The document discusses the evolution of banking systems in Asia from colonial times to modern financial systems. It describes how many Asian countries had "repressed" financial systems until the 1970s, characterized by government control of interest rates and credit allocation. This led to fragmented systems with specialized banks and growth of informal finance. It then discusses the financial crisis of 1997 in Southeast Asia, which was caused by a combination of factors including high foreign debt, fixed exchange rates, deregulation, moral hazard, and overexuberance of international investors in the region's rapid growth.
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The document discusses the evolution of banking systems in Asia from colonial times to modern financial systems. It describes how many Asian countries had "repressed" financial systems until the 1970s, characterized by government control of interest rates and credit allocation. This led to fragmented systems with specialized banks and growth of informal finance. It then discusses the financial crisis of 1997 in Southeast Asia, which was caused by a combination of factors including high foreign debt, fixed exchange rates, deregulation, moral hazard, and overexuberance of international investors in the region's rapid growth.
Download as DOCX, PDF, TXT or read online on Scribd
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Introduction banks were not allowed to enter the market or
where their presence was highly regulated.
The financial system is an integral component of modern economies. In most Asian countries, Financial Repression commercial banks constitute the primary component of the financial system. However, “Repressed” financial systems were characterized by low or negative real interest informal financial institutions also play an important role. Furthermore, in the last decade rates and a low and sometimes falling ratio of monetary assets to GDP/GNP. In a repressed or so, other financial institutions, including insurance companies and pension funds, as well system, the government usually plays a dominant role in controlling the banking system as stock and bond markets, have gained greater importance. by imposing these kinds of controls, using banks to serve as the instruments for allocating credit Banking and the Financial System to key selected sectors. Often, specialized banks were created to address the needs of particular The banking and financial systems in the sectors. developing economies in Asia evolved from systems that were in place during the colonial Rural banks were often created for this purpose period. In South Asia, Taiwan, Malaysia, Hong in the early stages of development and were Kong and Singapore, the British system was complemented by banks focusing on key adopted, while in East Asia, the Japanese model industries later in the development process. was adopted in Korea. In cases such as Thailand At the same time, credit to other potential and China, which were not colonized to any significant extent, the financial system were borrowers was lacking. As a result, informal or “kerb” markets developed outside the formal borrowed from the industrial countries. financial system to mobilize and direct credit to By the early 1970s, the region as a whole could those sectors not effectively serviced by the be characterized by the widespread presence of formal financial and banking system. financial repression. It is a situation, first The overall impact of these developments was a described fully by Shaw (1973) and McKinnon(1973), where government taxes and fragmented banking system where the organized banking system serviced only a small subsidies distort the domestic capital market (compared with a free and competitive system part of the total capital market while informal finance emerged to serve the needs of other where private banks are supervised by a central bank) by imposing interest rate restrictions and borrowers. high reserve requirements. Financial Liberalization At the same time there are compulsory credit Designed to remove all the restrictions allocations to some sectors and the lack of that characterize financial repression. These credit to others. As a result, loans extended by include the lowering of reserve requirements, banks were not thoroughly analyzed in terms of freeing up interest rates, and allowing them to risk or proper viability. Competition among respond to market forces. Managed credit banks was also limited, particularly as foreign allocations to key sectors should be reduced or eliminated, and loan officers should be required seemed to offer better rates of return than to evaluate potential borrowers on the merits lower growth economies in the West. of the project and not to give loans Current account deficits. Countries like indiscriminately based on other economic criteria. Competitive forces should be allowed Thailand, Indonesia, South Korea had large current account deficits; this meant they were to operate in the banking system to improve economic efficiency through the relaxation of importing more goods and services than they were exporting – it was a reflection of very high entry requirements, both domestically and for international banks. rates of economic growth and consumption. The current account deficits were financed by The Financial Crisis of 1997 hot money flows (on capital account). Hot money flows were accumulated because of The Asian financial crisis of 1997 refers to a higher interest rates in the East. macroeconomic shock experienced by several Asian economies – including Thailand, Fixed or semi-fixed exchange rates. This made Philippines, Malaysia, South Korea and currencies vulnerable to speculation. Also, Indonesia. Typically countries experienced rapid interest rates were used to maintain the value devaluation and capital outflows as investor of a currency. Causing relatively high-interest confidence turned from over-exuberance to rates in S.E. Asia which caused hot money flows. contagious pessimism as the structural imbalances in the economy became more Financial deregulation encouraged more loans and helped to create asset bubbles. But, the apparent. regulatory framework and structure of banking The crisis of ’97-99 followed several years of and firms meant loans were often made rapid economic growth, capital inflows and without sufficient scrutiny of profitability and build up of debt, which led to an unbalanced rates of return. economy. In the years preceding the crisis, government borrowing rose, and firms Moral Hazard. With a strong political desire for rapid economic growth, governments often overstretched themselves in a ‘dash for growth.’ When market sentiment changed gave implicit guarantees to private sector projects. This was magnified by the close foreign investors sought to reduce their stake in these Asian economies causing destabilishing relationships between large firms, banks and the government. This closeness encouraged capital outflows, which caused rapid devaluation and further loss of confidence. private firms to place less emphasis on the costs of projects and an assumption expansion plans Long-term causes of the Asian Financial Crisis would be supported by the government
Foreign debt-to-GDP ratios rose from 100% to
167% in the four large ASEAN economies in 1993-96. Foreign companies were attracting Over-exuberance. The booming economy and booming property markets encouraged capital inflows from the developed world. Investors in the West were seeking better rates expansive borrowing by firms. It also encouraged international investors to move the of return, and the “Asian economic miracle’ capital to these fast-growing economies. There was an element of irrational exuberance – the idea that Asian economies were undergoing an economic miracle where high returns were guaranteed.
Informal Finance
Informal finance is defined as contracts or
agreements conducted without reference or recourse to the legal system to exchange cash in the present for promises of cash in the future.