The Political Economy of Distress in East Asian Financial Institutions

22 Pages Posted: 5 May 2000

See all articles by Paola Bongini

Paola Bongini

Università degli Studi di Milano-Bicocca

Stijn Claessens

Bank for International Settlements (BIS)

Giovanni Ferri

LUMSA University

Multiple version iconThere are 2 versions of this paper

Date Written: January 2000

Abstract

In the East Asian crisis, connections - with industrial groups or influential families - increased the probability of distress for financial institutions. Connections also made closure more, not less, likely, suggesting that the closure processes themselves were transparent. But larger institutions, although more likely to be distressed, were less likely to be closed, suggesting a too big to fail policy.

Politics and regulatory capture can play an important role in financial institutions' distress. East Asia's financial crisis featured many distressed and closed financial intermediaries in an environment with many links between government, politicians, supervisors, and financial institutions. This makes the East Asian financial crisis a good event for studying how such connections affect the resolution of financial institutions' distress.

Bongini, Claessens, and Ferri investigate distress and closure decisions for 186 banks and 97 nonbank financial institutions in Indonesia, the Republic of Korea, Malaysia, the Philippines, and Thailand. They find that after July 1997, 42 percent of the institutions experienced distress (were closed, merged, or recapitalized, or had their operations temporarily suspended). By July 1999, 13 percent of all institutions in existence in July 1997 had been closed.

Using financial data for 1996, the authors find that:

Traditional CAMEL-type variables - returns on assets, loan growth, and the ratio of loan loss reserves to capital, of net interest income to total income, and of loans to borrowings - help predict subsequent distress and closure.

None of the foreign - controlled institutions was closed, and foreign portfolio ownership lowered an institution`s probability of distress.

Connections - with industrial groups or influential families - increased the probability of distress, suggesting that supervisors had granted forbearance from regulations. Connections also made closure more, not less, likely - suggesting that the closure processes themselves were transparent.

But larger institutions, although more likely to be distressed, were less likely to be closed, while (smaller) nonbank financial institutions were more likely to be closed. This suggests a too big to fail policy.

These policies, together with the fact that resolution processes were late and not necessarily comprehensive, may have added to the overall uncertainty and loss of confidence in the East Asian countries, aggravating the financial crisis.

This paper - a product of the Financial Sector Strategy and Policy Group, Financial Sector Vice Presidency - is part of a larger effort in the group to study the causes and resolution of financial distress.

Keywords: financial sector fragility, early warning systems, East-Asia financial crisis

JEL Classification: G21, G33, G38

Suggested Citation

Bongini, Paola and Claessens, Stijn and Ferri, Giovanni, The Political Economy of Distress in East Asian Financial Institutions (January 2000). World Bank Policy Research Working Paper Series. Available at SSRN: https://ssrn.com/abstract=202050

Paola Bongini (Contact Author)

Università degli Studi di Milano-Bicocca ( email )

piazza dell'Ateneo Nuovo 1
Milano, 20126
Italy
+39 0264483012 (Phone)

Stijn Claessens

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Giovanni Ferri

LUMSA University ( email )

Via della Traspontina
Roma, Rome 00192
Italy

HOME PAGE: http://www.lumsa.it/giovanni-ferri

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