Financial sector reforms have been at the core of the IMF-supported programs for the Asian crisis countries. The focus was on the financial sector because (1) distress and weaknesses in the sector were widely perceived as a major cause of the crisis; (2) reestablishing banking system soundness was crucial to restoring macroeconomic stability; (3) restoring confidence in banks was essential for the return of funding into the financial system; and (4) the crisis generated demands for the authorities to address the causes of the crisis by carrying out major reforms, thus providing impetus for implementing reform that in some cases had been planned for years. In the Philippines, the structural component in the program was smaller, because major shortcomings of the financial system had been addressed earlier. Malaysia’s strategy, although different in some respects from the IMF–supported programs in the crisis countries, also had a major focus on financial sector reforms.

While the magnitude of the financial sector crises was larger than anything experienced before, IMF staff was able to draw on its experience in recent years both from actual crisis involvement and analytical work.⁶² Although many of the events in the unfolding crisis were familiar, differences in key elements added new dimensions to the crisis requiring particular care in choosing the restructuring approach. Such elements were the structure of the banking and corporate sectors, business practices, limitations in the legal systems, and the authorities’ strong preferences for certain institutional arrangements. The magnitude of the crisis and the speed at which it developed required immediate responses. Thus, the development of strategies and policies involved extensive discussions among the authorities and IMF staff, and new approaches and procedures needed to be developed, taking into account the characteristics and constraints of each country at that particular point in time, while maintaining a certain amount of uniformity of policies among the countries.

The reform strategy for each country was incorporated in letters of intent and memoranda of economic and financial policies, both of which spell out the details of the IMF-supported programs. These strategies included measures to ensure the exit of nonviable institutions, the strengthening of those that remained in operation, the restructuring of the corporate sector, and the adoption of institutional reforms to help prevent future crises. Box 13 summarizes the measures included in letters of intent and memoranda of economic and financial policies of the countries that received IMF financial support. From the onset, these documents included both immediate actions and broad outlines of the medium-term strategy for restructuring and its sequencing. Given that the precise nature and timing of future actions could not be determined at the outset, the programs left sufficient flexibility in implementation. Subsequently, they were refined in the course of reviews as new information became available and as required by the evolving circumstances in each country. The market sensitivity of certain actions required in the initial stages of the program ruled out the inclusion of such actions in the letters of intent.

Several issues arose in adapting complex medium-term bank restructuring strategies to the format and conditionality of IMF-supported programs. IMF conditionality has usually been quantitative and strictly time-bound, involving actions under the control of the authorities. In the case of bank restructuring, however, conditionality has to be set cautiously, as the process involves steps that are seldom amenable to measurement, often take longer than planned, are not directly under the control of the authorities, require legal steps to be adhered to, and involve negotiations between different parties in the public and private sector. Moreover, since restructuring actions have a significant impact on private property and wealth, they must be undertaken in a manner consistent with each countries’ legal and judicial framework.

The timing and pace of reforms requires a delicate balance between short-term IMF conditionality and the medium-term nature of financial sector restructuring. To maintain momentum and credibility, reforms must proceed rapidly, but the complexity of the process and country-specific constraints have to be taken into account. For instance, rapid recapitalization of financial institutions was a desirable goal in principle, but in reality, too rapid a pace would have meant that necessary concomitant measures, such as operational restructuring and banks’ search for private capital, would not have been feasible and that banks would have had to cut credits even more drastically, thus aggravating the crises. Thus, the recapitalization was phased and strictly monitored under the IMF-supported programs. Similarly, in Korea, policies to address the excessive maturity mismatches between foreign exchange assets and liabilities had to be phased in, taking into account the difficulty in converting short-term to longer-term foreign financing at the time. To introduce meaningful benchmarks for measures like privatization, which involves complex negotiations with private parties, is even more challenging.

Detailed information on the financial condition of individual banks was necessary in order to assess the situation of the system, design a restructuring strategy, and monitor compliance with the program. Generally, it is impossible to deal with a systemic banking crisis efficiently without access to bank-by-bank data. IMF staff had access to detailed supervisory data for individual banks in the three crisis countries. Such access was necessary to evaluate the quality of the restructuring policies and to monitor their implementation. In Malaysia and the Philippines, access to such data was more restricted. Handling of bank information had to be done according to agreed-upon procedures and in accordance with bank secrecy laws in each country.

While the Asian crisis showed that the IMF would need to play a central role in assisting the authorities in the management of the initial crisis and in the design of the overall restructuring strategy, it also demonstrated the need for close cooperation with other multilateral agencies, particularly the World Bank. Cooperation with the World Bank was close from the beginning in all countries, although the division of labor differed. In particular, the urgent nature of many of the tasks and the heavy demand on IMF staff resources required very close collaboration between the staffs of both institutions and flexibility in their approach to the division of labor.

The IMF assumed the lead role in the three crisis countries and the World Bank made important contributions in specific aspects of program formulation and implementation. The IMF relied on its capacity to develop programs quickly and develop the linkages between macroeconomic stability and financial sector soundness. The World Bank provided expertise, and financing, to assist the authorities in program implementation and institution building, increasing its role in the crisis countries over time. In all crisis countries, the staffs of the IMF and World Bank have cooperated closely from the early stages, taking into account each other’s views in the program discussions with the authorities—which often included staff of both institutions attending meetings with the authorities on financial restructuring issues. Also, World Bank staff took the lead in the area of corporate restructuring and nonbank financial institutions. Work on strengthening legal and regulatory frameworks has been done jointly.

An important source of difficulties was related to the design and implementation of the immediate steps required to stabilize and restructure the financial system. In all three crisis countries, letters of intent were negotiated quickly and incorporated immediate steps to stabilize the financial system. These measures were negotiated without full World Bank involvement, although they included components for which the World Bank was expected to take the lead in implementation. This led to coordination problems initially, further complicated by the large number of departments involved in both institutions. In response, the World Bank created its Special Financial Operations Unit to bolster its capacity to quickly field staff that can participate in the initial rounds of program negotiations in crisis countries. As a result of their efforts, early problems in coordination have been solved.

In addition to financial support, the IMF had to assign a large number of staff to the five countries discussed in this paper. This was particularly the case for the three crisis countries. During fiscal years 1998 and 1999, staff from the IMF’s Monetary and Exchange Affairs (MAE) Department and headquarters-based consultants spent some 10 staff years in the field on missions to Indonesia, Korea, and Thailand. These visits were often made in parallel with or as part of Use of Fund Resources and Article IV missions. They were also done in conjunction with World Bank missions. Moreover, the IMF placed resident banking supervisors in Indonesia and Thailand and organized several expert visits to Korea. Participation of financial sector experts in missions to Malaysia and the Philippines has been less intense but has also required substantial IMF staff involvement, more recently as part of the IMF’s Asia and Pacific Department and World Bank missions. In addition to mission-related work in Washington, MAE staff and Washington-based consultants have spent a considerable part of their time at IMF headquarters following events in all the countries, providing follow-up comments and assistance in implementation, and coordinating with other institutions. This is, of course, in addition to IMF staff resources that other IMF departments (notably the Asia and Pacific Department, or APD) had to commit to financial sector matters in the context of the IMF’s day-to-day activities and surveillance work.