Stock Market Responses to Bank Restructuring Policies During the East Asian Crisis

Abstract

During a crisis of confidence, announcements of deposit guarantees may give market participants short-term comfort. But stock market responses show that using public funds for bank bailouts is not a credible way to restore the health of the financial sector. The East Asian crisis began in Thailand in mid-1997 when an ailing financial sector, a slowdown in exports, and large increases in central bank credit to weak financial institutions triggered a run on the baht. Then the crisis spread to other countries in the region as common vulnerabilities and revaluations of risk in emerging markets triggered large capital outflows. To better understand the impact of different policy responses to financial crises, Klingebiel, Kroszner, Laeven, and van Oijen investigate how stock markets in East Asian countries reacted to the initial policy announcements of bank and financial restructuring—especially how banking and nonfinancial sectors in Indonesia, the Republic of Korea, Malaysia, and Thailand fared in response to announcements of different restructuring measures. They find that prices of bank stocks responded positively to announcements about government guarantees of bank liabilities. Nonfinancial companies gained in value when guarantees were announced, but their stock prices were negatively affected by announcements favoring public recapitalization schemes and generous liquidity support programs. Possibly the market was concerned that public funds per se would not restore the health of the financial sector—that they would not be sufficient or would not be used to restructure bank balance sheets and operations and allow banks to engage in meaningful corporate restructuring. The announcements of increased public support may have been viewed as a signal that the financial institutions were in a financially weaker position than previously thought. This paper—a product of the Financial Sector Strategy and Policy Department—is part of a larger effort in the department to better understand the costs and benefits of different measures for resolving financial crisies. The authors may be contacted at [e-mail] or [e-mail].