The extreme disruption resulting from Asia's financial crisis demand a thorough reassessment of the standard models for financial sector reform. After reviewing a number of now discredited preconceptions about financial liberalization, such as that financial markets are self-regulating, or that foreign investors and credit-rating agencies are good at assessing risk, this paper explores some options that should be considered in planning for future financial systems development. These include: less ambitious economic growth targets; less reliance on debt finance and more on self-finance; insulating payment system functions from saving-investment functions; reinforcing capital-asset requirements with solvency reserve requirements; restricting some forms of capital inflows and requiring better disclosure of foreign borrowing; limiting bank secrecy rules and making banks more transparent; strengthening international co-ordination of prudential regulation and permitting direct intervention by regulatory authorities to deal with financial market manipulation.
Flotation of the Thai exchange rate in mid-1997 triggered a panicky reassessment of risks that fed into a contagious epidemic of negative expectations, collapsing asset prices and exchange rates across East and Southeast Asia. The initial responses to these crises followed conventional single-country foreign exchange-crisis models by imposing contractionary monetary and fiscal policies while attempting to preserve the payments systems and avoid bank runs. These measures proved seriously inadequate, although in varying degrees, for dealing with the region-wide panic and outflow of capital. Replacement of discredited political regimes in some countries opened the way for more effective government initiatives, but not before economic growth had turned into recession and most financial institutions as well as many businesses had become insolvent. All the countries of the region are still struggling to prevent further deterioration and to restore some stability as preconditions for addressing the longer term issues of recovery and rebuilding. However, the contagion has spread outside the region, hitting Russia and other countries hard, and this may well feed back into Asia.
Financial crises in Latin America in the 1980s and Mexico in the 1990s were blamed mainly on bad macroeconomic policies such as excessive fiscal deficits and overvalued exchange rates. The Asian countries, however, had generally been following reasonably good macro policies and, in addition, had been liberalizing their financial systems as one element of fuller participation in the expanding globalized economy. They were mainly relying on managed exchange rate regimes which had seemed to serve them well. Many observers initially blamed the Asian crisis on inadequate banking regulation and poor governance that allowed businesses to exploit regulatory weaknesses.' As the crisis spread and deepened there has been a growing awareness that more fundamental problems within the crisis countries and in the international markets were at work.
Although warnings had been given (see World Bank 1989) that financial liberalization needed to be preceded by effective legal, regulatory, human resource and informational reforms, most Asian countries (as well as others) had not been very successful in meeting those preconditions. That failure is now receiving much attention, and the presumption seems to be that such deficiencies can and must be remedied quickly. The solutions offered by international financial institutions and many world financial leaders have emphasized regulatory reform and improved governance as basic components of a continuing drive towards rapid financial liberalization and globalization.
Until very recently, there had been surprisingly little questioning of the suitability and practicality of the basic financial liberalization-globalization model that has been promoted widely in both developed and developing countries over the past 20 years. …