Download FINANCIAL LIBERALIZATION, CRISIS, AND RESCUE:

FINANCIAL LIBERALIZATION,
CRISIS, AND RESCUE:
Lessons for China from
Latin America and East Asia
Aims of Presentation

Introduction

Challenges facing China’s financial sector

Financial liberalization trends: LA and EA

Liberalization and crisis

Rescue costs

Lessons for China
Introduction

Liberalization has transformed financial
system in developing countries
-- Strengthened role of private sector and
market forces in decision making
-- Resulted in crises and need for rescues
-- Created new government role and
increased foreign ownership
China’s Financial Sector

People’s Bank of China

Policy banks

State-owned commercial banks (“Big 4”)

Publicly-listed commercial banks

Non-bank financial institutions

Securities markets
China’s Successes

Rapid growth over several decades

Strong external accounts, including
large volume of reserves

Stability in face of Asian Crisis
China’s Challenges

Clean up NPLs and raise capital ratios in
banking sector

Improve regulation and supervision,
corporate governance

Continue liberalization of financial sector
(domestic and international) without crisis
Financial Liberalization
Trends

Definition of liberalization, WB Index

Almost all countries have liberalized
domestic financial sector

LA has been eager, but volatile

EA has moved more gradually
Dome stic Financial Libe ralization Inde x, 1973-2002
3.5
3.0
2.5
2.0
1.5
1.0
0.5
01
nJa
Asia
99
nJa
97
nJa
Latin America
95
nJa
93
nJa
91
nJa
89
nJa
87
nJa
85
nJa
83
nJa
81
nJa
79
nJa
77
nJa
75
nJa
73
nJa
Developed Ctries
Policies Accompanying
Liberalization

Macroeconomic management

Prudential regulation and supervision

Capital account opening

Institutional development
Liberalization and Crisis (1)

Theoretical insights in recent literature
-- New explanations for crises (internal
oriented, external oriented)
-- Twin crises
-- Correlation between liberalization and
twin crises
Liberalization and Crisis (2)

Twin crises in LA and EA (Chile, Mexico, Argentina;
Thailand, Korea, Malaysia, Indonesia)

Typical “syndrome”
-- Liberalization and privatization
-- Lending boom, ignoring loan quality
-- Macroeconomic policies leading to capital
inflows, overvaluation, debt build-up
-- Twin crisis
Liberalization and Crisis (3)

Not all countries have suffered twin crises
-- Governments took early measures
(Brazil, Philippines)
-- Countries received less private capital
inflows (Peru, Philippines)
-- Other types of crisis (Colombia,
Venezuela, Taiwan)
Rescue (1)

Four rescue mechanisms commonly used
-- Assistance to increase liquidity
-- Assistance to raise capital ratios
-- Removal of bad loans
-- Take-over or closing of banks

Details matter for outcomes
Rescue (2)

Crises and rescues are very costly
-- Fiscal outlays are high
-- GDP losses are steep
-- Other costs add to burden
Latin America and East Asia: Cost of Financial Crises
Region/
country
Latin America
Argentina
Chile
Mexico
East Asia
Indonesia
Korea
Malaysia*
Thailand
Crisis
Year
Fiscal
Cost
GDP
Loss
Interest
Rate
Asset
Prices
Inflation
2002
1982
1995
26.4
na
33.5
19.3
-10.2
-11.0
-13.4
-6.2
38.4
44.6
46.0
24.7
-54
-54.7
na
-53.3
41.6
40.3
31.2
53.3
1998
1998
1998
1998
28.6
52.3
23.1
4.0
34.8
-9.5
-13.1
-6.7
-7.4
-10.8
11.9
3.3
21.6
5.3
17.2
-70.4
-78.5
-45.9
-79.9
-77.4
47.2
79.4
7.2
5.0
10.7
Rescue (3)

Costs of crises linger for years
-- Slower GDP growth
-- Lower investment ratios
-- Lack of credit availability
Latin America and East Asia: Performance Five Years after Crises
Region/
country
∆GDP
∆GDP Inv/GDP Inv/GDP Credit/GDP Credit/GDP
pre-crisis post-crisis pre-crisis post-crisis pre-crisis post-crisis
Latin America
Argentina*
Chile
Mexico
4.8
2.6
7.9
3.9
1.5
-2.0
2.9
3.5
20.3
16
23
22
20.7
15
23
24
38.7
24
53
39
27.7
11
54
18
East Asia
Indonesia
Korea
Malaysia
Thailand
7.8
7.6
7.1
8.7
7.9
2.5
0.6
4.2
2.8
2.2
38.4
31.6
38.2
42.0
41.7
23.1
16.0
29.4
21.8
25.2
114.5
61
73
158
166
93.3
24
104
142
103
Lessons for China (1)

Gradual domestic liberalization preferable
-- Importance not clear in LA and EA, but
Chinese banks lack experience
-- Clean up NPLs, increase capital ratios
-- Generally improve capacity of financial
institutions to meet new challenges before
full liberalization
Lessons for China (2)

Policies accompanying liberalization must
be selected with care
-- Real macro stability before liberalization
-- Strong prudential regulation and
supervision before liberalization
-- Partial capital account opening after
liberalization and adjustment
Lessons for China (3)

Institutions must be strengthened to
support liberalized system
-- Rule of law, judicial system
-- Ministry of finance, central bank,
regulatory agencies, credit bureaus

Improving institutions takes time,
furthering argument for gradual approach
Conclusions

China has opted for a market economy

Financial sector is a crucial component

May be some role for public-sector banks

But main component of financial sector
must be autonomous banks that operate
in stable, self-sustaining manner