Sound financial system key to Asian sustained growth

Sound financial system key to Asian sustained growth

By Vincent Lingga

HONG KONG, China (JP): An inadequate financial system could
threaten the foundation of Asian economic growth, financial
analysts, International Monetary Fund (IMF) and World Bank
executives here warn.

Almost all reports and analyses issued here regarding the
currency crisis in Thailand which began in early July and the
subsequent financial turbulence that hit Indonesia, Malaysia and
the Philippines put much of the blame on their weak financial
system, notably the banking sector.

The World Bank and IMF economists, here for their annual
meetings, showed how these countries had to pay the costs for
being late in responding to the new challenges to their
macroeconomic discipline brought about by the influx of private
capital.

But they remain bullish that robust growth will return to
these countries after a temporary slowdown.

"I am sure they will do well again after the hiccup in the
financial sector," World Bank president James D. Wolfenshon said
here yesterday.

The seeds of the currency turbulence were sown when the bulk
of the huge private capital flows since the early 1990s,
attracted by Southeast Asia's economic boom, entered through the
banking system, according to the advance copy of the IMF's World
Economic Outlook report which will be published next month.

Banks which were poorly managed and inadequately supervised
excessively expanded lendings without much regard to risks and
this led to a boom in domestic consumption and real estate
speculation and development. It also resulted in appreciating
exchange rates and a widening current account deficit.

But all banking systems in the world are potential victims of
the risk perception of the international financial community.

As the international financial community perceived, imminent
problems emerged due to unsustainable credit growth and external
imbalances. The market perception shifted, setting off a sudden
reversal of capital flows through the dumping of local currencies
and sharply reducing liquidity and credit.

Currency turmoil and the weakness of the real estate market,
all conspired to test the banks' creditworthiness at a time when
the support of the authorities has become less certain.

A World Bank study prepared after the currency crisis in
Thailand recounts that when the governments were forced to raise
short-term interests to defend the national currencies from
speculative attacks, they risked knocking out the banking system.

This is because many banks in emerging markets often fund
short and lend long in the absence of long-term funding
instruments.

"We have detected structural deficiencies in the Thai
financial sector and we have told them so," IMF Director Michael
Mussa told a seminar on Asia and the IMF here yesterday.

The two multilateral institutions highlight some deficiencies
in East Asia's financial system.

Their reports note that implicit state support has maintained
the creditworthiness of many rotten institutions, with credit
ratings dependent, to a large extent, on the quality of expected
state support rather than the quality of banks' balance sheets
and profitability.

Insolvency

Some countries which experienced bank insolvencies have often
tried to correct them by providing blanket coverage for
liabilities and imposing regulatory forbearance, according to the
reports.

"If they (Thailand) had acted early enough, the damages would
not have been as great. Even now, we would like them to move
faster on policy adjustments and structural reform," Wolfenshohn
said.

President of the Asian division of bank rating agency Thomson
BankWatch, Philippe Delhaise, came to a similar conclusion.

Delhaise observed in the latest BankWatch assessment of banks
in Asia that in many countries there are several state banks
operating under close government guidance. Such banks usually
exhibit performance ratios which are largely artificial,
essentially because their asset quality is abysmal.

The state banks are used as conduits for government
development and fiscal policies. Loan classification and
provisioning rules are largely inadequate.

In the pure private sector, according to BankWatch, reasonably
good asset quality can only be found in Hong Kong and Singapore,
with the Philippines and Malaysia at a distance. In those
countries, regulatory authorities enjoy, to various degrees, the
best reputation.

Banks in Hong Kong, Singapore and the Philippines also have
very high capital ratios. At the other extreme , banking systems
in Korea, Japan, China, Thailand, Indonesia and India suffer from
poor asset quality, the BankWatch study said.

The IMF, World Bank and BankWatch studies expressed similar
concerns on excessive lending to real estate.

They cautioned real estate problems hit banks in various ways.
Real estate is used as collateral in most types of lending,
compounding problems.

BankWatch cited an unfortunate pawnshop mentality among many
bankers. Loans are extended on the strength of collaterals
without much regard for the ability of the borrower to repay
principals and interest from its main line of activities.

Low liquidity, as often as fraud or bad luck, has historically
been responsible for bank failures.

Liquidity is the key to survival. A bank can be bankrupt,
unprofitable and at the lower end of the asset quality spectrum,
but it can still survive if authorities give it enough liquidity
and some leeway to "cook the books".

The three institutions believe reform of the banking sector is
critical because in most developing countries, where the
financial market still lacks depth and the debt market has a
limited number of instruments, the banking system controls most
new financial flows.

But the IMF, supposed to be the guardian of exchange stability
for its 181 member countries, did not want to be blamed for not
giving early warnings on the problems which led to Southeast
Asia's currency crisis.

It said it had warned Thailand as early as June last year,
Indonesia in July and Malaysia in August of the same year.

Claim

The IMF backed up its claim in its latest annual report,
issued last week, which also carries summaries of the IMF
consultations with its member governments last year.

For example, the summary on consultation between the IMF
board of directors and the Indonesian government in July, 1997
reveals the IMF's concern over Indonesia's banking sector.

The report also praises Indonesia for its prudent
macroeconomic management and steady reform.

Some excerpts from the IMF Directors-Indonesia consultation:
"Directors urged the authorities to address weaknesses in the
banking sector, and in particular to act decisively to resolve
the problems of insolvent banks and recover nonperforming loans.
They consider these actions critical in reducing the
vulnerability of the economy to shock and to lessen moral hazard.

"More generally, they strongly urged greater transparency in
policy implementation, especially a regulatory framework and tax
system that provides a level playing field."

But like in Thailand and Malaysia, it apparently took time for
the message to get through in Indonesia.

The Indonesian government announced on Sept. 3 a new package
of reform measures which include more vigorous efforts to bring
the financial sector under control by, if necessary, closing down
insolvent, poorly managed banks and finance companies.