Introduction

This paper assesses the condition and outlook of the financial sectors—in particular, the banking sector—in the East Asia region in the aftermath of the current global financial crisis.

First, I analyze risks in the banking systems using the standard supervisory framework, which assesses capital adequacy, asset quality, management, earnings, and liquidity (CAMEL). I find that banking systems in the region are sound, but that the short-term outlook is negative. Second, I review the measures introduced in Asian countries to support the banking systems. As in the United States (US) and Europe, Asian governments have introduced various measures since mid-2008 to support their banking systems. In some cases, they have offered critical fiscal support to stem the slowing of their economies. The main bank support measures—direct capital support, removal and guarantees of bad assets, direct liquidity support, and guarantees for banks' existing or newly issued obligations— might be necessary to ensure stability, but they need to be handled carefully to prevent longterm distortions. It remains to be seen whether Asian policymakers will manage skillfully the lifting of supports. Third, I conduct stress tests of the banking systems. The stress tests indicate that the largest banking systems in East Asia have almost US$1.2 trillion in Tier 1 capital and a possible shortfall of US$758 billion. Fourth, I assess the implication for liquidity of the increase in international banking flows and find that the banking system in the Republic of Korea (hereafter Korea) appears vulnerable to a reversal of capital flows. Fifth, I explore the implications of the crisis for credit formation, assessing whether nonbank financial institutions in the region have the capacity to provide sufficient liquidity. I conclude that they do not. The paper ends with a brief assessment of the impact of the crisis on the corporate sector, concluding that the effects of the crisis are likely to be significant but manageable.

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