Bank closures may `backfire'

Business Asia, Sept 30, 1999 by Janet Guttsman

A report on the lessons from Asia's financial crisis says attempts to close bad banks could backfire unless they are accompanied by strong management of the overall economy and by a blanket guarantee to creditors.

The International Monetary Fund (IMF) report found that Asia's financial crisis had highlighted the need for early and comprehensive action to resolve problems in fragile financial sectors.

Problems were hard to prevent and costly to resolve, said the IMF, which is cooperating with the World Bank in offering advice to countries as they seek to cope with the crisis.

"Bank closures are only successful if all clearly non-viable institutions are closed ... the action is part of a comprehensive and credible restructuring strategy, appropriate macroeconomic policies are in place and the process is clearly and credibly explained to the public," said the report.

But the IMF also admitted that these conditions were not met in Indonesia, where the fund pushed the authorities to close 16 small banks as the crisis there deepened.

"The experience of Indonesia showed that in a systemic crisis bank closings can, if not accompanied by proper information, strong overall economic management and a blanket guarantee, lead to a run on banks," it said.

The crisis, which started in Thailand in July 1997 and spread relentlessly around Asia and then beyond, was marked by deep problems in overburdened and poorly regulated financial sectors. Banks buckled under bad debts and both the IMF and the World Bank set up special units to deal with the problems.

The IMF report said Indonesia, Malaysia, South Korea and Thailand were likely to spend between 15 and 45 per cent of gross domestic product resolving the financial sector problems, although these estimates were still not set in stone.

Stefan Ingves, in charge of banking issues at the IMF, said financial sector restructuring was not yet complete.

"The final costs to each economy are still not known," he told a news conference. "Asia must not allow its commitment to restructuring to flag simply because economic indicators are rising again. Financial restructuring will be on the region's agenda for several years to come."