Before I go any further, I must explain how the core of any country’s economy runs around Banks. Banks accept deposits (bank accounts, fixed deposits) from not just the local residents (in local currency), but also from international institutions (which are called ?Loans? (in U.S Dollars)). The Banks also lend money to small borrowers (like you and me) and to the big borrowers like Industries. Banks PAY a lower interest rate (individually, we own just a mere 0.02% of total Bank’s cash trading volume) but CHARGE a high interest rate from industries (as they give away loan in millions). The industries must pledge some assert as collateral (the bank acts like a pawn broker!). So the banks must be careful about whom they loan the money to.
Banks make money from the difference in the interest rates and also by providing other services (for which they charge a ‘small(!) fee’ from the depositors). Banks remain in business even in case of emergencies only because of the mismatch of the time periods of borrowing and lending. Banks accept long term deposits (most of our deposits are long term and can’t be closed soon after opening a bank account). Banks lend money to Industries for a short term (say a year or six months). So, with stable lending, banks will generally always have sufficient money to meet the needs of any emergencies (panic closure of accounts by individual depositors, war etc.).
A Bank’s “assets” are the loans it gives to various companies. If they become “bad”, they turn into Non-Performing Assets (NPAs). “Bad” means, the company fails to return the Principal and the interest or fails to pay the monthly interest or makes heavy losses and hence is unable to return the money.
In Asian Economies, banks have always been under Government control. The industries that the banks should favour, the interest rates that they should charge and the maximum amount they can lend are all fixed by the Government. In such tight Government control, foreign industries find it hard to get loans in local currency, which is why there is such a clamour for deregulation and liberation of the Finance Markets. IMF had always been a staunch advocate of deregulation.
The Asian Governments wanted foreign investment and, hence, industrial development, to provide employment for their citizens and boost their economic growth. Hence, following the IMF’s deregulation drive, East Asian Banks had more capital inflow (through International short-term loans in U.S Dollars) and more autonomy to decide where these funds should be invested in.
This was the root cause of the crisis. Although IMF had given a vague call of deregulation, there were no proper guidelines on how the Government should play its supervisory role to enable the economy to sustain growth. There were no guidelines requesting transparency in the issue of Bank licenses. The domestic market was undeveloped. Most economies had no short term market in local currency and the industries had no choice but to depend on banks for the loans.
Moreover, now Asian Banks had full autonomy to decide whom they should favour for investing. There was no transparency involved in this procedure. Many scams have recently come to light in Thailand, Indonesia where bank officials exploited the financial chimera.
In 1990s, the property sector in Asian countries was booming. Banks, with great short sight, thought this boom would continue for a long period of time and hence invested in this sector (and other selective sectors). Thus, without a diverse assert portfolio (i.e., putting all their eggs in one basket), banks were gambling away most of their short term loans (which they borrowed in U.S. Dollars) in the property sector. The property prices zoomed artificially with the short sighted estimation of the market demand. This created a property bubble which burst in 1997.
When banks had companies that defaulted on their loans, they had NPAs. The banks started taking over the company properties that were pledged as collateral and ended up with much property on their hands. But, by this time, the property prices had crashed. The sale of company properties could hardly cover the interest left to be paid, leave alone the principal. In effect, a total loss of money.
Property is not liquid (it is not easily converted into cash) and when the time neared to pay off their U.S. Dollar debts, the banks had little or no money left (save the local currency). The banks had no way to raise money from the citizens (through the issue of stocks or bonds) as the Governments did not develop a short term market for local currency. The Companies could not raise money either. Smaller companies, which depended on these big companies, started defaulting on their loans too. So, the banks had a pool of NPAs and they themselves were on the verge of bankruptcy.
Thus, due to the concentration of the investments of ALL banks in a select few sectors, the domestic financial systems of Malaysia, Indonesia, Korea and Thailand were on the verge of collapse. Singapore did not deregulate rapidly and strict government control still exists, but many Singapore banks suffered a loss as their investments were mostly in the East Asian Region. One bank (Tat Lee Bank) was merged with another (Keppel). Tat Lee Bank had suffered major losses as most of its investments were in Indonesia.
India did not get affected at all, even though she had just opened up the market for foreign investors. [PDF] There was no move towards rapid deregulation., as Indian public servants had foreseen the catastrophe that would be caused by such rapid deregulation without having a strong domestic structure in place. Indian Government facilitated the creation of a market for raising money through bonds and stocks in Indian Rupees even before the Asian Financial Crisis happened.
My salute to the Indian Mandarins! :)
Disclaimer: I do not claim all this to be true and the ONLY explanation for the Crisis. This is just MY vague overall understanding of the Crisis… I have at least six more weeks with the Asian Financial Crisis! For all you know, I might do an about turn on my views on IMF ;) Update: a>A good link to everything about Asian Financial Crisis