asian restructuring: from cyclical recovery to sustainable ...€¦ · also reflects excess...

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SINCE THE ONSET OF THE EAST ASIAN CRISIS

more than two years ago, the corporatesectors and financial systems in the cri-

sis economies have remained in severe distress.Nonperforming loans (loans made by the fi-nancial system that are not being fully repaid)have skyrocketed to unprecedented levels: 19percent of all loans and 27 percent of grossdomestic product (GDP) in the Republic of Ko-rea, 20 percent of all loans and 30 percent ofGDP in Malaysia, 45 percent of all loans and60 percent of GDP in Thailand, and over 50percent of all loans and 25 percent of GDP inIndonesia. In contrast, nonperforming loansin other major emerging market crises (Chilein the early 1980s and Mexico in 1995) wereless than 20 percent of GDP. In the Scandina-vian banking crises during the early 1990s,nonperforming loans amounted to approxi-mately 5 percent of GDP. East Asia’s heavyreliance on bank-based financial systems andthe high debt-equity ratios of corporations havemade the economic distress especially acute.

Nonetheless, recovery has begun. Thisrecovery, along with the major policy measuresused to resolve the distress, raises the possi-bility that the process may now work in re-verse: a rising tide may lift all boats. Thatwelcome possibility, however, cannot be pre-sumed. While a strong cyclical recovery maycontinue, the aftereffects of the financial shockwill persist, and continued restructuring isessential both to reinforce that recovery andto reduce future vulnerabilities.

This chapter reviews the evidence on theextent of corporate and financial distress inEast Asia’s crisis countries and the significantprogress made to resolve that distress. It dis-cusses the relative roles of positive macroeco-nomic trends and financial restructuring forcontinued recovery and sustainable growth.It also draws policy lessons for managing cor-porate and financial distress.

The chapter reaches the following con-clusions:

• The ongoing recovery is still fragile anduneven. The externally triggered liquid-ity crisis during the second half of 1997indiscriminately submerged both strongand weak producers and financiers. Therising tide is lifting the strong, especiallythose benefiting from trade growth in elec-tronics products, but the financially weakcontinue to struggle on account of bothcrisis-induced and long standing vulner-abilities.

• Without vigorous corporate and financialrestructuring, the return to sustainablegrowth will likely take longer, the fiscalcosts of the crisis could rise, and the econo-mies will remain vulnerable to new exter-nal and internal shocks. Weak firms inEast Asia operated on thin margins in theyears leading up to the crisis, and theirinability to pay interest following the onsetof the crisis has added to their debt bur-den. Such firms constitute a significant

3Asian Restructuring:From Cyclical Recoveryto Sustainable Growth

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G L O B A L E C O N O M I C P R O S P E C T S

portion of the corporate sector in each ofthe crisis economies, and the appetite toinvest in them is extremely limited. Theywill continue to act as a drag on invest-ment and growth until the financial claimson these firms are resolved, and either theiroperations return to adequate profitabil-ity or their assets are redeployed.

• Recognizing the urgency, East Asian gov-ernments were quick to create an institu-tional structure for corporate and financialrestructuring; they also earmarked fundsfor bank recapitalization. The politicalmomentum for reform has, however,slowed down, in part because the deeperstructural problems now need to be ad-dressed. Experience from other econo-mies, including Japan, shows that aslackening of the reform effort can undoprogress.

• Government restructuring initiatives—though required on many fronts—need tobe guided by two policy considerations:limiting the likelihood of systemic disrup-tion; and clarifying financial claims whilealso facilitating asset reallocation. To con-tain fiscal outlays, these initiatives shouldbe directed principally to honor the so-cial contract to protect bank depositorsand, where necessary, to preserve the pay-ments system and the orderly flow ofcredit. Government funds should notnormally be required for corporate re-structuring.

• Bank restructuring is important becauseit contributes to both policy objectives.Expeditiously restoring the health of thebanking system is required because apoorly capitalized banking sector createscontinued systemic risks and growing fis-cal liabilities for governments. Healthybanks are also best positioned to enforceclaims and to pursue corporate restruc-turing.

• The process of restructuring can itself bedisruptive if it is not carefully managed.Restructuring should be undertaken in amanner that ensures the integrity and the

organizational capital of the financial sys-tem so that prudent lending to businessesand households may continue. Achievingthis objective requires difficult choices.Having provided implicit or explicit guar-antees, governments can either moveahead rapidly by taking fiscal responsi-bility for the costs of the crisis, or theycan encourage private resolution of thedistress while applying regulatory forbear-ance. Waiting to resolve problems is likelyto make them worse. However, expedi-tious and transparent action should beaccompanied by market-based measuresto recoup fiscal costs and to signal cred-ibly a commitment to severely restrictguarantees and bailouts in the future.

• Corporate restructuring needs to deal firstwith the delineation and allocation oflosses. Improvements in accounting stan-dards and bankruptcy regimes can helpsupport this process. However, in the ab-sence of effective bankruptcy procedures,out-of-court procedures offer a mecha-nism for resolution. Once financial claimsare resolved, corporate restructuring canbe expected to occur through naturalmarket forces, except where major impedi-ments prevent such forces from working.Governments can facilitate asset mobil-ity by creating a framework for effectivedomestic and cross-border mergers and ac-quisitions. The Japanese experience cau-tions that, without an adequateframework for resolving claims and forfostering asset mobility, fundamental cor-porate restructuring can be indefinitelydeferred at a high economic cost even ina sophisticated economy.

The uneven recovery

Astrong cyclical recovery is taking placein the crisis economies of East Asia, rais-

ing the possibility that growth may alleviateor even eliminate the corporate and financialdistress. Although the sharp recovery from thedepression-like conditions is expected to con-

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tinue over the short to medium term (see chap-ter 1), its transformation into high and sus-tainable growth will require more than thepresent temporary stimuli: the buildup in in-ventories, low interest rates, and gains fromcurrency depreciation. The recovery has beenuneven thus far, with rapid growth in the hightechnology sectors but more modest growth,and even continued decline, in important seg-ments of the Asian economies. Banking sys-tems, therefore, remain severely distressed. Thecorporate and financial distress can persist,absent vigorous restructuring, because the in-centives to accept and allocate losses are weak.That delay, in turn, can hamper growth byrestraining investment and raising the fiscalcosts of resolution.

The sources of unevennessThe observed unevenness in recovery is notsurprising. “Creative destruction” permits theatrophy of the weak and the shift of resourcesto higher productivity sectors (Harberger1998). For instance, with currencies still be-low precrisis levels, a period of slow growthin the nontradable sectors can be expected.The crisis has also emphasized weaknesses

in the competitive ability of traditional manu-facturing and has had disproportionate ef-fects on small- and medium-size firms.1

Though the unevenness is not surprising, itis important, since weak production perfor-mance contributes to the already massive fi-nancial sector distress and, in turn, hampersgrowth.

Nontradable sectors. The aftermath of thecrisis has seen a sharp decline in the nontradedsectors, where production remains belowprecrisis levels (figure 3.1). This is to be ex-pected because currency depreciations, whichfavor traded goods, reduce the incentive toinvest in the nontraded goods sectors. The poorperformance of nontraded sectors was also afeature of Mexico’s revival from its crisis(Krueger and Tornell 1999). Mexicannontraded production took almost three yearsto reach precrisis levels.

As discussed below, the share of firmsunable to pay their debts is significantly higherin the nontradable sectors than in the trad-able sectors. In Malaysia about three-quartersof the nonperforming loans are to enterprisesin the nontradable sectors. The high distressreflects endemic characteristics. Even prior to

A S I A N R E S T R U C T U R I N G : F R O M C Y C L I C A L R E C O V E R Y T O S U S T A I N A B L E G R O W T H

Figure 3.1 Nontradable production before and after crises

105

Index=100 at the start of the crisis

100

95

90

856543210–1–2–3–4–5–6

Note: The index is a three-quarter moving average.Source: Datastream.

Mexico

Republic of Korea

Malaysia

Precrisis Postcrisis

Quarters

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the crisis, the nontradable sectors had beencharacterized by overcapacity and low pro-ductivity (Crafts 1999), reflecting local mo-nopolies in sectors such as retail trade anddistribution. The Japanese experience showsthat deregulation of domestic trade is impor-tant to spur competition and to increase pro-ductivity (Alexander 1999). Low productivityalso reflects excess capacity in the real estatesector.

Weaknesses in traditional manufacturing.Of all the crisis countries, Korea’s industrialproduction has recovered the fastest, risingabove precrisis levels (figure 3.2). The morerapid recovery in Korea reflects in part itsgreater strengths in sectors such as electron-ics, computers, and telecommunications (fig-ure 3.3). Korean firms have also done well inthe transport equipment sector, whereas Ma-laysian and Thai firms in this sector have suf-fered. Traditional manufacturing sectorswould have been expected to lead the way torecovery in the lower wage crisis countries.In Thailand the textiles sector grew rapidlyfollowing the depreciation, but output hasfallen back to precrisis levels as the currencyhas appreciated. Thai products are having a

hard time competing in export markets (EIU1999b). Traditional manufacturing in Korearebounded only slightly after the crisis, rein-forcing a secular decline that significantly pre-dates the crisis (figure 3.3).

Effects on small and medium-size firms.Small and medium-size firms are suffering dis-proportionately. While aggregate Korean in-dustrial production bottomed out in late 1998,production by small firms continued to fall inabsolute terms until July 1999, resulting in adecline of about one-third from precrisis pro-duction levels. In other countries, where smalland medium-size firms have a greater indus-trial presence, their financial inability to with-stand crisis has proved more of aneconomy-wide setback (see Domac and Ferri1998 for Korea; Domac 1999 and EIU 1999afor Malaysia; Mako 1999 for Thailand). Forexample, more than 50,000 small firms and400,000 households throughout Thailand ac-count for about 50 percent of the country’snonperforming loans (Mako 1999).The inabil-ity to restructure these debts effectively con-tributes to financial sector problems, whichfeed back into continued financial difficultiesfor small firms.2

Figure 3.2 Industrial production before and after crises

110

Index=100 at the start of the crisis

100

90

80

70-24 -18 -12 -6 0 6 12 18 24

PostcrisisPrecrisis

Indonesia

Thailand

Malaysia

Republic of Korea

Note: The index is a three-month moving average.Source: Datastream.

Months

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Even though large firms have been thedrivers of recovery, they—especially the largeconglomerates—also pose systemic risks. InKorea the onset of the crisis was, in part, as-sociated with the collapse of two conglomer-ates, Hanbo Steel and Kia. In Thailand thefinancial troubles of Thai Petrochemicals sym-bolized overinvestment in capacity and exces-sive reliance on external debt. Throughout theregion diversified conglomerates were initiallyregarded as too big to fail, as demonstrated in

the Korean and Malaysian governments’ earlyefforts to support the survival of their largestbusiness groups. However, that perception maybe changing, especially in Korea, as troubleshave mounted at the chaebol Daewoo, wherea creditor-led restructuring is ongoing.

Continued high levels of corporate andfinancial distressThe uneven recovery is reflected in continuedcorporate and financial distress. Two measures


Table 3.1 Corporate distress, past and projected, 1995–2002(percentage of firms unable to meet current debt repayments)

1999 (Q2) 2000– 2000–

1995 1996 1997 1998 2002a 2002b

Country Total Total Total Total Total Manufacturing Services Real estate Total Total

Indonesia 12.6 17.9 40.3 58.2 63.8 41.8 66.8 86.9 52.9 60.8Korea, Rep. of 8.5 11.2 24.3 33.8 26.7 19.6 28.1 43.9 17.2 22.6Malaysiac 3.4 5.6 17.1 34.3 26.3 39.3 33.3 52.8 13.8 17.4Thailand 6.7 10.4 32.6 30.4 28.3 21.8 29.4 46.9 22.3 27.1

a. Estimate, based on the assumption that interest rates stay at their current level throughout the period.b. Estimate, based on the assumption that interest rates regain their 1990–95 averages.c. Malaysian firms in agriculture and utilities bring down the average for all firms in 1999.Note: Growth rates assumed through 2002 are based on IMF projections (IMF 1998).Source: Claessens, Djankov, and Klingebiel 1999; sectoral estimates provided by Claessens, Djankov, and Klingebiel for thispublication.

Figure 3.3 Production index in Korea by industry(1995=100, seasonally adjusted)

120

30

Q2 1996

Source: Datastream.

60

90

150

180

210

240

270

300

Q3 1996

Q4 1996

Q2 1997

Q1 1997

Q3 1997

Q4 1997

Q1 1998

Q2 1998

Q3 1998

Q1 1999

Q4 1998

Q2 1999

Q3 1999

Communication equipment

Transport equipment

Base metals

Paper and pulp products

Computers

ChemicalsFood

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of distress are firms’ inability to meet their debtobligations and the mirror image of that in-ability in nonperforming loans on the balancesheet of banks. These measures rank the levelof country distress similarly. Indonesia has thehighest level of financial distress, whereasKorea and Malaysia have the lowest.3 Thedistress in all four countries is, however, his-torically severe when compared with othercountries that have experienced financialcrises, because of the high levels of bank credit-to-GDP ratios and high corporate debt-to-equity ratios (World Bank 1999). While thesharply lower interest rates should providerelief, several factors, which are likely to per-sist, have kept the distress at high levels.

Interest rates and fiscal distress. Lowerinterest rates are unlikely to suffice in elimi-nating distress. Based on financial statementsof firms listed on stock exchanges, the abilityof firms to meet their current interest paymentobligations can be estimated (table 3.1). Theseestimates need to be interpreted carefully be-cause they are typically based on a smallsample of listed firms for which the most com-plete information is available.

In all countries, the level of distress hadbeen building since 1995. In 1996, even whengrowth was still booming, more than 10 per-cent of firms (except in Malaysia) were alreadyunable to service their debt. The estimatesshow that in the second quarter of 1999 morethan a quarter of listed firms in Korea and

Malaysia were unable to service their currentdebt repayments. In Indonesia almost two-thirds of all firms were under severe liquiditystress (table 3.1). In all countries, distress wasespecially high in the nontraded sectors (ser-vices and real estate), as could be expectedfrom the trends in nontraded production de-scribed in the previous section.

The crisis of 1997 moved many marginalfirms into illiquidity. Moreover, such firmshave accumulated debt since the crisis becausethey have been unable to make interest pay-ments. This suggests that many firms that haverecently emerged from the worst effects of thecrisis are still in a precarious situation and arevulnerable to further shocks. Projections for2000–2002 show that, on current assumptionsof growth rates in the respective countries, asignificant portion of the firms will remain indistress. If interest rates rise from their presentlow levels to their 1990–95 averages, the dis-tress will be even greater.

Interest rates and nonperforming loans.Nonperforming loans increased in the first halfof 1999 despite declining interest rates, andare stubbornly high—at historically unprec-edented levels (table 3.2).4 In Thailand theproblems now center around the commercialbanks because, following their closure afterthe crisis, the assets in nonbank finance com-panies have shrunk to a small fraction of fi-nancial system assets. However, in Korea andMalaysia, the noncommercial bank sector (in-

Table 3.2 Ratio of nonperforming loans to total loans, December 1998–September 1999(percent)

Malaysia Rep. of Korea Thailand

Dec. 1998 June 1999 Dec. 1998 June 1999 Dec. 1998 Sept. 1999

Commercial banks 13.0 12.8 7.4 8.7 42.9 44.6Merchant banks 30.6 31.6 20.0 11.9 — —Other financial institutions 26.8 23.9 13.1 14.5 70.2 62.3Asset management companies 100.0 100.0 100.0 100.0 — —Total financial system 19.7 21.2 16.8 19.2 45.0 45.3

— Not applicable.Note: Nonperforming loans are measured on a gross, three-month basis and include assets carved out for sale by the assetmanagement companies, which by definition have 100 percent of their loans nonperforming. The steps toward sales ofnonperforming loans are discussed later in this chapter.Source: Financial Supervisory Services (Republic of Korea), Bank Negara (Malaysia), and Bank of Thailand.

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surance companies and investment and trustcompanies in Korea, and finance companiesand merchant banks in Malaysia) continuesto account for about a quarter of thenonperforming loans. Projections of contin-ued growth in nonperforming loans stemlargely from the likely increase of such loansin the nonbank financial institutions (see, forexample, Xie 1999).

The decline in interest rates has not beensufficient to provide immediate relief. On thecontrary, especially in Thailand, but also inIndonesia and Korea, nonperforming loansrose even as interest rates fell (figure 3.4).5

Fragile firms, operating on thin margins, ex-perienced a severe decline in their net worthwhen interest rates rose sharply. The sharp fallin output further aggravated the problem.Recovery for the distressed firms will likelybe slow. Experience shows that economicdownturns associated with financial criseshave more enduring consequences than down-turns caused, for example, by inventory-drivenbusiness cycles (Furman and Stiglitz 1998).

Risks of a low-level equilibriumGiven enough time, financial institutions andcorporations can overcome their distress as

stakeholders resolve their claims on assets,even in the absence of formal bankruptcy pro-cedures, and as restructuring is induced bymarket pressures. Without additional shocks,the economies would then return to their newlong-term sustainable growth path, whichcould be lower than the precrisis level (WorldBank 1999). The important issue is: how muchtime? That is, can better management of therestructuring process reduce the costs of thecrisis and the length of the period in a “lowlevel equilibrium”?

A slowdown or mismanagement of therestructuring process raises two concerns. First,continued distress lowers investment, whichlowers growth, and in turn further contrib-utes to nonperforming loans and reduced in-vestment and growth prospects. While rapidrecovery may counteract this negative dy-namic, the evidence cautions against such apresumption. Nonperforming loans are likelyto remain high, and investment rates havefallen sharply, lowering growth prospects inthe short run. Second, strong incentives existfor all parties to wait rather than to resolvetheir problems (box 3.1). Failure to assess andallocate the losses could lead to their social-ization and rising fiscal costs.


Figure 3.4 Thai nonperforming loans and interest rates, June 1998–September 1999

50

45

40

35

30

25

20

18

16

14

12

10

8

6

4

2

0

PercentPercent

June1998

3-month moneymarket rate(right axis)

July1998

Aug.1998

Sept.1998

Oct.1998

Nov.1998

Dec.1998

Jan.1999

Feb.1999

Mar.1999

Apr.1999

May1999

June1999

July1999

Source: Bank of Thailand.

Nonperforming loans ratio(left axis)

Sept.1999

80


Nonperforming loans in East Asia. InThailand nonperforming loans have declinedmodestly from their peak levels. In other coun-tries, however, data up to June 1999 showcontinued growth in nonperforming loans. Anumber of factors contribute to the high levelof nonperforming loans and the possibility thatthey may actually grow in the short and me-dium term. First, the accounting methods inplace have not revealed the full extent ofnonperforming loans, especially in Korea andMalaysia, where nonbank financial companiesare especially important. Poor accounting andfaulty credit analysis masked borrowers whowere often connected to the lending institu-tions and who could not pay but were never-theless able to borrow repeatedly to meet theirdebt obligations. While many of thesenonperforming borrowers have been revealed,some observers believe, for example, thatKorean nonperforming loans could grow byover a third from their present levels beforethey start falling (Warburg Dillon Read 1999).

Second, many firms with thin operatingmargins and high debt levels are endemicallyweak, and thus have been unable to servicetheir debt despite the recovery. Because of thecapitalization of interest, their debt levels havegrown and will remain above precrisis levelsfor a number of years, even under optimisticgrowth scenarios.

Third, announcements of restructuringagreements led to the expectation thatnonperforming loans would fall as a share oftotal bank loans. However, most agreementsare just that—agreements in principle—andwill take time to become effective. More im-portant, and as discussed below, restructur-ing agreements have mainly taken the form ofdeferred debt payments, and there is little evi-dence to suggest that assets have been funda-mentally repositioned. As such, someagreements have proved unsustainable.

Fourth, except in Korea, there has beenvirtually no new lending, implying that banksare not likely to grow out of their bad debt

easily forthcoming. The problem is aggravatedbecause those in distress have an incentive toundertake further risky investments. Their risksare no greater than when they were merely wait-ing for the resolution of past problems. For bothcreditors and debtors, there is the hope that theproblems will just go away when growth resumesor if the government bails them out.

As firms and banks wait for their fortunesto improve, debt continues to accumulate. Thelonger that interest payments are deferred andcapitalized, the higher future growth must be fora company to emerge from negative to positivecash flows. The problem becomes systemic ascorporate distress reduces demand by loweringthe purchases of inputs and by reducing consumerconfidence, further increasing the strain on corpo-rate cash flow and balance sheets. Continuedrestructuring is required to counteract such anegative feedback loop.

Box 3.1 Why distress can persist

T he combination of high corporate financialdistress, unabated banking sector problems,

low levels of investment, and reduced growth ratescan cause distress to persist. In a good equilibrium,several factors go together, including high growth,high demand, rising property values, and an appro-priate level of credit from the financial system. In abad equilibrium, poor corporate performance con-tributes to banks’ nonperforming loans, reducingboth their capacity and willingness to lend. Whenproperty represents a large proportion of the cor-porate balance sheet or important collateral forloans, as in many parts of East Asia, a decline inproperty prices further weighs down recovery.

The private incentives to wait hamper theresolution of the losses. For debtors who haveexperienced large losses in their equity holdings,there is little downside to waiting. They cannotlose much more. For creditors, acknowledging thelosses requires raising new capital, which is not

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problem soon. In Indonesia and Malaysia,deposits have grown significantly in 1999 (fig-ure 3.5), reflecting a confidence in the bank-ing systems, or at least in the governments’ability to meet their obligations to insureddepositors. Increased deposits, in turn, haveimproved banks’ liquidity, but that has not ledto increased lending to the private sector.

Korea, the only crisis country to experience acredit expansion, has also had the strongestrecovery. Such credit expansion will continueto be necessary as Korean firms stopdestocking and start rebuilding their invento-ries. However, with most of the banking sys-tem now owned and controlled by thegovernment, the quality of the lending remains


Figure 3.5 Change in bank deposits and lending to the private sector, December 1998–July 1999

20

10

0

-10

-20

Percentage change

-30

-40

-50

-60Indonesia Republic of KoreaMalaysia Thailand

Note: June 1999 is used for the Republic of Korea.Source: IMF, International Financial Statistics.

Total deposit

Total lending

Figure 3.6 Total investment in East Asia

45

40

35

30

25

20

15

10

5

0Indonesia Republic of KoreaMalaysia Thailand

Source: Datastream; IMF, International Financial Statistics.

Percentage of GDP

Q2 1999

Q1 1999

1998

1992–97 (average)

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a concern. Korean banks hold significant de-posits in the financially fragile investment andtrust companies and have been under somepressure to retain these deposits.

Estimates also suggest that income gener-ated from the difference between lending anddeposit interest rates will not to be enough todeal with the nonperforming loans and therecapitalization of banks in Indonesia andThailand (Claessens, Djankov, and Klingebiel1999). In Korea and Malaysia, the better banksare positioned to grow out of their problems.However, even in those countries, significantdistressed segments will require continued re-structuring and infusion of capital. Koreanbanks, for example, are expected to lose 4 tril-lion won in 1999 to provision against strin-gent asset classification standards and becauseof increased exposure to nonperforming loans.

Fifth, some fraction of nonperformingloans are strategic—that is, borrowers canrepay, but choose not to because they cannoteasily be pursued by their creditors. Accord-ing to informal estimates, the share of strate-gic defaulters in Thailand is between a fifthand a third of all defaulters. This adds to theburden on banks.

Distress, investment, and growth. A highlevel of distress lowers investment and growthprospects. Investment rates have fallen sharplysince the onset of the crisis (figure 3.6). Rela-tive to the average of 1992–97, the investmentrate in the second quarter of 1999 was downby about 57 percent in Indonesia, 40 percentin Thailand, and 30 percent in Korea. Theextent of the fall in investment is greater wherethe ratio of nonperforming loans is higher.Thus, distressed firms, unable to meet theirdebt service obligations, have been unable toobtain credit and to undertake new investment.Healthy firms have continued to invest, includ-ing in restructuring to reposition and insulatethemselves from future crises. The extent ofthe decline in investment in Malaysia is greaterthan may have been anticipated by the rela-tively low level of nonperforming loans andby the low exposure of Malaysian banks andcompanies to foreign currency debt.

Where investment was initially excessiveand misdirected, the fall in investment is de-sirable. However, a prolonged drought in in-vestment could continue to depress growthin the short run and erode competitive abil-ity in the long run. Moreover, the evidenceshows that a decline in investment spendingis associated with reduced consumer confi-dence and reduced consumer spending, thecumulative effect of which is to reduce growthsignificantly.

The fall in interest rates from the highpostcrisis levels should help stimulate invest-ment, though short-term prospects are damp-ened by a recent rise in the costs of capital.During the second quarter of 1999 the invest-ment rate actually increased in Korea andMalaysia (figure 3.6). However, low levels ofinvestment can be expected to continue in theshort term, because significant capacity liesunused, corporate distress is still widespread,and continued uncertainties remain. In addi-tion, the large fluctuations in stock market in-dices since the peaks reached earlier in the year(see chapter 1) and the continuing upwardpressure on government bond yields imply arising cost of capital and a higher discountingof future growth prospects.

A negative feedback loop potentially op-erates: distressed firms weigh down growthprospects, but it is growth that helps the firmemerge from its financial troubles. For ex-ample, a firm that is just able to service itsdebt before a shock and then, following theshock, misses a year’s debt service finds itselfin deeper trouble at the end of the year as theinterest is capitalized. To meet its higher debtservice obligation, the firm must grow sig-nificantly faster than the rate of interest. Fora firm with high dependence on debt, agrowth rate double the interest rate, continu-ously for two or three years, may be requiredto achieve positive cash flows net of interestpayments.

International experience with restructur-ing. International experience suggests thatdelaying restructuring is costly. Studies of fi-nancial crises show that the average recovery

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time back to trend growth rates is 2.8 yearsfor banking crises and 1.5 years for currencycrises (IMF 1998). The time required to re-solve banking crises in Latin America has beenlonger, approximately four to five years (Rojas-Suarez and Weisrod 1996).

The Mexican experience in 1995 and theChilean experience in 1982 offer useful les-sons for East Asia. The Mexican recovery ben-efited from the country’s participation in theNorth American Free Trade Agreement andfrom a favorable international economy.Mexico also took steps early on to resolve itsbanking crisis. The government carved out asubstantial fraction of bad loans in the sys-tem and placed them in a special agency, theFund for the Protection of Bank Savings(FOBAPROA), to be managed and sold.

However, despite its early and impressiverecovery from the crisis, Mexico’s growthperformance since that time has been mod-est, especially in 1999. Growth has beenweighed down especially by the sluggishnessin the domestic economy, including thenontradable sector, and by the unwillingnessand inability of the banks to lend.FOBAPROA was unable to sell virtually anyof the assets it had acquired. More important,the banking sector’s problems were not fullyresolved and nonperforming loans continuedto increase. Krueger and Tornell (1999, 33–34) find that “nonperforming loans are un-likely to disappear on their own, even undera high GDP growth scenario.” The contin-ued presence of nonperforming loans has hurtthe ability of the bank sector to perform itsfunctions adequately, with credit especiallyconstrained to producers selling in the domes-tic market. The authors draw three lessonsfrom their findings. First, the Mexican authori-ties could have been more ambitious in ex-tracting problem loans from the bankingsystem. Second, the government did not takesufficient steps to subsequently discipline thebanking sector, leaving open the prospect offurther bailouts. Finally, Mexico’s bankruptcyprocedures are still ineffective, rendering re-structuring problematic.

In comparison with Mexico’s recovery,Chile’s recovery was much slower. Yet, despitethe slow recovery, Chile has enjoyed robustand sustained growth. What explains the dif-ference? First, although initially slow to rec-ognize the full extent of the problem, Chileanauthorities persisted in their efforts to resolvethe problems of the banking sector, includingundertaking measures to discipline it. Second,Chile undertook far-reaching reforms to fos-ter capital market development and to encour-age greater competition in the economy,especially in nontradable sectors such as in-frastructure.

Mounting fiscal costsThe fiscal costs of the crisis are large (table3.3). These estimated costs are illustrative anddepend upon a number of assumptions, includ-ing the extent of nonperforming loans at theirpeak, the degree to which the nonperformingloans will have some future value, and theinterest rate that the governments will needto pay for the recapitalization funds (as de-scribed in more detail in the next section, table3.7). Keeping in view these limitations, in allcountries plausible scenarios indicate that thebank recapitalization costs are significantlylarge in relation to existing public debt. Onceagain, the extent of Korea’s problem is largebut still modest in relation to that of others,while Indonesia’s problem is the most severe.Korea has had low public debt and, while re-capitalization costs are significant and mayeven grow, the interest burden is modest. Thereported Malaysian recapitalization costs arerelatively small because it is assumed that sig-nificant repayments can be collected fromexisting nonperforming loans. Without theability to collect on nonperforming loans,however, Malaysian debt levels will actuallybe higher.

These higher debt levels can reducegrowth prospects through different channels.By increasing the government demand forfunds, they raise interest rates and, hence,crowd out private investment. Governmentflexibility to act in a countercyclical manner


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is reduced. Higher income and corporate taxrates reduce incentives to invest while highertrade taxes can lead to misallocation of re-sources. Note also that recent analysis hascalled into question the reported budget defi-cit estimates in the crisis countries (Kharas andMishra 1999). The analysis indicates that thetrue budget deficits have been larger than re-ported because activities with significant fi-nancial implications have been undertaken offbudget. In such a context, the rise in the debtlevels could have a more serious impact oninterest rates, government flexibility, and taxrates.

The focal point of restructuring:the financial sector

In contrast to corporate restructuring, whichshould be led by the private sector, finan-

cial sector restructuring is more thegovernment’s responsibility. Major system-wide concerns (safeguarding the paymentssystem and restoring credit availability) andthe potentially large fiscal costs are centeredaround banks and other distressed segmentsof the financial systems. Moreover, throughrestructuring the financial system, govern-ments can facilitate corporate restructuring:healthy and soundly managed financial inter-

mediaries are better positioned to negotiatewith borrowers and to encourage corporaterestructuring than are governments. Govern-ments can also assist corporate restructuringby implementing policies that clarify and en-force financial claims, as discussed in the nextsection.

Governments in East Asia took early stepsto contain the crisis by extending insuranceto depositors and creditors. As the crisis spreadand deepened, this was followed by the estab-lishment of an institutional structure for man-aging the restructuring process and by closing,merging, and nationalizing several banks andnonbank financial companies. Significant re-capitalization funds were committed, some ofwhich have since been disbursed.

The lesson of this crisis, as well as of pastcrises, is that the momentum of governmentaction needs to be maintained, while ensur-ing, whenever possible, that the informationaland organizational capital of the financialsystem is preserved. Forbearance has been usedto permit the graduated attainment of pruden-tial standards, and this can have some impor-tant benefits. Judging by experience, however,continued generalized forbearance runs therisk of increasing the scale of future problems.Because governments have provided extensiveguarantees to bank depositors and creditors,

Table 3.3 Public debt and recapitalization costs as share of GDP, 1998(percent)

Indonesia Malaysia Rep. of Korea Thailand

Public debt, 1996 23.9 35.3 8.0 3.7Public debt, 1998a 72.5 33.3 10.5 14.6Estimated recapitalization costs a, b 58.3 10.0 16.0 31.9

Funds disbursed 10.6 4.2 12.5 23.9Expected additional costs 47.7 5.8 3.6 8.0

Estimated debt after recapitalization 106.6 43.3 26.5 46.6Total interest payment 16.7 3.1 1.9 5.0

Portion for recapitalization 9.2 0.7 1.2 3.4Fiscal surplus/deficit, 1998a 1.4 –1.6 –2.9 –2.8Government bond yield (percent)c 15.7 7.3 7.2 10.8

a. 1997 data is used for Indonesia.b. For details on recapitalization costs, see table 3.6. For Thailand, the fiscal costs in this table include the net costs incurred forthe finance companies (B600 billion) less private resources raised (B250 billion).c. The bank lending rate is used for Malaysia.Source: IMF, International Financial Statistics.

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on balance, it is desirable for governments toassume early responsibility for recapitalization.At the same time, measures to contain the fis-cal burden should be used to signal a commit-ment that the government is serious aboutlimiting further exposure through explicit orimplicit guarantees. These measures includesharing in the upside of nonperforming assetsthat are sold, making it worthwhile for banksto recoup from defaulting debtors whennonperforming loans are left with banks, andprivatizing acquired banks.

Early and stronggovernment involvementThe East Asian economies were quick to be-gin dealing with the banking sector crisis bycreating new institutions, reorganizing the fi-nancial sector, and creating mechanisms forasset resolution and the recapitalization ofbanks.

Institutions for restructuring. An impres-sive array of institutions has been put in placeto deal with corporate and financial restruc-turing (table 3.4). The agencies for voluntary


Table 3.4 Institutional arrangements for corporate and financial restructuring

Voluntary corporate workout Asset resolution company Agency for bank recapitalization

Indonesia Jakarta Initiative Indonesian Bank Indonesian BankTask Force Restructuring Authority Restructuring Authority

Korea, Rep. of Corporate Restructuring Korea Asset Management Korea Deposit InsuranceCoordination Committee Corporation Corporation

Malaysia Corporate Debt Danaharta DanamodalRestructuring Committee

Thailand Corporate Debt Restructuring Financial Sector Restructuring Financial RestructuringAdvisory Committee Authority and Asset Advisory Committee

Management Corporation (funded by the Financial(for nonbank finance Institutions Developmentcompanies) Fund)

Table 3.5 Structural changes in the financial system

Closures State takeovers Mergers

Indonesia 64 banks 12 commercial banks 4 of 7 state banks to be merged(18 percent) (20 percent) into a single bank (54 percent)

Korea, Rep. of 5 commercial banks, 4 commercial banks 9 banks and 2 merchant banks17 merchant banks, and more (25 percent) to create 4 new commercialthan 100 nonbank financial banks (15 percent)institutions (15 percent)

Malaysia None 1 commercial bank, 6 mergers of finance companies1 merchant bank, and 3 financial and commercial bankscompanies under central bank (2 percent)control (12 percent)

Thailand 57 finance companies 7 commercial banks 5 commercial banks and 13(11 percent) and 1 (13–15 percent) and 12 finance finance companies into 3commercial bank (2 percent) companies (2.2 percent) banks (20 percent)

Note: Figures in parentheses refer to percentage of assets in the financial sector.Source: IMF 1999; World Bank country reports.

Source: IMF 1999; World Bank staff.

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corporate workouts and asset resolution haveall been established since the crisis. In Malay-sia the agency for bank recapitalization,Danamodal, is also new. Recapitalization agen-cies in the other countries have been adaptedto deal with the crisis. The contrast with Ja-pan is especially striking. In Japan, recogniz-ing the problem took much longer, but in thecrisis countries of East Asia, the problems weretoo severe to wait.

Reorganization of the financial sector. Eventhough the institutional structures for dealingwith the crisis are similar, the different coun-tries have chosen quite different restructuringoptions. These options range from closing non-viable financial institutions early on and dis-posing of their assets, to retaining the institutionsbut fostering strength through mergers.

The early closure option has been em-ployed in several countries. In Thailand vir-tually the entire segment of finance companieswas closed; in Korea select finance companiesand commercial banks, and many small bankswere closed; and in Indonesia several weakbanks were closed (table 3.5). However, in In-donesia more than 170 banks remain evenafter the closures. Malaysia has not closed anyof the financial institutions and is relying in-stead on extensive mergers of financial insti-tutions; the government expects mergers withgood banks to help resolve the problems ofthe poorly performing banks. The Malaysianplan to mandate the reconstitution of the en-tire financial sector into six groups has givenway to a more flexible, but as yet evolvingapproach.

While Thailand has largely dismantled itsnonbank financial institutions and Malaysiahas decided to merge them into more viable,often parent, banks, Korea has yet to developa strategy for this segment of the financialsector. The close ties between the nonbankfinancial institutions and the Korean chaebolshas complicated and aggravated the restruc-turing task. For example, the absence of earlyrestructuring at the second largest chaebol,Daewoo, led to a significant deterioration inthe financial status of nonbank financial com-

panies. These institutions, moreover, were notsubjected to the necessary discipline and con-tinued to lend to Daewoo, even while its vi-ability was in question. The revelation of thatdebt’s unsustainability casts the main shadowon Korea’s recovery.

Since governments have become substan-tial owners of the banking systems throughtheir direct takeovers and recapitalization ini-tiatives, the reprivatization of these institutionsposes a major challenge that will influence thelong-term structure and performance of thefinancial sectors. So far, efforts at privatizationhave encountered problems, partly as a resultof the continued growth of nonperformingloans, which new acquirers have difficultyvaluing. The recent experience suggests thatdifferences in perceptions of value can be large.The protracted negotiations for the sale ofKorea First Bank centered around the valua-tion of nonperforming loans that had not beencarved out or revealed and on the extent ofcontinued government obligations to assumenonperforming loans following theprivatization. With Daewoo as a principal cli-ent of Korea First Bank, the uncertainties invaluation were not altogether surprising. Thesale of Seoul Bank has, for the present, beendeferred. In Indonesia and also in Thailand,sales of banks have stalled for similar reasons.While several possibilities exist in Thailand,so far in 1999 two small nationalized bankshave been sold, with substantial governmentinjection of funds or commitment to assumeresponsibility for further growth innonperforming loans.

Asset resolution mechanisms. The twoextreme choices for asset management strate-gies include setting up a government agencywith the full responsibility of acquiring, re-structuring, and selling the assets or lettingbanks manage their own nonperforming as-sets. A specialized agency may be requiredwhen the task of dealing with nonperformingloans is fundamentally different from that ofmaking new loans and banks possess limitedmanagement capacity with a comparative ad-vantage in new lending. However, justification

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for that agency to be government-owned and-operated arises either when extrajudicial pow-ers are required to deal with the nonperformingloans problem, or when there exist significanteconomies of scale in asset management thatcannot be realized by private contracting. In-termediate approaches include those employedin Thailand with the government principallyacting as an intermediary for the market-basedsales of nonperforming assets or facilitatingprivate asset management through tax incen-tives.

Governments removed a significant shareof nonperforming loans from the financialsystem and transferred them to governmentagencies: 26 percent ($37 billion) in Korea,66 percent ($28 billion) in Indonesia, and 50percent ($11 billion) in Malaysia (Claessens,Djankov, and Klingebiel 1999).6 In Thailand,the entire assets of 57 nonbank finance com-panies (over $20 billion) were transferred tothe Financial Sector Restructuring Authority,followed by the only significant subsequentresale of nonperforming assets. However, theThai government has not acquired thenonperforming assets of commercial banks.

Government ownership or managementof a specialized asset management companymay be justified if it is given administrativepowers that overcome the higher transactioncosts of the regular bankruptcy and judicialsystem. In Indonesia and Malaysia, the Indo-nesian Bank Restructuring Authority and

Danaharta, respectively, have extrajudicialpowers to receive compensation from debt-ors. Malaysia’s Danaharta also plans to takea more active role in restructuring assets be-fore selling them. Through restructuring of theassets prior to their sale, the expectation isthat value will be enhanced. The evidence onsuccessful restructuring by a government-runasset management company for loans otherthan for real estate is, however, weak(Klingebiel 1999). The realization rate byMexico’s FOBAPROA is expected to be in thelow single digits. The resources and skills re-quired for success restructuring of assets aredemanding. In fact, government agencies canreduce the effectiveness of market-based so-lutions. The terms offered by Danaharta tobanks—for example, special provisioning re-quirements and generous share of recoveredamounts—has implied that private buyers ofdistressed debt have essentially been priced out,thus reducing the space for market-orientedrestructuring.

In Korea, and especially in Thailand, al-ternative market-based approaches are beingattempted. The speed at which the FinancialSector Restructuring Authority in Thailandoperated was noteworthy. The realization rateof 25 percent was low, but there is no evidencethat waiting would have increased it. In Ko-rea, the Korea Asset Management Company,which acquires the nonperforming loans, ex-pects to delegate the task of managing and


Table 3.6 Estimated recapitalization costs for commercial banks, mid-October 1999

Amount disbursed Remainingfiscal costs

Percentage as percentageEstimated costs Local currency U.S. dollars of GDP of GDP

Indonesia 550 trillion rupiah 100 trillion 14 billion 11 48Korea, Rep. of 72 trillion won 56 trillion 47 billion 13 4Malaysiaa 31 billion ringgit 13 billion 3.4 billion 4 6Thailandb 1,121 billion baht 751 billion 11 billion 16 8

a. Estimated costs include those to be incurred by Danaharta for purchasing nonperforming loans (15 billion ringgit) andrecapitalization funds injected by Danamodal (16 billion ringgit).b. Amount disbursed includes significant private sector funding of recapitalization, as discussed in the text.Note: These are illustrative numbers based on varying assumptions of recovery of nonperforming loans, as discussed in the text.Source: Central bank data.

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selling these loans to private contractors. Forcommercial banks in Thailand the governmentis providing special tax incentives to privatelyrun asset management companies.

Recapitalization of commercial banks. Allthe crisis countries have taken significant ini-tiatives toward injecting new funds into theirbanking systems (table 3.6). Except in Thai-land, governments have been the dominantsource of funds. In all countries, however,much remains to be done.

Reported estimates of recapitalizationcosts vary significantly, in part because thestrategies are complex, but also because im-portant judgments are required to arrive at afinal number. First, a judgment is required onwhether nonperforming loans will continue toincrease. Some estimates suggest that they willin both Korea and Malaysia, but have reachedtheir peak in Indonesia and Thailand (WarburgDillon Read 1999). Second, a judgment is re-quired on what fraction of the nonperformingloans will eventually be recovered. This judg-ment is perhaps more difficult to make thanthe first. The estimates of recapitalization costsin table 3.6, which are based on official coun-try sources, assume that the recovery rate onnonperforming loans will be around 50 per-cent in Korea and Thailand, about 70 percentin Malaysia, and less than 25 percent in Indo-nesia. The range reflects assumptions abouteconomic growth and interest rates and alsoabout the intrinsic worth of those assets. Auc-tions of distressed assets conducted in Koreaand Thailand caution that the realization ratesmay be lower than currently anticipated. Inboth countries real estate loans have sold forabout 50 percent of the original value of theloan. Loans based on automobile hire-pur-chase contracts have been similarly discounted.Commercial or business loans have fared sub-stantially worse, with realization levels typi-cally in the 20 percent range. When all loanssold are added up, the realization rate in Thai-land has been approximately 25 percent.

The pressure on Thai fiscal resources hasbeen mitigated through private efforts to raisecapital, which has amounted to about B250

billion, or about one-third the amount so fardisbursed. The Thai government has set asideB300 billion in a scheme to provide matchingfunds for privately raised capital. However,only B32.5 billion have been used by privatebanks because the government funding wastied to management changes, which has ledto private solutions. Privately funded recapi-talization through equity issues and innova-tive debt instruments has, therefore, been moreextensive in Thailand than elsewhere. Whilesuch private solutions are desirable, thus farthey have resulted in high costs of funding,which is unlikely to heal the cash flows of thealready distressed banks.

Government funds for augmenting thebalance sheets of banks have been the small-est in Malaysia, where about RM13 billion(4 percent of GDP) were disbursed by July1999 through Danaharta’s purchase ofnonperforming loans and through capital in-jections via Danamodal. Malaysia’s smallercosts in relation to GDP reflect both thesmaller shock Malaysia’s financial system facesrelative to other countries and the precrisislevels of capitalization, which were, on aver-age, higher than in the other crisis countries.However, costs will be greater if thenonperforming loans continue to rise, as someobservers expect, and also if the realizationrates on these loans are lower than those cur-rently assumed. For funding the recapitaliza-tion, Malaysia has relied on zero-couponbonds—that is, on bonds that pay no intereston an ongoing basis. While this alleviatesshort-term fiscal costs, the repayments will bebunched and, therefore, presume either sig-nificant economic growth or the continuedability to roll over the debt.

Complex tradeoffs for policymakersWhile the achievements thus far have beensignificant, major challenges remain. Largesegments of the banking systems remain un-dercapitalized and, except in Korea, bankshave been reluctant or unable to increase theirstock of loans. The institutional structure cre-ated to deal with the crisis has few “sticks” to

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force the pace and has, consequently, not coun-teracted creditors’ and debtors’ natural ten-dency to wait (box 3.1). With fiscal costs risingand some of the more difficult problems stillahead, governments face the complex task ofmanaging their fiscal costs while also ensur-ing the continued integrity of, and in somecases the strengthening of, their countries’ fi-nancial systems. Yet experience has shown thata loss of political momentum in dealing withthe problems is only likely to aggravate them.

Forbearance versus recapitalization. Inthe wake of a crisis, the objective of bank re-structuring should be to maintain the flow ofcredit while ensuring that the new lending isprudent (Stiglitz 1999). Achieving this objec-tive presents different options. Lending couldbe encouraged by exercising regulatory for-bearance. However, the evidence does notsuggest that simply encouraging voluntaryworkouts while engaging in regulatory for-bearance leads to a resumption of lending. Infact, the experience from past systemic criseswarns that forbearance without tight over-sight could make matters worse. At the sametime, the alternative strategy of government-financed recapitalization could stimulate newlending, but may entail large fiscal costs andmay reduce incentives for prudent lending.Both forbearance and government bailoutsmay undermine the regulatory challenge ofbuilding a sound and competitive financialsystem.

While all countries have updated their fi-nancial sector regulatory systems to be morein line with international reporting standardsand prudential norms, varying degrees of regu-latory forbearance are in place to permit agraduated achievement of these norms. Theseapply, for example, to the following:

• Less stringent recognition of nonperform-ing loans (as in Malaysia, where loans areconsidered nonperforming if they have notbeen serviced for six months rather thanthree months elsewhere)7

• Relaxed provisioning against the non-performing loans (as in Korea, where

loans considered restructured have verylow provisioning when, in fact, they re-main extremely risky)

• Breathing room to achieve capital ad-equacy standards (especially in Indonesiaand Thailand).

There are important reasons for exercis-ing forbearance. First, bank restructuring andcorporate restructuring through a workoutprogram are inextricably tied to each otherwith respect to incentives. The banks need tohave incentives to take the debtors throughthe workout process, which is often difficult,protracted, and costly. Also, workouts oftentake place while the bank itself is undergoingrestructuring and is under severe pressure tomeet capital adequacy ratio requirements.Banks need to be encouraged to reach a re-structuring agreement with the debtor that isrealistic and that matches the debtor’s abilityto repay. Reassurances from regulatory au-thorities of capital adequacy forbearance canhelp. Otherwise, banks will be tempted topaper over their agreements with their debt-ors and not to recognize the true extent ofpotential portfolio losses. As such, initial for-bearance may have been the most realistic re-sponse to systemic crisis and simultaneousdistress among hundreds of large corporationsand thousands of smaller ones. Second, in theabsence of forbearance, the alternative maybe to close down an institution, which cre-ates a bankruptcy cost—that is, the constitu-ent elements of a closed institution may sellfor less than the institution’s value as an on-going entity.

However, the evidence suggests that, whileselective forbearance of relatively sound banksand securitized transactions may be appropri-ate, continued generalized forbearance couldultimately prove costly. The timely adoptionof more stringent accounting standards forrestructured debt is needed. Forbearance doesnot create stronger balance sheets, which arerequired to meet the new working capital needsof firms in distress. Rather, it dilutes the banks’incentives to negotiate more forcefully with


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the controlling shareholders of distressed cor-porations and leads to an unrealistic assess-ment of recapitalization needs. The over-whelming international experience is thatforbearance, on balance, works to delay, butnot to heal (Kane 1989; Brinkmann, Horvitz,and Huang 1996; and Sheng 1996).

Government financed recapitalization alsopresents difficult tradeoffs. Early recapitaliza-tion can release capacity for new lending thatpermits a broad-based recovery. “An essen-tial element of banking reform is recapitaliza-tion of the banks with enough income earningassets to leave a prudential capital base in placeafter provisioning for bad loans” (vanWijnbergen 1998, 11). However, recapitaliza-tion of the financial system generates not onlyimmediate fiscal costs, but also creates a moralhazard for the future. Early resolution of theproblems is favored, because the dilemma cantypically be expected to worsen. Firms withheavy debt burdens, unable to obtain new fi-nancing and hence unable to grow, find theirdebt burden increasing over time, thereby in-creasing the extent and severity of nonper-forming loans at banks (Stiglitz 1999). Delaysmay also contribute to a culture of debt de-fault, further aggravating both the size of theproblem and the uncertainties in the timingof government outlays.

Under the circumstances, an early recog-nition of the governments’ fiscal obligationsis needed not just to honor their commitmentsto depositors, but also to create the basis formarket-led restructuring. To protect depositors,banks can, for example, be “paid” with gov-ernment bonds, the interest on which can becombined with a portion of the net earningsto service the interest claims of depositors.Bonds should also be tradable to permit re-payment where depositors decide to take theirsavings elsewhere. At the same time, as safeassets, the bonds on the balance sheet of thebanks would greatly improve the capital of thebanks. This should improve the incentives ofbanks to recognize losses without fear of de-pleting capital to an unsustainable level. Suchrecognition should, in turn, improve the effi-

ciency of the corporate restructuring process.In addition, if governments can credibly com-mit to refrain from further bailouts, incentivesfor further risky lending would decline.

Recovering recapitalization cost. The costof recapitalization can be lowered throughincentives to encourage increased reflows fromthe nonperforming assets. Government sup-port could be conditional on contractual pro-visions that share in the success if asset valuesrecover. For example, when Chrysler Corpo-ration was bailed out in the United States, thegovernment obtained warrants as a quid proquo that could be exercised at favorable valuein the event of a recovery. Similarly, when abank retains a nonperforming loan to benefitfrom government recapitalization, the pro-ceeds from any recovery could be shared withthe bank managing the loan. Such a provisionwas used in Chile. Finally, the privatizationof government-acquired banking institutionsremains a priority, both to recover fiscal out-lays and to lay the foundation for private riskbearing. Especially in Malaysia, which envis-ages an extensive merger program, but also inother countries the objective of containing fis-cal costs and restructuring the banking sectormay be combined. In place of administrativelymandated mergers, governments could use thesale of their ownership stakes to promotemarket-based mergers.

The role of deposit insurance role in cri-sis situations.8 An explicit system of depositinsurance put in place when the banking sys-tem is in sound health should, in the event ofa crisis, deal with its obligations early to con-tain the crisis. However, extending the systemof deposit insurance after the onset of a crisiscreates bad incentives (Garcia 1999). In Indo-nesia unconditional and comprehensive guar-antees were extended to all parts of the system,which was soon revealed to have deep-seatedproblems. Guarantees were even extended tosome depositors of the 16 banks that had beenclosed down before the guarantee scheme wasannounced. In Thailand a July 1997 cabinetdecision partially guaranteed depositors andcreditors of the 57 finance companies that were

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subsequently closed down; this was followedby a blanket guarantee covering all deposi-tors and creditors of the remaining financecompanies and commercial banks (IMF 1999).Evidence from other postcrisis situations sug-gests that imposing losses on depositors andcreditors need not lead to panics and bankruns.9

Corporate restructuring: someprogress, but a long way to go

Government funds are not required for cor-porate restructuring, and their supply

may even hinder private resolution as stake-holders are induced to seek these subsidies.The proper role for governments is to facili-tate resolution of financial claims and fosterthe reallocation and mobility of assets. In theabsence of efficiently functioning systems toresolve financial claims, governments in all thecrisis countries have instituted out-of-courtmechanisms to encourage financial settle-ments. Beyond these immediate measures, butalso aiding in the short term, are ongoing ef-forts to achieve effective bankruptcy regimesand improved accounting standards. Once fi-

nancial property rights have been clarified, themarket system and the private sector shouldbe in a position to undertake the required re-allocations of productive assets, but govern-ments can play an important role in permittinggreater asset mobility. The Japanese experi-ence shows that without fundamental reformsto foster asset mobility through bankruptcyprocesses and mergers and acquisitions poli-cies, corporations may be slow to undertakesignificant restructuring (box 3.2). That ex-perience, though, also shows that success re-quires continuing procedural innovation andadaptation to meet the evolving needs of thecorporate sector.

Slow resolution of financial claimsImmediately following the crisis, governmentsin the crisis countries helped establish out-of-court mechanisms (see table 3.4) that couldspeed up the settlement of financial claims inthe absence of bankruptcy regimes able tohandle the large-scale distress. These mecha-nisms have been slow to produce results, inpart because they depend on moral suasion.However, progress has been achieved in Ko-rea and Malaysia. At the same time, account-


Table 3.7 Restructuring: out-of-court and in-court progress, August 1999

Indonesia Malaysia Rep. of Korea Thailand

Out-of-court proceduresAll or the majority of financial institutions No Yes Yes Yes signed on to accordFormal process of arbitration exists, with deadlines No Yes No YesProvision of penalties for noncompliance No No Yes Yesa

Out-of-court restructuringsNumber of registered cases 234 53 92 825Number of cases started 157 27 83 430Number of restructured cases 22 10 46 167Percentage of restructured debt in total debt 13 32 40 22

In-court restructuringsNumber of registered cases 88 52 48 30Number of cases started 78 34 27 22Number of restructured cases 8 12 19 8Percentage of restructured debt in total debt 4 .. 8 7

.. Not available.a. In Thailand, penalties for noncompliance were introduced in August 1999 for creditors who had signed intercreditoragreements.Source: Claessens, Djankov, and Klingebiel 1999.

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Bankruptcy. Until the early 1990s, approxi-mately 15 percent of broadly defined business fail-ures involved formal bankruptcy proceedings. Theproportion has risen in recent years to 30 percent, aslarger firms are now failing. These firms are morelikely to prefer the protections and safeguards ofcourts over the cheaper and faster proceedings ofprivate negotiations. For small firms, private proce-dures typically implied a freezing of credit and thecessation of operations, which is the worst possiblesocial outcome.

Gatekeeping procedures in Japanese law andregulations act as a barrier to court actions. Advancedeposits for court costs are especially onerous forsmall firms. Japanese courts can take a few monthsto determine if a bankruptcy petition meets certainconditions, and they do not issue an automatic stay,rendering firms vulnerable to raiding by creditors.

Several changes are being proposed to makebankruptcy procedures more efficient. In April 1998the Justice Ministry proposed revisions to integratethe five laws governing corporate bankruptcy into asingle law. Many of the changes are aimed at makingformal bankruptcy more accessible to small firms.Officials have sought to enhance the prospects ofreorganization rather than liquidation. The currentlaw permits applications for reorganization onlyafter a firm is virtually insolvent, favors change in

Box 3.2 Redeployment of assets:lessons from Japan

Restructuring in Japan is finally beginning underthe immense pressures of a long recession, but

it is being helped by improved regulations govern-ing bankruptcy and mergers and acquisitions. Japa-nese businesses are restructuring at a faster pacethan during past economic downturns. Mergers andacquisitions are occurring in numbers unprec-edented for Japan, while the debt associated withbankruptcies has also hit new highs. The unem-ployment rate is at a postwar peak, with more than1 million jobs lost in the last 18 months alone. Thiscontrasts with the 1990–91 recession, when Japa-nese firms were much more reluctant to reducetheir work force. Companies are also sheddingcross-held shares and major corporations are shut-ting down subsidiaries, closing operations, andselling off unprofitable businesses.

The Japanese experience offers several les-sons. Delays in restructuring weak banks andcorporations can contribute to long periods of lowgrowth. Absent active governmental effort, aninadequate institutional infrastructure for resolv-ing financial claims can persist even in an indus-trial country. Moreover, effective redeployment ofassets through bankruptcy processes and mergersand acquisitions requires an ongoing adaptationof regulations, and changes in business practices,as constraints are revealed.

ing standards and bankruptcy systems, whereneeded, have been reformed, which may alsohelp resolution of financial claims in the shortrun and may provide a sounder basis for im-proved corporate governance in the long run.

Voluntary workout mechanisms. Volun-tary mechanisms rely on the so-called LondonApproach and provide a framework withinwhich claims can be settled.10 While the de-tails vary across countries, their main featuresinclude: binding agreements on the part ofbanks to participate in and honor the agree-ments, with some possibility of penalties ifagreements are not adhered to; timetables to

achieve resolution; and standardized agree-ments between debtors and creditors and,equally important, between creditors them-selves. The main characteristics of such mecha-nisms across countries and their achievementsare described in table 3.7.

Korea and Malaysia appear to have ben-efited the most from these out-of-court mecha-nisms, in part because they have more bindingagreements among banks. In Korea, penaltiesexist for noncompliance, while Malaysia haswell-defined implementation schedules. Thaiprocedures, though similar to those of Ma-laysia, have achieved less, reflecting the deeper

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problems of Thai restructuring and the rela-tive weakness of the bankruptcy regime in thatcountry. Stronger procedures recently includedin Thailand—penalties for noncompliance bycreditors who have signed intercreditor agree-ments—should help force the pace.

While the progress achieved is significant,it is premature to judge the quality of theserestructurings and the impact that they willhave on the debt resolution problems. A wait-ing strategy is reflected in the use of instru-ments that postpone the repayment of debtand has been especially evident in, though notconfined to, Malaysia. The Malaysian Corpo-

rate Debt Restructuring Committee, whichoversees the voluntary debt workout program,had, by June 1999, helped reschedule approxi-mately RM11 billion of debt (EIU 1999a). Ofthat amount, RM8.5 involved the issuance ofa seven-year zero-coupon bond to purchasethe existing debt of Renong Corporation andits subsidiary, United Engineers Malaysia. TheRatings Agency of Malaysia has assessed thatRenong and United Engineers Malaysia willbe unable to pay the debt and would, conse-quently, need to refinance 60 percent of thedebt outstanding at the time the bond matures.According to Claessens, Djankov, and


management, and requires a reorganization plan atabout the same time as the bankruptcy petition.Under the proposed approach, companies couldapply to the courts for protection with more oftheir assets intact, keep their management in place,and receive more time to draw up a turnaroundplan. Also included in the proposal is the shorteningof the period of asset assessment from the currentthree to seven months to one month. Other changescall for greater information disclosure and removalof barriers to selling parts of a company.

Mergers and acquisitions. Mergers and acquisi-tions are on the rise in Japan, though their impor-tance to the economy is still a small fraction of thatin the United Kingdom or the United States. Thevalue of foreign takeovers in Japan rose from $1.1billion in 1997 to $6.9 billion in 1998, and thenshot up to $7.1 billion in just the first quarter of1999. Similarly, domestic mergers and acquisitionshave also risen briskly.

For years, mergers and acquisitions were amark of failure associated with companies on theverge of bankruptcy, but there were also real eco-nomic barriers. The lack of transparency in thebooks of potential targets was a serious problem.For example, a department store with a strongfranchise and substantial real estate assets foundno buyers because the scale of off-balance sheetguarantees provided by the store was large anduncertain. Another problem was the widespread

system of cross-shareholding. The practice of mu-tual shareholding, initiated in the 1970s, was de-signed explicitly to ward off undesiredacquisitions.

However, economic forces are eroding barriersto mergers and acquisitions, aided by the decline incross-shareholdings and facilitated by regulatorychanges. Many Japanese companies, especially fam-ily-owned businesses established in the early post-war period, are seeking injections of capital, asoperating losses and write-offs of bad assets havebeen a drain. Cross-shareholdings are being elimi-nated, as the returns on these equity holdings havebeen persistently low or negative. At the same time,many regulatory constraints on business activitiesare being removed, and specific measures to facili-tate mergers and acquisitions are being instituted.For instance, a 1997 amendment of the CommercialCode by the Japanese Diet reduces the number ofshareholder meetings to approve mergers. TheHolding Company Law of 1997 removes constraintson carving out subsidiaries for sale and allows buy-ers more freedom in structuring their acquisitions.The securities transaction tax formerly requiredwhen an acquisition involved share purchases wasdiscarded in April 1999. In addition, the moves tointernational accounting principles and, in particu-lar, consolidated reporting, are bringing more trans-parency to the operation of subsidiaries.

Source: Alexander 1999.

Box 3.2 (continued)

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Klingebiel (1999), two-thirds of the restruc-turing agreements in Korea involve a combi-nation of interest rate reduction, capitalizationof the interest rate, and longer grace periods.11

In Thailand the quality of the restructuringagreements has been such that 13 percent ofthe restructured debts have already revertedto nonperforming status. Note also that re-ported nonperforming loans do not yet regis-ter the impact of agreements. This may partlyreflect a statistical reporting lag, becausenonperforming loan data may not yet havebeen updated to reflect the agreements, orbecause weaknesses exist in the agreementsthemselves.

Bankruptcy reform. By creating a legalbasis and orderly mechanisms for the resolu-tion of debt defaults, bankruptcy procedurescan provide the stick that complements vol-untary restructuring initiatives in the crisiscountries. Effective bankruptcy systems shouldresolve the conflicting claims of stakeholderson the assets of insolvent corporations. Theyshould help preserve and quickly restructureviable firms as ongoing entities and shouldresult in the expeditious liquidation of nonvi-able firms.

Indonesia and Thailand have implementedsignificant legislative changes since the onsetof the crisis. Korea and Malaysia, in contrast,have relatively sophisticated bankruptcy codes.In Korea, the law, though well established, isalso thought to be complex in its implemen-tation and to favor debtors excessively (seeThe Economist 1999). Thus, except in Ma-laysia, the bankruptcy process is unlikely toplay a significant role in resolving the presentdebt overhang.

To a greater extent than in other coun-tries, procedural capacity in Indonesia remainsa bottleneck to the effective enforcement ofinsolvency laws. In August 1998 Indonesiaamended its bankruptcy legislation, creating,in particular, a specialized commercial courtwith jurisdiction over all bankruptcy-relatedmatters and subject to review only by the Su-preme Court (Mojdehi and Ito 1998). Theamendment also created expedited timetables

and introduced a stay provision similar to thatunder the U.S. Bankruptcy Code. At the sametime, the voluntary workout mechanism un-der the Jakarta Initiative Task Force (see table3.4) is helping to develop precedents for deal-ing with complex debt renegotiations. In prac-tice, however, the amended bankruptcy lawhas not succeeded in alleviating the widespreadcorporate and financial distress. Realistically,the bankruptcy court can help only modestlyin the present crisis by pronouncing in a con-sistent manner on a select number of cases.The vast majority of the 15,000 nonper-forming loans will be settled out of court.

The early workings of a new bankruptcyregime is expected to be frustrating. In adopt-ing a comprehensive bankruptcy law, Hungaryexperienced a crush in the tumult of the earlypostcommunist years. Due to an automatictrigger that required all firms with arrears ofmore than 90 days to file for either reorgani-zation or liquidation, Hungarian courts wereoverwhelmed by some 22,000 bankruptcycases soon after the law’s enactment (Gray,Schlorke, and Szanyi 1996, 425). While theexperience “indisputably spurred institutionbuilding in the courts, the trustee profession,and the banks,” during a crisis, the formaljudicial process will clearly be overwhelmedin most developing and transition countries.

The Thai experience, however, shows that,despite the many constraints, pushing aheadwith improvements in bankruptcy code pro-cedures can bring benefits. In Thailand a con-troversial piece of legislation has sought toenforce the rights of creditors more forcefully,including enforcing rights to personal guar-antees that served as collateral. A study ex-amined the relationship between the progressof Thai bankruptcy legislation and the equityvaluation of financial and nonfinancial com-panies (Foley 1999). Announcements indicat-ing a potential strengthening of bankruptcylaws enhanced the equity values for both debt-ors and creditors. In other words, market par-ticipants do not view a stronger bankruptcylaw as a zero-sum outcome where creditorsgain and equity holders lose. Rather, both can

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gain, though creditors are likely to benefitmore. The positive gain for all parties impliesthat inefficient and protracted bankruptcy pro-ceedings have a real economic cost.

A short-term agenda for bankruptcy re-form requires further development of infor-mal, extrajudiciary processes to resolveproblems, in parallel with and as a comple-ment to, the formal insolvency process. Inaddition to the government-sponsored work-out mechanisms, prepackaged bankruptcyprocedures can speed things up. Under pre-packaging, the parties involved agree to theterms of the workout, and the court then usesan expedited procedure to bind a dissentingminority and to formalize the agreement. Per-haps more so than in industrial countries, out-of-court settlements may also include methodsfor auctioning the rights to the firm (seeBebchuk 1996; Hauch and Ramachandran1999). Auction procedures can help both tomaintain seniority among creditors and toreveal the value of the firm.

The bankruptcy process is especially proneto fraud, and the absence of adequate account-ing standards makes the difficult problem ofasset valuation even more complex. This un-

derscores the urgent need for accounting andcorporate governance reforms. A more imme-diate task may be to create greater transpar-ency in the appointment of judges and torequire the publication of decisions along withdetailed rationales for those decisions.

Enhanced asset mobilityOnce the financial claims on a company areresolved, market-driven mechanisms will prob-ably reallocate the resources to their best uses.Additional government interventions may,however, be justified by the existence of insti-tutional and market failures, such as monopo-lies and weak competition, cross-holdings andconnected lending, or labor market rigidities.These imperfections, which were often thesource of resource misallocations prior to thecrisis, also now hinder the required process ofreallocation.12

Of special importance are policies facili-tating mergers and acquisitions and encour-aging foreign direct investment. East Asiangovernments have taken several steps to en-courage mergers, both international and do-mestic. Also, foreign investment has beenliberalized in all the countries, though to vary-

Figure 3.7 Cross-border mergers and acquisitions, Q1 1997–Q2 1999

0Q1 1997 Q2 1997 Q3 1997 Q4 1997 Q1 1998 Q2 1998 Q3 1998 Q4 1998 Q1 1999 Q2 1999

2

4

6

8

10

12

14

16Number

Note: Cross-border transactions involve majority foreign ownership.Source: Securities Data Company.

Indonesia

Republic of Korea

Malaysia

Thailand

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ing degrees. As with bankruptcy, success ofmergers and acquisitions depends heavily onprocedural simplicity and clarity (see box 3.2on the Japanese evolution in this respect).Reforms following the crisis also includedshort-term tax measures to facilitate assettransactions and, more importantly from along-term perspective, better accounting stan-dards, which should contribute to improved

corporate governance through better evalua-tion of financial assets and liabilities (table3.8).

Mergers and acquisitions. Since their cri-ses in 1997, Korea and Thailand have intro-duced various measures to encourage businessconsolidation, leading to a rapid rise in cross-border mergers and acquisitions in these twocountries (figure 3.7). The Korean government

Table 3.8 Illustrative postcrisis policy reforms in crisis countries

Corporate governance Loss allocation and transfer Factor mobility

Indonesia Presence of a corporate Tax exemptions for loan-loss Relaxation of foreign ownershipsecretary to improve disclosure reserves held by banks restrictions (September 1997)Bankruptcy Law updated (March 1998) Tax exemptions of up to(August 1998) 8 years for new investmentsCode of best practice for in 22 industries (January 1999)corporate governance(in progress)

Korea, Rep. of Restrictions on cross-debt Revaluation and adjustment Introduction of Foreignguarantees (April 1998) of capital and foreign Investment Promotion ActEnhancing institutional exchange losses (November 1998)voter rights (June 1998) (August 1999)Introduction of internationalaccounting standards(August 1999)Lowering the minimum equityholding requirement to exerciseshareholder’s rights (1999)

Malaysia Creation of High-Level Reduction of corporate tax Reduction of real property gainsFinance Committee on rate from 30 percent to tax rate from 30 percent toCorporate Governance 28 percent (October 1997) 5 percent for nonresidents onCode on takeovers and mergers Tax exemption on interest the sale of a property held forwith stricter disclosure from NPLs (effective a minimum of five yearsstandards (January 1999) for 1999 and 2000) (October 1997)

Exemption of real property gainstax on mergers of financialinstitutions (October 1998)

Thailand Financial statements of public Elimination/deferral of income Alien Business Law (Augustcompanies and financial tax and taxes on asset transfer 1998, revised in October 1999)institutions to be in accord with and unpaid interest Tax-free mergers and acquisitionsinternational best practices (January 1999) in cases of 100 percent mergers(1999) Introduction of new asset (January 1999)Requirement of board audit depreciation method Introduction of Equity Fund,committees (1999) (March 1999) Thailand Recovery Fund forBankruptcy and foreclosure large- and medium-scalelaws amended (March 1999) companies, and Venture Capital

Fund for small and medium-sizeenterprises (March 1999)Reduction of real estate transferfee from 2 to 0.01 percent of theappraised value (March 1999)

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released a new legislative framework in July1999 to reduce transaction-related taxes in-curred in corporate mergers, acquisitions,and restructurings. For domestic transactions,the government has provided tax exemptionsand deferrals on capital gains from so-called “big deals”—that is, exchange of busi-nesses through the transfer of shares. Thai-land approved a set of new measures inJanuary 1999, including temporary measures(expiring on December 31, 1999) to lowertaxes on gains to debtors from the write-offof debts and on asset transfers from debtorsto creditors. Permanent measures in Thailandare designed to facilitate mergers and businessreorganization.

Unlike in Korea and Thailand where cross-border mergers have shot up, in Malaysiacross-border mergers and acquisitions havebeen low compared to just prior to the crisis.Malaysia has, however, had high levels ofdomestic mergers and acquisitions.13

Malaysia’s Promotion of Investment Act of1986 and other measures provide various taxincentives, including investment tax allow-ances in the services sector. The high level ofdomestic merger and acquisitions activity inMalaysia suggests that the policy regime isbasically a friendly one. Cross-border activityhas been relatively low, possibly on accountof restrictions on the repatriation of earnings(though the long-term effects of these restric-tions await further empirical examination).14

In contrast, the Indonesian system appearsnot to favor mergers and acquisitions. Gainsfrom transfers of assets in corporate reorga-nizations are taxable, and companies cannot

transfer tax losses in a liquidation process,merger, or acquisition (Asia Law 1998). Cer-tain exceptions apply only to banks, financialinstitutions, and companies going public.Merger and acquisitions activity has remainedat extremely low levels.

Foreign direct investment. Foreign directinvestment (FDI) inflows to Korea and Thai-land increased in 1998 by 82 percent and 26percent, respectively, and flows to these coun-tries continued at high levels in 1999 (table3.9). Both countries have taken effective mea-sures to deregulate and liberalize their foreigninvestment policies since late 1997. Note,however, FDI includes mergers and acquisi-tions involving existing enterprises as well asnew, or greenfield, investments. The FDItrends, therefore, reflect in part the trends incross-border mergers and acquisitions de-scribed in the previous section (figure 3.6).

Korea has opened several sectors to for-eign investors since April 1998, including vari-ous property businesses, securities dealings,and other financing businesses. The ceiling onforeign stock investment was abolished as ofMay 1998, granting foreign investors the rightto purchase all the shares of a domestic firm.Meanwhile, the Foreign Investment PromotionAct of November 1998 affords protection forforeign direct investment through nationaltreatment, the reduction and exemption ofcertain corporate taxes, the provision of fi-nancial support for local governments to at-tract foreign direct investment, and theestablishment of foreign investment zones.

In Thailand the Board of Investment haseased its regulations to promote foreign par-

Table 3.9 FDI flows in East Asia, 1992–99(billions of U.S. dollars)

1992 1993 1994 1995 1996 1997 1998 Q1 1999 Q2 1999

Indonesia 1.8 2.0 2.1 4.4 6.2 4.7 –0.4 –0.03 —Korea, Rep. of 0.7 0.6 0.8 1.8 2.3 2.8 5.1 1.0 1.8Malaysia 5.2 5.0 4.3 4.1 5.1 5.1 5.0 — —Thailand 2.1 1.8 1.4 2.1 2.3 3.8 6.8 1.0 2.2

— Not available.Source: World Bank Debtor Reporting System; IMF, International Financial Statistics.


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ticipation in the economy. The 20-year-oldAlien Business Law was replaced in August1998 (and has since been revised again inOctober 1999) to incorporate sectoral liber-alization measures. Under the August 1998provisions, foreign firms are allowed to holdup to 100 percent equity in banks and in fi-nance companies for up to 10 years, and 39sectors have been opened for increased for-eign participation, including transportationand pharmaceuticals production. Policy lib-eralization includes a temporary measure in-troduced in November 1998 (expiring inDecember 1999) allowing foreign firms to owna majority stake in joint ventures that receivedfavorable policy treatment, and authorizingthem to distribute their products domestically.In the meantime, the proposed cutback ofimport tariffs is expected to help reduce pro-duction costs for both domestic and foreignfirms dependent on imported raw materialsand intermediate products.

Mirroring the trends on cross-bordermergers and acquisitions, foreign direct invest-ment inflows into Malaysia, though tradition-ally high, have not responded as they have inKorea or Thailand, and flows have fallensharply in Indonesia. In Malaysia new effortsto attract foreign investments have been un-dertaken; for example, restrictions on foreignholdings in new export-oriented manufactur-ing projects have been suspended until 2000and foreign ownership limits have been re-laxed. However, the value of approved projectsduring January–May 1999 at RM6.4 billionremained at the same annualized rate as in1998; the value of new FDI applications fellover the six month period to RM3 billion,compared with RM12.6 billion for calendar1998. In Indonesia the value of approved andrealized foreign direct investment declined by80 percent in the first quarter of 1999. Indo-nesia has recently started to implement newincentives to attract foreign investors. Foreignownership of up to 99 percent of banks hasformally been effective since May 1999. InJune 1999 a new decree was announced toallow shareholdings up to 100 percent in ex-

isting establishments and to provide a clearerlegal framework for the conversion of bondsissued locally into equity.

Notes1. Although East Asian firms, including those in

the crisis countries, have been adept at adopting newmanufacturing techniques, they have faced continu-ing challenges both from low-wage producers and fromJapan (see Mody, Suri, and Sanders 1992).

2. Such a financial accelerator has been docu-mented, for example, by Bernanke, Gertler, andGilchrist (1996, 2) who conclude: “A fall in theborrower’s net worth, by raising the premium on ex-ternal finance and increasing the amount of externalfinance required, reduces the borrower’s spending andproduction. This last result is the heart of the finan-cial accelerator: To the extent that negative shocks tothe economy reduce the net worth of borrowers (orpositive shocks increase the net worth), the spendingand production effects of the initial shock will be am-plified.” Small firms are especially prone to the down-ward spiral of the financial accelerator, but large,credit-constrained firms operating on thin margins maybe equally vulnerable.

3. While Thailand’s relative position on the twoscales is the same, the share of Thai firms unable topay debt, 28.3 percent, is much lower than the 45 per-cent of nonperforming loans in Thailand, unlike coun-tries where the ratios are quite similar. This may reflect,in part, the phenomenon of Thai strategic defaulters—that is, those able to, but not paying, their debts. Inaddition, small, unlisted firms contribute heavily toThai nonperforming loans. However, Mako (1999)reports that even among listed firms, about half wereunable to pay their debt, a ratio more consistent withnonperforming loans.

4. In the Scandinavian banking crises of thelate 1980s and early 1990s, the share of nonper-forming loans ranged from 5 to 7 percent, and theseloans mainly represented failed real estate lending.Even in Chile, at the onset of the early 1980scrisis, nonperforming loans were about 5 percent ofall loans.

5. Official numbers on nonperforming loans areless readily available for Indonesia. However, the per-centage is generally regarded as in the range of 50 per-cent and is expected to rise to more than 60 percentbefore falling.

6. In Malaysia, unlike in the other countries,Danaharta has not only purchased some of thenonperforming assets, but also is a management agentfor the restructuring of nonperforming assets.

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7. The more stringent definition of nonper-forming loans is, however, still used for supervision.

8. The principles for creating a competitive butsound financial system center around the appropriaterole of deposit insurance, bank capital, and diversityand competition in the financial sector (see, for ex-ample, Greenspan 1998; Hellmann, Murdock, andStiglitz 1998).

9. See Dziobek and Pazarbasioglu (1998) for ex-perience in Côte d’Ivoire, Latvia, and Spain; Drees andPazarbasioglu (1998) for the Norwegian experience;Baer and Klingebiel (1995) for a variety of historicalepisodes.

10. The London Approach operates under theauspices of the Bank of England and has been used forcorporate workouts in recessionary periods when nor-mal bankruptcy procedures have proved insufficient(see Kent 1997).

11. As of early November 1999 discussions ofDaewoo’s debt restructuring also included a signifi-cant component of deferred debt payments (the WallStreet Journal, Novemer 2, 1999).

12. For a review of the postcrisis industrial policyagenda, see Mody (1999).

13. The total number of domestic mergers andacquisitions has been about 50 to 70 per quarter inMalaysia in 1997–99, while it remained low (in therange of 4 to 10) in the other countries (see SecuritiesData Company 1999).

14. Survey results of Japanese investors in theearly 1990s show them to be sensitive in their invest-ment decisions to restrictions on profit repatriation(see Mody, Dasgupta, and Sinha 1999).

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