Bank Support in the Asia-Pacific Region

As in the US and Europe, governments in the Asia and Pacific region have introduced various measures since mid-2008 to support their respective banking systems and—in some cases, even more critically—to limit the slowing of their economies. The announced bank support and fiscal measures by the larger, more developed economies—Australia; PRC; Hong Kong, China; India; Japan; Singapore; Korea; and Taipei, China—vary widely depending on the perceived need for support (given the funding and balance sheet strength of their banks), the exposure of their economy to the global downturn, and the policy stance of the government (interventionist or not). Korea, Australia, Japan, and PRC have so far been the most active. In this section, I review the main bank-support measures introduced by the authorities in different countries (Table 7 [ PDF 17.5KB | 1 page ]). The classification system differentiates between direct capital support, removal and guarantees of bad assets, direct liquidity support, and guarantees for banks' existing or newly issued obligations.

The most common support instrument to date has been state guarantees for banks' obligations, including deposits and borrowings. Blanket deposit guarantees were introduced in Australia; Hong Kong, China; Malaysia; New Zealand; Singapore; and Taipei, China. Of these, Australia, New Zealand, and Korea stand out in offering to guarantee banks' debt obligations. In addition, there have been numerous cases of central bank liquidity support for the system. Capital injections have so far not been necessary. Korea; Japan; India; and Hong Kong, China, however, have announced their intent to set up capital funds for their banks to tap. The impetus is not so much that the banks have a clear need for such capital at this stage, but rather that the government wants to maintain public confidence in the banks (especially if higher credit costs do begin to erode capital) and to enable banks to continue lending. Similarly, governments have rarely removed problematic assets from banks' balance sheets (such programs exist only in Korea and Japan). Only Korea has guaranteed loans to small- and medium-sized enterprises that are struggling to meet their liquidity needs. It is possible that, as the crisis progresses, some countries will introduce additional measures to make their banking systems more stable and avoid a possible competitive disadvantage compared with other systems.

Other regulatory forbearance measures in the Asia and Pacific region are focused on relaxing prudential regulations designed to increase liquidity, such as lowering the minimum liquidity ratios and minimum deposit reserve requirements. In some jurisdictions, maximum loan-to-value restrictions for mortgages and limits on consumer borrower indebtedness have been lifted to encourage lending. In some instances, accounting standards have been relaxed with regard to the valuation of securities (Japan) and the classification of restructured loans (India). It remains to be seen to what extent further regulatory forbearance will be granted in the region with regard to broader loan classifications, provisioning requirements, and capital ratios.

In this context, it is important to recall that regulatory forbearance is not a new concept. It arose in East Asia during the 1997 crisis and in the US in the early 1980s. In the US, among other measures, deposit insurance ceilings were raised, and capital adequacy requirements were relaxed for thrifts facing insolvency. East Asia adopted various forbearance measures, including blanket guarantees, capital, and nonperforming loan forbearance (IMF 1999). This may have helped banks to survive but, according to an FDIC report, The Banking Crises of the 1980s and Early 1990s: Summary and Implications (FDIC 2000: 46–47), it also postponed and amplified the later crisis. Forbearance can work, but it is not a cure-all. The FDIC report contrasts beneficial and harmful forbearance programs, but it criticizes largescale forbearance programs in no uncertain terms:

Longer-term, wholesale forbearance as practiced by the FSLIC [Federal Savings and Loan Insurance Corporation] was a high-risk regulatory policy whose main chances of success were that the economic environment for thrifts would improve before their condition deteriorated beyond repair or that the new, riskier investment powers they had been granted would pay off. The latter type of forbearance, which the FSLIC adopted against the background of a depleted insurance fund, is widely judged to have increased the cost of thrift failures.

The early 1990s saw precisely the opposite; the FDIC Improvement Act of 1991, for example, limited regulatory discretion in dealing with struggling institutions.

Blanket Guarantees. East Asia is not alone in using blanket guarantees. We are witnessing the widespread use of guarantees throughout the world. The Royal Bank of Scotland's Overview on Guarantee Schemes (Royal Bank of Scotland 2009) provides an informed overview of bank debt guarantee schemes around the globe. Numerous countries have recently established guarantee schemes: Germany (Norddeutsche Landesbank), Korea, United Kingdom, France (Dexia), Canada, Spain, Australia, Austria, Denmark, Finland, Greece, Ireland, Italy, Netherlands, New Zealand, Portugal, and Sweden. However, the lessons from the Asian crisis and the experience of other countries suggest that blanket guarantees can have adverse consequences for financial system stability. While the guarantees introduced in East Asia did bring stability, they also limited the subsequent options for dealing with financial distress and are hard to exit. For instance, as discussed in Box 2 [ PDF 14.9KB | 1 page ], the recent IMF Financial System Stability Assessment of Thailand adressees the difficulties in existing blanket guarantees.

What are the findings in the academic literature? The theoretical literature is unequivocal in associating moral hazard with blanket guarantees and points out that governments limit their policy options by implementing blanket guarantees that extend forbearance. Moreover, the fiscal costs of a crisis are endogenous and increase due to blanket guarantees. Much of the variation in fiscal costs is explained by poor policy measures, such as forbearance, blanket guarantees, and muddling through with half measures. If the underlying problems are ignored, the "silent" crisis rages on and the costs escalate. My empirical research on the topic finds robust statistical evidence that blanket guarantees increase fiscal costs, prolong the duration of a crisis, and extend the loss of GDP. The academic literature favors a stricter response to crisis resolution, finding that accommodative policies, reflected in blanket guarantees and other forms of forbearance, add to the fiscal cost of banking crises but do not accelerate the speed of recovery. The reason why governments continue to use blanket guarantees in crisis after crisis, despite the overwhelming consensus that they entail high contingent costs and create moral hazard problems, is easy to explain. Governments use blanket guarantees to stabilize sizable systemic financial crises in the absence of the institutional and political will or the fiscal flexibility needed to address the problems directly. Policymakers are advised to adopt a program that deals with the underlying problems and to use blanket government guarantees sparingly. Use of guarantees should be rare and for narrowly targeted objectives, such as new debt issuance as opposed to covering all the outstanding debt. Guarantees should be properly priced and explicitly budgeted, with their costs disclosed.

Removal and Guarantees of Bad Assets. The government bureaucracy has neither the expertise nor the motivation to make decisive decisions on the resolution of troubled assets. For example, during the 1997 Asian crisis, the Korea Asset Management Corporation collected public funds by resolving nonperforming loans of financial institutions and held public sales of assets entrusted to the government agencies. While Korea Asset Management Corporation gained experience over time, progress was slow. In Indonesia, the Indonesian Bank Restructuring Agency did not make satisfactory progress with the disposal of assets following the crisis. Of key importance is the practical difficulty of introducing a new organization with adequate experience. It is not desirable for governments by themselves to remove bad assets and transfer them to publicly owned companies. While the government needs to be actively involved in the resolution process, this process should rely, to whatever extent possible, on market forces rather than on government efforts to establish the right incentives for sound financial behavior. For example, an appropriate mix of penalties and rewards can induce financial institutions to take steps to resolve nonperforming loans, such as by conveying excess nonperforming loans to an asset management company for resolution. Capital adequacy forbearance might be appropriate for a limited time in cases where the deteriorating capital position is attributable to the disposition of nonperforming loans. The design should ensure that several criteria are met. First, the troubled assets should be worked out in the private sector. Second, the proposed approach should secure private equity capital, while providing government working capital. This program should further align the interests of the managers with the interests of the public, since the managers' own money is at risk. Third, the program should create capacity and competition in the private sector to deal with the problem of impaired assets.

Direct Capital Support. The provision of outright capital support from the government without a requirement that banks meet any prior conditions creates considerable moral hazard. There should be several tests for capital support: (i) market-based valuations of capital injections, (ii) links to matching funds from the private sector, and (iii) capital contributions, in the form of a preferred or convertible security, that are made contingent on the recognition of losses.

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