Transcript European Business School London Regents College

Sapienza Università di Roma
International Banking
Lecture Ten
Financial crises
Prof. G. Vento
Agenda
• Introduction to financial crises
• Bubbles
• The South East Asian Financial Crisis
April 2013
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
April 2013
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 collateral’s 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
April 2013
1. Financial crises: bubbles 2/2
• Unit’s 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
April 2013
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
April 2013
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
April 2013
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
April 2013
The South
East Asian
Financial
Crisis
April 2013
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
April 2013
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
April 2013
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.)
April 2013
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 country’s 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
April 2013
2. The South East Asian Financial Crisis (1997 –
99): The financial sector
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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 onlent 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
April 2013
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 other’s 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
April 2013
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
April 2013
Scandinavian Banking Crises
April 2013
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.
April 2013
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.
April 2013
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.
April 2013
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.
April 2013
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.
April 2013
3. Scandinavian Banking Crises: Some Policy
Responses in Norway
April 2013
Next Lecture :
BANKING IN USA
April 2013