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However, Korea had the legal framework to deal with the chaebol problems. Creditors
have been able to use the courts to put the chaebol into receivership. Though the
Daewoo crisis did not come to the fore until mid-1999, its creditors negotiated rate
reductions, grace periods and debt–equity conversions to stabilise its debt of $80 billion,
then proceed with the break-up and sale of its assets. Other chaebol have been stabilised,
after debt restructuring agreements with bankers. The state also intervened, requiring
gearing ratios to be reduced to at least 200%, and prohibiting cross-guarantees of chaebol
members’ debt.21
The situation is quite different in Indonesia and Thailand, where corporate restructuring
has been hampered by the absence of clear legal guidelines on issues such as foreclosure,
the definition of insolvency and the legal rights of creditors.
ž Exchange rate regimes: these countries had all adopted some type of US dollar peg.22
In the absence of any serious inflation, real effective exchange rates were stable, with
only a slight rise in 1995–96. Trade weighted exchange rates were also stable. Once
the Thai baht came under pressure, and floated in July 1997, it depreciated rapidly. The
other countries responded by widening their fluctuation bands (depending on the system
of pegging), but the runs continued, forcing them, with the exception of Malaysia,23 to
float their respective currencies. The Indonesia rupiah was floated in August; the Korean
won in December. All of these governments had used their central banks to defend the
currency, exhausting much of their foreign exchange reserves24 and pushing up domestic
interest rates.
The financial sector
ž All of the Asian economies were bank dominated, with underdeveloped money markets.
Between 1990 and 1997, bank credit grew by 18% per annum for Thailand and Indonesia,
12% for Korea. By way of contrast, credit growth averaged 4% per annum for the G-10,
and was just 0.5% for the USA. By 1997, bank credit as a percentage of GDP for Thailand,
Korea and Indonesia was, respectively, 105%, 64% and 57% – amounts that were close
to, or in the case of Thailand above, those for developed countries. The rapid increase in
the supply of credit, in the absence of the growth of profitable investment opportunities,
caused interest margins to narrow (to the point that they were roughly equal to operating
costs), even though riskier business loans were being made, largely in construction and
property. Property was also used as collateral – soaring property prices fooled the banks
into thinking the risk they faced from property-backed loans was minimal.
21 This account comes from Scott (2002), pp. 61, 63. 22 Hong Kong was the only economy in the region with a currency board. Ferri et al. (2001), using data on SME
borrowers (1997–98), show that during a systemic banking crisis, relationship banking with the banks that survive
has a positive value because it reduced liquidity problems for SMEs, and therefore made bankruptcy less likely.
23 Prime Minister Mahathir of Malaysia blamed speculators for the run on the ringgit and refused to float the
currency, though the band was widened.
24 For example, foreign exchange reserves in Thailand amounted to about $25 billion pre-crisis, but by the time
the baht was floated, the central bank had issued about $23 billion worth of forward foreign exchange contracts.
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Table 8.3 Bank Performance Indicators
Thailand Indonesia Korea Malaysia
Weighted Capital Assets Ratio 1997 9.3 4.6 9.1 10.3
1999 12.4 −18.2 9.8 12.5
ROA 1997 −0.1 −0.1 9.1 10.3
1999 −2.5 −17.4 9.8 12.5
Spread∗ 1997 3.8 1.5 3.6 2.3
1999 4.8 7.7 2.2 4.5
∗ Spread: short-term lending rate – short-term deposit rate.
Source: BIS (2001), table III.5.
ž The build-up of bad credit would not have been possible had foreign lenders been
unwilling to lend to these countries. In a First World awash with liquidity,25 there were a
number of reasons why Japanese and western banks found these markets attractive. Until
the onset of the currency crises, the economic performance of these tiger economies had
been impressive. Through the 1990s, real economic growth rates were high, inflation
appeared to be under control, they had high savings and investment rates, and good
fiscal discipline: government budgets were balanced. As Table 8.3 shows, the weighted
capital assets ratios were, with the exception of Indonesia, respectable. Borrowers (usually
local banks) were prepared to agree a loan denominated in a foreign currency (dollars,
yen), thus freeing up the lender from the need to hedge against currency risk. Shortterm lending was particularly attractive, allowing western banks to avoid the standard
mismatch arising from borrowing short (deposits) and lending long to firms. Finally,
many foreign lenders were under the impression these banks would be supported by the
government/central bank in the unlikely event of any problems (see below).
ž Increasing reliance on short-term borrowing as a form of external finance: international
bank and bond finance for the five Asian countries between 1990–94 was $14 billion,
rising to $75 billion between 1995 and the third quarter of 1996. By 1995, the main
source of the loans was European banks, and nearly 60% of it was interbank. By the
beginning of 1997, foreign credit made up 40% of total loans in Asia.26 Of these loans,
60% were denominated in dollars, the rest in yen. Two-thirds of the debt had a maturity
of less than a year.27
ž The almost unlimited availability of bank credit led to over-investment in industry and
excess capacity. There was a close link between local bank lending and the construction
and real estate sectors, especially property development. In Thailand, by the end of 1996,
30–40% of the capital inflow consisted of bank loans to the property sector, mainly
25 In the west, there was an easing of monetary policy from 1993. However, after the relatively harsh recession
between 1990 and 1991, companies were reluctant to borrow or invest until 1997, when the economic boom
increased borrowing once again. Japanese banks were keen to gain market share overseas.
26 Foreign investors were also attracted to the Asian stock markets – about 33% of domestic equities were held by
foreigners at the end of 1996.
27 Source of these figures: Bank for International Settlements (1998, table VII.2).
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developers. The figure for Indonesia was 25–30%. The problem was compounded by the
use of collateral, mainly property. The loan to collateral ratios stood between 80 and
100%, creating a collateral value effect, that would further destabilise banking sectors
once property (and equity) prices began to decline. The role of collateral and collateral
values in models of shocks and money transmission has been emphasised by Bernanke
and Gertler in various papers.28
ž Some government policies could inadvertently contribute to the problem. For example,
the Thai government introduced the Bangkok International Banking Facility (BIBF) in
1993, to promote Bangkok as a regional banking sector and encourage the entry of international banks. The BIBF was also used by domestic banks to diversify into international
banking intermediation by obtaining offshore funds for domestic or international lending.
Unfortunately, they gave Thai banks29 a new way of borrowing from abroad, using BIBF
proceeds to invest heavily in property and related sectors.
ž Asian banks borrowed in yen and dollars from Japan and the west, and on-lent to local
firms in the domestic currency. There was little use of forward cover against the currency
risk arising from these liabilities because of the relative success of the peg, up to 1997. For
example, the Thai baht had not been devalued since 1984, with only slight fluctuations
around the exchange rate (BT25.5:$1). Rising interest rates and a collapsing currency
proved lethal. Firms could not repay their debt, and banks found it increasingly difficult to
repay the principal and interest on the dollar debt. Non-performing loans as a percentage
of total loans soared, especially in Thailand and Indonesia. As Table 8.7 shows, by 1998,
the percentage of non-performing loans was just under 40%.
ž A tradition of forbearance towards troubled banks, and the widespread impression that
governments would support the banking sector – through either implicit or explicit
guarantees. For example, in Indonesia, the costly and protracted closing of Bank Summa
in 1992 resulted in a policy of no bank closures in the years prior to the crisis.30
Similar attitudes prevailed in all these countries. An added problem was that even if the
authorities had wanted to close insolvent banks, an inadequate legal framework in most
of these countries made it very difficult to force firms into insolvency.
ž Regulation of the financial sector was nominal, for several reasons. First, named as
opposed to analytical lending, i.e. it was the individual’s connections with the bank that
mattered. There was little in the way of assessment of the feasibility of proposed projects,
nor was the risk profile of the borrower evaluated. Together with a lack of staff training
and expertise, it meant no modern methods of risk assessment were used by the banks.
In Korea political interference meant some financial institutions were subject to unfair
audits and penalties.31
ž In Thailand, the same group of top officials moved back and forth between business, the
banking sector and government. Offices were run to enhance an official’s future standing,
28 See for example, Bernanke and Gertler (1995). 29 In December 1996, 45 financial firms were licensed to handle BIBFs, or, effectively, engage in offshore activities.
15 were Thai banks and 30 were foreign banks or bank branches. The Thai banks used their BIBFs to borrow from
abroad and lend locally.
30 Batunaggar (2002), p. 5. 31 Casserley and Gibb (1999), p. 325.
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and for regulators, this meant avoiding any controversial action which would upset senior
bankers and/or politicians. Many of the banks had family connections: a family would
succeed in a certain area of business and then expand into banking by buying up its shares.
For example, in the early 1900s, the Tejapaibul family began a liquor and pawnshop
business in Thailand, and by the 1950s the business was so large that ownership of a bank
would ensure a ready source of capital. They established the Bangkok Metropolitan Bank
in 1950, and bought controlling stakes in other banks in the 1970s and 1980s. After
problems in the 1990s, the central bank appointed the managing director and other staff,
while a family member remained as President. In 1996, US regulators ordered it to cease
its US operations. In early 1998, with 40% of total loans designated non-performing, the
family was forced to accept recapitalisation by the state and loss of management control,
with the family losing close to $100 million.32 It is currently owned by the Financial
Institutions Development Fund. Part of the Bank of Thailand, the FIDF was set up in the
1980s as a legal entity to provide financial support to both illiquid and insolvent banks.
It normally takes over a bank by buying all its shares at a huge discount.
ž The ratio of non-performing loans to total loans illustrates the growing problem of bad
debt. Table 8.4 reports the BIS estimates. Even in 1996, they were on the high side if the
benchmark for healthy banks is assumed to vary between 1% and 4%. In 1997, Thailand’s
NPL/TL rose to 22.5%. In 1998, Korea’s and Malaysia’s percentage of NPLs are high by
international standards, but dwarfed by the estimates for Thailand and Indonesia. These
ratios are understatements because of lax provisioning practices. In most industrialised
economies a loan is declared non-performing after 3 months. In these Asian economies,
it is between 6 and 12 months. Bankers also practised evergreening:
33 a new loan is granted
to ensure payments can be made or the old loan can be serviced.
ž Weak financial institutions/sectors, supported by the state. By the time of the onset of the
crisis (and in Indonesia’s case, long before), it was apparent that these countries’ financial
sectors were part of the problem. In Thailand there was tight control over the issue
of bank licences, but finance companies were allowed to expand unchecked. By 1997,
the country had 15 domestic banks and 91 finance companies – their market share in
lending grew from just over 10% in 1986 to a quarter of the market by 1997. In response
to pressure from the World Trade Organisation, Thailand allowed limited foreign bank
Table 8.4 BIS Estimates of Non-performing Loans as a Percentage of Total Loans
Thailand Indonesia Korea Malaysia Philippines
1996 7.7 8.8 4.1 3.9 na
1997 22.5 7.1 na 3.2 na
1999 38.6 37.0 6.2 9 na
Source: Goldstein (1998); BIS (2001).
32 Source: Casserley and Gibb (1999). 33 See Chapter 6 and Goldstein (1998), p. 12.
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entry, with 21 foreign banks in 1997. However, their activities were severely constrained
because each one was only allowed a few branches.
ž In the Korean financial sector, activities were strictly segmented by function. Specialised
banks provided credit to certain sectors, for example, the Housing and Commercial Bank,
development banks (e.g. the Korea Long Term Credit Bank and the Export Import Bank),
and nation-wide/regional banks. By 1997, there were eight national banks, serving the
chaebol and the retail sector. Ten regional and local banks offered services to regional
(or local) business and retail clients. Government influence was all pervasive. Not only
did they own shares in some banks, but all executive appointments were political. There
was directed lending – the government would pressure a bank to grant specific amounts
of credit to firms. Political connections, not creditworthiness, was the determining factor
in many bank loan decisions.
ž There were also investment institutions, which held about 20% of total assets in 1997.
They were made up of merchant banks, securities firms and trusts. Merchant banks had
no access to retail markets, raising their funding costs. Using funds raised by commercial
paper issues, overnight deposits and US dollar loans, they invested in relatively risky
assets, including risky domestic loans and Indonesian and Thai corporate bonds. Once
these economies collapsed, these banks faced mounting losses. Depositors panicked,
especially those who held US dollar accounts. Loan rollovers were also terminated, which
forced these banks to buy US dollars.
The central bank tried to defend the won but by late 1997, had used up all of their
foreign exchange reserves. An application for IMF standby credit was agreed by early
December. It amounted to $21 billion over 3 years, with just under $6 billion for immediate
disbursement. A few days later, the won was floated – in 6 weeks it lost 50% of its value
against the US dollar.
Indonesia’s banking sector aggravated the crisis in that country. It was unique among
the countries in allowing foreign bank participation. Foreign banks could own up to 85%
of joint ventures. Major banking reforms came into effect in 1988, and between 1988 and
1996, the number of licensed banks grew from 20 to 240. Branch networks grew and new
services were offered by banks. This stretched the supervisory services, and banks began
to engage in questionable practices. There was intense competition among banks. This
contributed to the rapid expansion of credit, much of it named or ‘‘connected’’, 25–30% of
it going to the property sector, especially developers.
In 1991, prudential regulation was tightened by Bank Indonesia. Banks had to meet
capital ratios, and were rated. Mergers were encouraged, but did not take place, and banks
used their political connections to escape the tough new measures. From 1990, Indonesia’s
private corporate (non-bank) sector borrowed heavily from overseas, with most of the debt
denominated in dollars.34 By 1997, it had grown to $78 billion, exceeding the amount of
sovereign external debt by close to $20 billion. Lack of confidence in the banking and
corporate sectors caused the currency crisis to deepen, even after the rupiah was floated.
34 The government had stopped banks from taking on much external debt.