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The East Asia crisis is deemed as one of the main significant economical actions in the recent past. It is considered a major financial crisis in a developing country within other major currency or financial crises in 1990’s like Russia (1998), Mexico (1995), and Brazil (1998-1999) (Radelet and Sachs  2001). The East Asia crisis started in the first half of 1997 with speculative attacks on the Thai currency baht that resulted to the float of the currency on second July of the same year, and according to research, this turned out to be one of the major crises ever in emerging markets (Radelet and Sachs 1998). The most impacted countries included Indonesia, Thailand, Korea, Philippines, and Malaysia, when weighed up by the percentage devaluation measure up to the United State dollar between the years 1997 and 1998. One of the major impact of the crisis was devaluation with research, indicating that there was 40 percent devaluations in Philippines and Malaysia, about 55 percent in Thailand and Korea, and more that 80 percent in Indonesia (Krugman 1998). Furthermore, these countries, except Philippines, were faced by critical reductions in real gross domestic product (GDP). According to statistics, Malaysia reduced by 6.7 percent, Korea by 5.8 percent, Indonesia by 14 percent and Thailand by 9.4 percent (Bacha 2002) and most of these nations did not recover completely from the crises. In this case, it is very interesting to assess the causes of the crises. The East Asian crisis of the 1990’s, which led to these devastating effects, is linked with various factors one of them being bad lending. This paper will focus on bad lending as the cause of the crisis, description of the major features and economic explanation of the problem.

Two Views to the Crisis

In an attempt of explaining what contributed to the East Asian crisis, research has offered two views to the same. One of the perceptions is that the East Asian economies did not essentially have any problems and, in fact, they were performing very well prior to the crisis. However, these countries were made susceptible to a financial panic as they experienced a surge for capital inflows with an aim of financing productive investments (Radelet and Sachs 1998). This insufficient policy reactions and panic generated a regional-wide crisis that was later followed by economic disruption. The other perception of the crisis was that the weaknesses in the financial sector of the Asian region were the causes of the crisis. According to research, these weaknesses were greatly influenced by lack of incentives for efficient risk management generated by explicit or implicit government assurances against failure (Moreno et al. 1998). The weaknesses in the regions’ financial systems, covered by speedy growth, heightened by large capital inflows that were partially swayed by pegged exchange rates.

The Crisis Period: 1997-1998

The speculative attack of the Thai baht in July 1997 was the main catalyst that resulted from vulnerability to a major crisis. The first attack became worse and spread very fast to various East Asia nations, when statistics showed that the level of Thai’s central bank usable reserves was, in fact, much less compared to what was initially reported.  Studies showed that these speculative attacks were not novel as in the year 1995; the currencies had experienced a similar attack as a result of the Mexican Peso crises (Krugman 1998). While in 1995 the currency was successfully defended, it was not the same case in 1997-1998. During the latter, there was massive capital outflow, and in addition to speculative attack, it was considered to be the major factor that resulted to a full-blown crisis. For instance, in such countries like Thailand, the projected capital outflow was 26 percent of the Gross Domestic Product within the initial six months of the Asia crisis (Krugman 1998). The massive capital outflow was linked to the response to vulnerabilities, which had been building up and currently seriously affected by the depreciating currencies.

In their attempts to steady their currencies, the central banks were challenged by three factors: interest rates, low reserves and capital outflows. Faced with capital flights, which resulted to devaluation of their currencies in addition to the low reserves, the only choice left to the central banks was to raise interest rates and float their currencies with an aim of preventing a financial collapse. However, this did not yield better results, given the exceedingly leveraged nature of their domestic economies, increasing the rates of interest was very counterproductive and painful to the entire economy.

With depreciating currencies, increasing interest rates turned out to be the mechanism, through which the currency crisis was passed on into the banking sector crisis. Three East Asian countries including Malaysia, Thailand and Korea showed signs of twin crisis in early 1998. In these countries, the banking sector was adversely affected, whilst the real or corporate sector started to lurch under penetratingly amplified rates of interest, while non-performing loans spiked (Radelet and Sachs 2001). This resulted to a near collapse of the banking sector. The table below offers data for the crisis period.

Real sector

1997

1998

Real GDP growth

Malaysia

Republic of Korea

Thailand

Consumption expenditure growth

Malaysia

Republic of Korea

Thailand

Gross domestic investment growth

Malaysia

Republic of Korea

Thailand

Monetary sector – M2 growth per cent

Malaysia

Republic of Korea

Thailand

Three-month interbank rate

Malaysia

Republic of Korea

Thailand

Domestic credit growth

Malaysia

Republic of Korea

Thailand

Capital account balance, per cent of GDP

Malaysia

Republic of Korea

Thailand

Unemployment rate per cent

Malaysia

Republic of Korea

Thailand

 

7.3

5.0

-1.4

Private              public

9.3                      -10.3

9.1                      -11.7

4.4                      -11.5

 

 

12

-8

-22

 

 

23

14

16

 

 

14.1

17

 

29.3

23.3

34.3

 

 

-6.0

-4.4

-6.0

 

2.6

2.6

0.9

 

-7.4

-6.7

-10.5

Private                 public

8.9                       -8.9

40.6                     -.0.4

1.6                        3.9

 

 

-44

-38

-51

 

 

2

24

10

 

 

14.6

16.8

 

-2.7

11.6

-1.3

 

 

-7.2

-4.8

-4.9

 

3.2

6.8

4.4

(Radelet and Sachs 2001)

The growth in gross domestic product is a clear evident of the severity of the East Asia crises. From the table above, it is clear that the three nations experienced a contraction of GDP growth during the two years, but especially in 1998. For this year, the average growth in gross domestic product for these countries was about -8 percent. This fall in gross domestic product was linked with considerable reduction in gross domestic investment (GDI) and consumption expenditure, particularly in public consumption (Bacha 2000). In 1998, gross domestic investment reduced with an average of 40 percent. Besides, the monetary sector was also faced with drastic contraction and it is clear that in both Thailand and Malaysia, the growth in money supply reduced sharply, although the Republic of Korea recorded a boost in the growth of money supply. Monetary contraction was very obvious, where credit growth and interest rates were concerned. For instance, the three months interbank rates, which were high as a measure of controlling the currency in 1997, remained at around 15 percent of the following year (Radelet and Sachs 1998). Most banks reduced on new loans provision, as they were already shuddering from the increasing NPL’s, and in 1998, domestic credit growth became negative with the exception of the Republic of Korea.

The contractionary monetary and fiscal policies that were aimed at stabilizing the currency and as a result, restoring confidence was not available. The unemployment rate, which is deemed as a sign of social cost to the economy, recorded an increase in all countries, with the Republic of Korea, recording the highest-level rise (Krugman 1998). However, considering the low inflation, the 6.8 percent increase in unemployment levels cannot be supposed to result to too drastic social costs, bearing in mind that some countries still experience higher unemployment rates even in normal times.

The economic shocks, which affected the East Asian countries, were followed by runs on currencies and financial systems rather than normal cyclical downturn. According to some researchers, these runs mirrored a classical financial fear, which did not mirror poor institutional arrangements or economic policies. It is apparent that even well managed financial intermediaries or banks are susceptible to panics, because they take part in maturity transformations. This means that banks or financial institutions accept deposits from their customers with short maturities, for instance, four months, with an aim of financing loans with longer maturities, for instance, two years.

Nevertheless, maturity transformation is advantageous because it increases the availability of funds to productive investors, especially the long-term ones. Under normal circumstance, it is clear that financial institutions can be able to manage their portfolios adequately in order to meet the projected withdrawals. Nonetheless, in situations, whereby all depositors made decisions to withdraw their funds from a specific financial institution all at once, such an institution will not have sufficient liquid assets to satisfy its requirements, and this would threaten the feasibility of a solvent financial institution (Radelet and Sachs 1998).

It is evident from studies that East Asia financial institutions and banks had gained a considerable magnitude of external liquid liabilities, which were not wholly backed by sufficient liquid assets, and this made them susceptible to panics (Radelet and Sachs 1998). In consequence of this maturity transformation, most of the financial institutions that were deemed solvent were rendered insolvent, as they were not able to deal with the abrupt interruption in the global flow of funds (Radelet and Sachs 1998).

Nevertheless, it is true that the effect of the crises differed considerably across the various East Asian economies. Specifically, as investors tested financial systems and currency pegs in the region, South Korea, Indonesia and Thailand, some of the economies that were believed to have the most susceptible financial sectors had experienced the most critical crises (Bacha 2000). On the contrary, such countries as Singapore with well-capitalized and robust financial institutions did not experience the same disruptions, despite the fact that they had reducing asset value and slowing economic activities. Without doubt, the collapse of the Thai baht in 1997 was initiated by signs of considerable weaknesses in the domestic financial institutions, for instance, the incapability of the domestic borrowers to pay back their debts (Radelet and Sachs 1998). In such countries as Indonesia, it turned out to be clear, following the crisis, that domestic institutions could not sufficiently monitor the financial situation of their borrowers, a condition that only made the severity of the crisis worse. This, as a result, implies that understanding the factors, which led to the weakness of the financial institutions of the greatly impacted economies, may assist in making them less susceptible to future crises.

Some of the East Asian countries possessed various characteristics similar to other nations, which experienced similar crisis before. One of these characteristic was that financial intermediaries did not have the freedom of using business criteria in the allocation of credit. In certain circumstance, well-linked borrowers were not refused credit and this led to specific situations, in which poorly managed companies could get loans from financial institutions and banks to meet government policy goal. According to research, the cumulative impacts of this kind of credit allocation created massive losses as most of the borrowers were not in a position to service back their loans (Moreno et al. 1998). This, as a result, led to considerable effects to the entire economy as such factors as gross domestic product, domestic credit growth and unemployment were greatly influenced.

The second characteristic was that the financial intermediaries were not supposed to bear the entire costs of institutional failure, and this lessened the incentive to efficiently manage risks. Particularly, financial institutions were protected by explicit and implicit government assurances against losses, because governments did not have the capability of bearing the costs of huge shocks to the payment systems (Krugman 1998) or because persons in the government (Krugman 1998) owned some of the financial intermediaries. Furthermore, Krugman (1998) puts forth that such assurances may generate asset price inflation, lessen economic welfare, and in due course make the financial system susceptible to collapse.

The significance of implicit government assurances in the majority impacted countries is emphasized by the generous support, offered to financial institutions that experienced difficulties. For instance, in South Korea, the elevated general debt ratios of corporate corporations, which were 400 percent and over, implied that such borrowers were eventually expecting the government to support them in case of unpleasant results (Bacha 2000). This was proven by the 1997 events, when the governments supported banks and financial institutions to give emergency loans to various corporations, which were troubled and which were experiencing problems, servicing their debts in addition to these solvent financial institutions, extending special loans to insolvent and weak banks and financial institutions (Radelet and Sachs 1998). These reactions weakened further the lenders financial position, contributing to the improbability, which triggered the most severe financial crises of 1997-1998. Disruption in the borrower and bank balance sheets resulted to extensive bankruptcies in addition to the disruption of the credit flows, especially in the highly impacted economies. Due to this, economic activities, in the short run, slowed whilst others contracted severely in the affected East Asian economies.

According to the above review, that has analyzed East Asian experience in the 1990’s crisis a classic panic might have contributed to the crises, weaknesses of the financial sector. Bad lending was a major cause of the crisis. These weaknesses emerge to mirror the lenders incapacities to employ business criteria in credit allocation, explicit and implicit government assurances against risks. This denotes that it would be practical to accompany attempts to stimulate resurgence in the East Asian economies by specific reforms, redesigned with an aim of strengthening the financial system. It is evident from studies that East Asia financial institutions and banks had gained a considerable magnitude of external liquid liabilities, which were not wholly backed by sufficient liquid assets, and this made them susceptible to panics (Radelet and Sachs 1998). In consequence of this maturity transformation, most of the financial institutions that were deemed solvent were rendered insolvent, as they were not able to deal with the abrupt interruption in the global flow of funds (Radelet and Sachs 1998). The fact that  financial intermediaries did not have the freedom of using business criteria in the allocation of credit and that these financial intermediaries were not supposed to bear the entire costs of institutional failure, which lessened the incentive to efficiently manage risks, aggravated the crisis further. 

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