Sapienza Universit

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Sapienza Università di Roma

• International Banking
• Lecture Ten
• Financial crises
• Prof. G. Vento

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Agenda

• Introduction to financial crises
• Bubbles
• The South East Asian Financial Crisis

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1. Financial crises an introduction

• Financial crisis is normally associated with a
  banking crisis and when the stability of the
  banking system is threatened, the financial
  infrastructure could collapse in the absence of
  central bank intervention
• The collapse of a key financial firm normally
  prompts runs on the banks customers are unable
  to distinguish between healthy and problem banks
  and withdraw their deposits
• In the absence of central bank intervention,
  providing liquidity to solvent but illiquid
  banks, healthy banks are also threatened

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1. Financial crises bubbles 1/2

• A bubble occurs when prices increase over an
  extended range
• Agents with savings or credits shift their
  finance to the new profit areas
• An increase in credit finances a boom, and
  expands money supply investors euphoria sets in
• The financial system becomes increasingly
  fragile
• - banks make insufficient provisions for risk,
  possibly because of an optimistic view of the
  collaterals value
• - demand outstrips supply in the new profitable
  sectors. Prices increases
• - group behaviour together with increasingly
  speculative activity is observed, involving
  inexperienced agents who do not normally
  undertake investment

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1. Financial crises bubbles 2/2

• Units financing shifts from hedge finance to
  speculative finance
• The speculative boom continues until it snaps
• Distress selling begins when firms or
  households, unable to repay their debt, are
  forced to liquidate their assets
• Sellers outnumber buyers causing prices to fall
  rush to liquidate
• The bubble implodes and panic erupts

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1. Common trends in financial crises

• Agents starts to be excessively optimistic about
  the future price of certain assets, but at some
  points grow excessively pessimistic
• Are agents irrational? Is it consistent with the
  efficient market hypothesis? According to the
  school of behavioural finance bubbles are the
  demonstration of irrational behaviours
• Financial crises require injection of public
  funds, together with, in some cases, private
  funds from banks and international funds

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1. Financial crises in emerging markets

• A crisis occurs when a central bank is about to
  run out of reserves, or cannot service foreign
  debt obligations, denominated in another currency
• Once this unexpected news is made public, there
  is a rapid outflow of foreign capital, a collapse
  of domestic equity bond markets, and a decline in
  the value of the home currency
• High net inflows of foreign capital can trigger a
  crisis, which is even more severe if the foreign
  capital is largely in the form of short-term debt
  denominated in dollars
• Foreign lenders become excessively optimistic,
  the capital market overshoots, but some event
  causes concern among lenders, who start cutting
  back on loans to the country that triggers the
  crisis

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1. Common trends in financial crises

• Agents starts to be excessively optimistic about
  the future price of certain assets, but at some
  points grow excessively pessimistic
• Are agents irrational? Is it consistent with the
  efficient market hypothesis? According to the
  school of behavioural finance bubbles are the
  demonstration of irrational behaviours
• Financial crises require injection of public
  funds, together with, in some cases, private
  funds from banks and international funds

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The South East Asian Financial Crisis
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2. The South East Asian Financial Crisis (1997
99) the environment

• Originated in Thailand, then spread quickly to
  South Korea, Indonesia, Malaysia, and other Asian
  economies
• The speed and seriousness of the crises took
  expert by surprise
• - spread on Asian bonds had substantially
  narrowed during 1996 and for most of 1997
• - credit ratings remained largely unchanged
• - fiscal and monetary indicators were relatively
  stable

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2. The South East Asian Financial Crisis (1997
99) Thai crisis 1/2

• The first sign of trouble was when the prices of
  the Thai stock market began to fall in February
  1997, and by the year-end had declined by more
  than 30
• Pressure on Thai bath quickly turned into a
  currency crisis, which spread to the financial
  sector
• Thailand has experienced a massive net capital
  inflow during the previous three years (13 of
  Thai GDP)
• The year 1997 saw this inflow at first stop, and
  by the second and third quarters, sharply reverse
• An unexpected fall in exports in early 1997
  heightened concerns about the sustainability of
  the bath
• The Thai bath was pegged to the US dollars it
  depreciated through 1996 and 1997, but within the
  intervention band

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2. The South East Asian Financial Crisis (1997
99) Thai crisis 2/2

• The Thai central bank intervened heavily, buying
  bath to maintain the peg
• Thai government imposed capital control in May
  overnight interest rates soared an by July the
  government allowed the bath to float
• Meanwhile, pressure was building on other pegged
  currencies (Malaysia, Indonesia, etc.)

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2. The South East Asian Financial Crisis (1997
99) Industrial, trade and exchange rate policy

• All these economies have experienced rapid,
  although declining, growth rates
• Exports trebled between 1986 and 1996 in the
  region and made up about 40 of each countrys
  GDP by 1996
• Firms were frequently foreign owned
• Restriction on capital movements had been
  liberalised and in 1996 were completely free
• Increasingly, foreign firms were looking to China
  as the Asian base for their manufacturing plants
• These countries had all adopted some type of US
  dollar peg

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2. The South East Asian Financial Crisis (1997
99) The financial sector

• 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
• Increasing reliance on short-term borrowing as a
  form of external finance
• The almost unlimited availability of bank credit
  led to over-investment in industry and excess
  capacity (especially in property sector)
• Asian banks borrowed in yen and dollars from
  Japan and the west, and on-lent to local firms in
  the domestic currency
• A tradition of forbearance towards troubled banks
  and the widespread impression that governments
  would support the banking sector
• Name lending had been opposed to analytical
  lending
• Links between financial companies and industrial
  companies
• Weak financial institution/sector used to be
  supported by the states
• In the Korean financial sector, activities were
  strictly segmented by function

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2. The South East Asian Financial Crisis (1997
99) The contagion effect

• Initially the currency crisis spread from
  Thailand to other countries because investors
  tended to group these countries together
• The currency crisis spread rapidly because of
  the high substitutability of many of each others
  exports, the absence of capital controls, and the
  perceived similarity of financial conditions
• High interest rates and a deteriorating economic
  outlook caused a steep decline in the property
  and equity market
• Sound loans looked problematic , causing concerns
  on the viability of the banks with high
  percentage of non-performing loans, backed by
  collateral, the value of which was collapsing

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2. The South East Asian Financial Crisis (1997
99) policy responses

• IMF package included
• Closure of insolvent banks/fianncial insituttions
• Liquidity support to other banks, subject to
  conditions
• Purchase and disposal of non-performing loans,
  normally by an asset management company
• Loan classification and provisioning rules were
  raised to meet international standards
• Review of bank supervision laws
• New, tighter prudential regulation
• Introduction of deposit insurance schemes

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Scandinavian Banking Crises
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3. Scandinavian Banking Crises

• They are usually mentioned as successful examples
  due to the ways authorities managed the crises.
• Finland, Norway and Sweden experienced systemic
  banking crises in the late 1980s and early 1990s.
• Largest banks in each country required capital
  injections and many smaller banks were affected.

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3. Scandinavian Banking Crises the Macroeconomic
Situation

• Prior to the onset of the crises, real GDP growth
  rates were steady (between 4 and 6 for each
  country).
• The growth of credit was regulated by the
  governments, but these were removed in the 80s.
• Real interest rate was low and, in some years,
  negative.
• Boom of lending, that generated a rapid rise in
  property and stock market prices. Property was
  the main collateral.

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3. Scandinavian Banking Crises Some Mistakes

• Banks wanted to lend, after many years of
  restrictions
• Illusion that collateral could substantially
  reduce risk
• The bubble burst as a result of economic shocks
• Norway oil prices dropped in 1985 86
• Finland and Sweden crash in export due to Soviet
  Union implosion.
• The recession, combined with the rapid
  depreciation of real estate prices, caused large
  credit losses for financial institutions. The
  first to be affected were finance companies.

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3. Scandinavian Banking Crises Some Evidences

• Several bank defaulted.
• Central banks injected liquidity.
• A massive government rescue operation was
  required to prevent the collapse of the financial
  system.
• Support amounting to 4 of GDP was given to the
  banks.
• The crisis was rapidly resolved.

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3. Scandinavian Banking Crises Some Policy
Responses in Sweden

• Sweden. The total amount paid by the Banking
  Supervisory Authority to the banks was SEK 65
  billion. However, part of that money, was paid
  back to the government through dividends, selling
  of shares, and the value of retained shares.

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3. Scandinavian Banking Crises Some Policy
Responses in Norway
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Banking IN USA

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