Recovering from Financial Crises
The previous chapter identified the reforms needed to realize the benefits of financial globalization while avoiding the devastation brought on by financial crises. To make financial globalization work, emerging market countries must have institutions and policies in place that can not only help prevent financial crises but also help them recover quickly and at minimal cost if such crises do occur.
What steps can emerging market countries take to recover quickly from crises?
The key to a rapid recovery is restoration of confidence. Only when confidence in the system returns will participants return to the financial markets so that the system will again be able to channel funds to those with productive investment opportunities. When the problems in the financial system are homegrown, the government must demonstrate that it is serious about reform, to restore the confidence of its own citizens and of foreign partners. It must take immediate steps to fully recapitalize the financial system,1 and it must allow the creditors and owners of banks to suffer large losses.2 Furthermore, the government must quickly make a commitment to increase and strengthen prudential regulation and supervision to promote a healthy financial system.
Speed is of the essence in recapitalizing the financial system and implementing financial sector reforms. The faster the government gets the reforms under way, the quicker confidence will be restored and the recovery can