Chapter 44 Lessons from the Asian Crisis
- International Monetary Fund
- Published Date:
- January 2001
It has been a great pleasure to participate in this conference for the past two days. I congratulate the Federal Reserve Bank of Chicago and the International Monetary Fund for putting it on. We should remember that this type of open dialogue is part of a process of transparency and accountability and, perhaps, adjust our rhetoric accordingly.
My remarks are in two parts: introductory comments on the topic of the conference and more specific comments on the topic of this roundtable.
First, six general comments. It is premature and naive to think on October 10, 1998 that we can have learned all the “lessons” of the Asian Financial Crisis because that crisis and its global ramifications are not over yet. A lesson prematurely learned may be the wrong lesson. We do not have a full accounting or even reasonable estimates of the costs and benefits of many of the potential or proposed remedies. All remedies impose costs; if they were costless, they would have been applied years ago.
Second, we should recognize that lessons from this crisis have two dimensions: for the longer term and for ongoing short-term crisis management. The latter dimension requires ad hoc remedies that we hope will not be counter productive to the structure we would like to build over the longer term. Moreover, we need to be sensitive to the fact that locking in new long-term solutions in the middle of a crisis suggests that mistakes will be made. Successful generals do not normally abruptly change their longer-term strategies in the middle of a battle.
Third, for both the short term and long term we are dealing with decision making under uncertainty. If we knew in August 1997 how the Asian crisis would evolve, no doubt different decisions would have been taken. Similarly, constructing a rigid and absolutist structure for the handling of future crises based on an incomplete model of this crisis strikes me as methodologically unsound.
Fourth, I like to distinguish between the international monetary system that governs reactions among sovereign nations with the IMF at the center and the much broader international financial system—Eichengreen’s environment in which actors public and private make their decisions. In this crisis, the two have been intertwined, perhaps they always are in crises, but they are not in the same manner on each occasion.
Fifth, the objective of the IMF, at least in my view, is not to act as a lender of last resort to the international financial system. It is to maximize the welfare of all the citizens of countries participating in the international monetary system by, inter alia, preventing the adoption of antisocial policies though the mechanism or inducement of the provision of financial resources to member governments and through the promotion of positive collective responses, see Bob Litan’s proposals at this conference.
Finally, all international financial crises do not involve national banking crises and vice versa. In Graciela Kaminsky’s database, she identifies eighty-nine separate crises. Only half (thirteen) of her twenty-six banking crises involved external financial crises, and most of the other seventy-plus countries that have had banking crises over the past fifteen years have also not had associated external financial crises—the United States, the United Kingdom, and Japan to name three. It is reasonable to ask why. Moreover, only two of the joint banking and external financing crises ultimately involved IMF lending programs. At the same time, less than a twenty percent (thirteen) of Kaminsky’s seventy-six external financial crises involved banking crises. Moreover, only a quarter of those crises (twenty-three) involved IMF programs. I conclude from these facts that it would probably be a mistake to hard wire the solutions to these two types of crises.
That having been said, I’d like to offer some thoughts on fourteen lessons for the international financial system from the Asian crises. I divide them into two tranches. Tranche I involves points where we can say with some confidence that the benefits of applying the lesson clearly outweigh the costs. Tranche II involves points where the jury is still out on whether the benefits outweigh the costs; we don’t yet know enough about either.
I have identified eight reasonably clear lessons:
First, national authorities must have a well-articulated and consistently pursued vision of the role of the financial system in their economies. I associate this lesson with Jerry Corrigan. The point is that such a vision helps to guide policies moving forward and to avoid the mistakes of the past.
Second, there is little or no scope for the Asian model of finance in today’s world, i.e., there is no place today for insider trading and lending directed by the government toward its chosen projects and activities. Asian leaders, in particular Japanese leaders, may not accept this lesson but most of the rest of the world does.
Third, supervisory systems need to be strengthened. The place to start is with the Basle Core Principles of Effective Banking Supervision, but that is not the place to end. This involves more than “regulating,” “monitoring,” and “supervising” the banking system. The establishment of a sound credit culture is required. But success should not be associated with the prevention of all bank failures; it should be measured by fewer failures and reduced economic and financial effects of those that occur.
Fourth, the legal infrastructure surrounding the financial system needs to be strengthened, i.e., bankruptcy laws, their unbiased application, and their prompt enforcement.
Fifth, more generally, what is needed is a culture of credit where lenders and investors make informed and rational judgments on the extension of credit and are prepared to take the consequences as well as reap the rewards of their decisions. All this takes time, just to get started. For example, Thailand was expected in its program that was endorsed by the IMF in late August 1997 to come up with a robust comprehensive program of banking system reforms in a few months. Instead, the first real plan was released on August 14, 1998! Some feel it is less than perfect. But all this is the easy stuff, i.e., establishing the plan for a new regime. The more difficult challenges lie in the consistent implementation of a sound plan.
Sixth, an important element of this process is the establishment of a transparent scheme of less than universal deposit insurance and associated standards with respect to structured early intervention to deal with the problems of financial institutions, as well as with respect to insolvency regimes. A decade ago this proposition would not have been agreed to internationally. Today we have learned that the national and international costs of de facto 100 percent deposit insurance outweigh any benefits with respect to increased financial stability. While progress will be slow, there is a clear need for common standards in this area as was called for in the report of the Working Group on Strengthening Financial Systems that was releasted on October 5.
Seven, more attention needs to be paid to the development of national bond markets and the associated infrastructures (such as accounting and disclosure practices) supporting both bond and equity markets. Again, this takes time. Much has been done in this area, especially in the Western Hemisphere, but more remains to be done if we are to avoid the frequent repetion of crises of the Asian type.
Finally, a related point, the authorities need to be alert to the excesses associated with credit booms. This is also easier said then done, but the place to start is with a countercyclical rather than a pro-cyclical supervisory policies.
In tranche II, I have six candidate lessons to suggest.
First, when a crisis emerges in the financial system, especially if it is systemic in nature, the first requirement is to apply a comprehensive solution. This is one of the messages delivered at this conference by the former governor of the Central Bank of Thailand, Mr. Chaiyawat. If this lesson is accepted, it implies the need for dramatic action closing institutions and, if needed, effectively nationalizing the remainder, imposing high prices on shareholders and managements. The ad hoc, piecemeal approach is more clostly in terms of the real economy and taxpayers’ funds. My reading of the Chilian and Scandinavian experiences is consistent with support for this lesson. To apply this approach effectively, however, one needs strong ex ante supervision and reporting and clear legal structures and instruments.
If this lesson is not agreed, we need to understand why. Is it because of a concern with the health of the real economy, as in Japan? Or is it because of a view that time will cure all? The latter solution is difficult to achieve in a noninflationary environment.
Second, once a country has a serious domestic banking crisis, it is likely that any recovery in the real growth of bank credit will take years, which means it is all the more important to explore other means to de-leverage the economy. Mexico is an example where real bank credit declined for three years following its 1994 crisis. Abrupt action flies in the face of the Asian consensus model, but it is consistent with the model of arm’s-length dealing.
Third, sequencing is important, but there does not appear to be consensus, including at this conference, about whether one should first restructure the financial system and later turn to the nonfinancial corporate sector or vice versa. One view that we heard from Curt Hunter was that one should start with the financial sector because the aim is to decouple it from the corporate sector; moreover, restructuring the nonfinancial corporate sector will take time, and meanwhile the economy needs a functional financial system. The alternative view that we heard at this conference from Yung Chul Park is that the reconstruction of the corporate sector must come first. Bank claims must be written down and converted to equity; until this is done it makes little sense to pretend that the banking system is strong. There is a middle way: buy out the banks claims on the nonfinancial sector as part of the banking system’s restructuring. I conclude that we have no agreement on this point.
Fourth, another controversial issue is whether the authorities should place restrictions on the operations in foreign currency of domestic financial institutions. There is a clear need to weigh costs and benefits in this area, which involves many complicated issues. Should this be done by home country authorities? If so, on what basis: assets, liabilities, net positions? If so, through what means: guidelines, reserves, restrictions, capital charges? Should this be done by host countries? If so, should restrictions be imposed on foreign establishments? If so, through capital charges on lending institutions?
Fifth, what role should foreign investment in the financial system play? Again this is a controversial question despite Charles Calomiris’s categorical positive answer. Do the gains from having a national banking/financial system outweigh the costs? The costs are clear: potential liability to shareholders, costs of administration, etc. What are the gains once we agree on the need for a genuine culture of credit?
Finally, what role should the various international organizations (e.g., the IMF, IBRD, and regional development banks, or even the WTO) play in all this, and what should be the relative roles of the international and regional groupings of national supervisors? For example, in setting standards, monitoring compliance, providing technical assistance and imposing solutions, where does the comparative advantage and the international interest lie? The IMF’s role should not be zero, and a great deal is being done by the IMF, but there is less than complete consensus on how to build on the IMF’s current activities going forward. For example, to the extent that the IMF is to play a major role monitoring compliance with international standards, are we concerned about (1) a lack of IMF expertise, and (2) the moral-hazard implications of country’s financial system receiving a clean bill of health from the IMF? Concern about this second consideration has led some of us to think about an independent process of assessment of national financial systems and their supervisory structures. One suggested model is the accreditation process used in the United States for hospitals and educational institutions. Whatever is done in a prevention mode, the IMF clearly will be involved in crisis situations. But where does that leave the activities of other international financial institutions?
By way of conclusion, I believe we have come a long way and learned a great deal about this crisis, but we still have a lot to learn, in part, because this crisis is not over. My congratulations to the IMF and the Federal Reserve Bank of Chicago for helping us move forward.
Acknowledgment: The views expressed are solely my responsibility and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with it.