result, ex-post workout provisions for bank and other foreign debt obligations are important and need to be perfected.

  • The East Asian crises have had deeper and more lasting adverse effects on the macroeconomics than initially believed. Indeed, a number of speakers were almost prophets of doom and gloom, emphasizing the parallels with the long-lasting LDC problems of the 1980s rather than with the much briefer Mexican and Argentinean problems of the mid-1990s. But it may be that, just as we tended to be late in predicting or recognizing the seriousness of the current problems, we may be late in recognizing a bottoming out of the crises. At least some cheery news of sightings of possible recoveries was reported for South Korea and Thailand and of no significant further deterioration elsewhere. Russia is a special case, although it effects other countries through portfolio rebalancing and a general “flight to safety” by large international investors. A key to Asian recovery remains Japan.

The major area of heated debate and disagreement was on the past and potential future role of the IMF. A number of speakers mentioned the old medical adage “do no harm,” but there was no agreement on whether the IMF had achieved this. The high interest rates that the IMF encouraged assisted countries to attempt to prevent further deterioration in their exchange rates came in for particular criticism. No one argued that the IMF had acted perfectly in the past and many IMF speakers appeared more open and candid about its past weaknesses and current problems than before. They recommended a number of changes in their own procedures to improve their future performance. Many of these focused on more timely and transparent information and reducing the moral hazard responses by banks, bank depositors, particularly foreign depositors, and investors in assisted countries.

But this did not satisfy everyone. Some believed that the IMF had often done more harm than good in the past and that it should be greatly overhauled and its activities curtailed, if not abolished altogether. World private capital markets could and would provide liquidity but not insolvency assistance with fewer adverse moral hazard consequences. Is the fact that Taiwan has largely escaped the recent Asian flu attributable to it not being a member of the IMF and therefore subject to stronger market discipline? Other participants called for the continuation of the IMF (possibly combined with the World Bank) to provide credit on a more limited and better defined basis for true liquidity problems, although some doubted whether it is possible to distinguish between liquidity and solvency problems for sovereign countries. They argue that “less is more” and that the IMF should be resurrected to concentrate solely on crisis prevention and management.

On the other polar extreme were those who preferred a larger and more powerful institution that is effectively a global lender of last resort. Such an institution would require greater funding as international financial problems are now becoming much larger, particularly as transitional capital flows continue to increase in magnitude and speed of reversibility and to dominate current account imbalances in affecting exchange rates. As a result, the IMF needs to act before crises begin (be more proactive) rather than after crises have started (be less proactive). Others argued that either this is not feasible as a true lender of last resort needs to be able to print money without limit, something the IMF can not now and is never likely to be permitted to do, or that a true Bagehotian lender of last resort operating on a fully collateralized penalty rate basis would be a very small and hardly used institution.

If one could peel back the layers of disagreement in orderly fashion and examine one issue at a time, I believe that even on this issue considerable agreement could be reached. That is, there is more smoke than fire in many of the arguments. But some fires do exist and it will take time to work out agreements on the new architecture. Judging from the substance of the disagreements voiced at this conference, to separate the smoke from the fire and focus only on the fire, future discussions need to be held in open forums and include academics and practitioners as well as current policy makers. The cost of failing to discover and correct as many potential weaknesses as possible is too high to justify omitting any critics from the table.

In the meantime, what can we do now? We probably did not schedule sufficient time for this. Crisis management is as likely to be ad hoc in the near future as not and arguments will continue to focus on important issues, such as whether the IMF recommended increases in interest rates in East Asia were useful or not in preventing further depreciations in exchange rates and should be recommended again. In the longer run, agreement existed on the need for more stable macroeconomic policies and higher private capital levels for banks that could absorb the even larger shocks that are likely to occur in the future, particularly from greater and more volatile international capital flows. Because this final recommendation is one that I have vocally favored for many years, this is a good point for me to stop.


    Caprio, Gerard, Jr., William C.Hunter, George G.Kaufman, and Danny M.Leipziger.1998, Preventing Bank Crises: Lessons From Recent Global Bank Failures, Washington, DC: World Bank and Federal Reserve Bank of Chicago.

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