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Sapienza Universit di Roma International Banking Lecture Ten Financial crises Prof. G. Vento Agenda Introduction to financial crises Bubbles The South East Asian ... – PowerPoint PPT presentation

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Title: Sapienza Universit


1
Sapienza Università di Roma
  • International Banking
  • Lecture Ten
  • Financial crises
  • Prof. G. Vento

2
Agenda
  • Introduction to financial crises
  • Bubbles
  • The South East Asian Financial Crisis

3
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

4
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
    collaterals 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

5
1. Financial crises bubbles 2/2
  • Units 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

6
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

7
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

8
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

9
The South East Asian Financial Crisis
10
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

11
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

12
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.)

13
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 countrys
    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

14
2. The South East Asian Financial Crisis (1997
99) The financial sector
  • 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 on-lent 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

15
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 others
    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

16
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

17
Scandinavian Banking Crises
18
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.

19
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.

20
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.

21
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.

22
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.

23
3. Scandinavian Banking Crises Some Policy
Responses in Norway
24
Banking IN USA
  • Next Lecture
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