Basel III: Road To Resilient Banking (Book)

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CONTENTS
Introduction 1
Rescue Attempts 19
Asian Epidemic 36
IMF in Asia 49
Asian Scare 55
Thailand¶s Economy 61
Indonesia¶s Economy 68
Malaysia¶s Economy 76
Philippines¶ Economy 85
Singapore¶s Economy 91
Asia Today 95
Hong Kong¶s Economy 102
South Korea¶s Economy 105
Japan¶s Economy 108
China¶s Economy 111
Asian Tigers 115
US Born Crisis 120
Root Causes of the S&L Crisis 121
Burst of the dot.com Bubble 123
Development Leading to the Internet Boom 125
Subprime Mortgage Crisis 126
2008 Global Financial Crisis 129
Europe¶s Sovereign Debt Crisis 136
Basel Accords I, II, III 137
Basel I Capital Accord 142
Basel II Capital Accord 144
Basel III Capital Accord 147
Key Proposals under Basel III 152
Impacts of Basel III 156
Enhanced Risk Coverage under Basel III 169
Basel III Impact on Asia Region 170
Turkish Economy 174
Rise & Fall of the Ottoman Empire 174
New Republic under Atatürk¶s Reforms 176
Political Instability amid Privatization 178
Turkish Banking Sector before the 2001 Crisis 180
Turkish Banking Sector after the 2001 Crisis 183
A Decade Long Transformation 192
Basel III Impact on Turkish Banking Sector 199
Enhancing Risk Coverage under Basel III 205
Conclusion 209
References 217
v

ABOUT THE AUTHOR
John Taskinsoy has been teaching business communication, marketing,

finance and various other business courses for several years. Since 2011 he
has been teaching at Universiti Malaysia, Sarawak ± Unimas, where he has
worked as senior lecturer. John has served in a variety of leadership roles in
technology companies in. Other experiences in corporate management
include manufacturing manager, system integration manager, project
manager, international business manager, worldwide operations director,
project director, senior editor, director of manufacturing/procurement, and
operations director.
Over 20 years of professional experience in sales, manufacturing,

operations, marketing, human resource, budgeting, forecasting, outsourcing,
ISO implementations, new product introduction, international marketing,
aQG PDQDJHPHQW SRVLWLRQV HQDEOH -RKQ WR EULQJ ³UHDO ZRUOG´ experiences
and cases into his classroom teaching environment. Shortly after graduating
from San Francisco State University ± SFSU in 1997 with a BSc degree in
business administration, right away John was offered a management
position at Nortel Networks, one of the top five telecommunications
companies at the time, where he worked from 1997 to 2001, and then he
joined Flextronics International, LSI Logic, and Trexta in later years. While
he was employed, he also went on completing KLV ILUVW PDVWHU¶V 0%$
degree in 1999 at University of Phoenix, and then he decided to finish a
VHFRQGPDVWHU¶V06F - Telecommunication) at Golden Gate University in
2002. John enjoys living in culturally rich, diversified, as well as
challenging places. He has managed very complex technical projects in
China, Taiwan, Honk Kong, Brazil, Mexico, Canada, Germany, and
Turkey. He believes in himself and he always follows his dreams.
vi

PREFACE
Over the years, the banking system throughout the world has gone through
a series of regulation, deregulation, self-regulation, and now more
regulation; but, nothing seems to have worked so far and the world as a
result of that has witnessed four massive financial and economic shocks
which resulted in catastrophic financial loss of more than 20 trillion which
is about one third of the world GDP in current dollars.
Nearly four decades have passed since the establishment of the Basel
Committee on Banking Supervision (BCBS) in 1975. The CommitWHH¶V
number one mission was to create a resilient banking system capable of
absorbing economic and financial shocks during global-scale stress in the
financial system. The first test was the Asian crisis of 1998; the US Federal
Reserve (Fed) Chairman Alan Greenspan indicated that due to the financial
crisis, foreign investors in Asian equities (excluding those in Japan) lost an
estimated $700 billion, $30 billion by the American investors.
1H[WLQOLQHZDVWKHXQIROGLQJRIWKH³GRWFRPERRP´SKHQRPHQRQLQ the
United States. The mega invention of the Internet marked the beginning of
technology transformation first in the U.S. and then the rest of the world.
/LIHFKDQJLQJ,QWHUQHWEDVHG³GRWFRP´FRPSDQLHV¶,32VVWDUWHGKLWWLQJWKH
stock market; America Online, Yahoo, Amazon, eBay all came around in
1994-1995. On-line access gave boost to the financial firms to develop
more complex financial instruments and in the process another new
phenomenon came into existence; day traders who sat in front of computers
anGH[HFXWHG³EX\´DQG³VHOO´RUGHUVZLWKVPDOOPDUJLQVDOOGD\ However,
the Internet boom only lasted 3 years and by March 10, 2000 when the
NASDAQ hit its climax at 5,132 (intra-day high); from this point on
forward, the fast descending began and NASDAQ came down crashing. As
vii

PDQ\ DV ,QWHUQHW EDVHG ³GRWFRP´ FRPSDQLHV GLVDSSHDUHG IURP WKH
face of earth in the following year and only a hand full of Internet firms
with sound business plans survived; Amazon, Yahoo, eBay, and others.
Investors had lost a mind blowing $5 trillion which was half of the U.S.
GDP in 2002 ($10.01 trillion).
Only a few years after the dot.com mess, the United States has found itself
in yet another crisis of its own, but this time a much bigger financial
catastrophe called subprime mortgage crisis in 2007. Massive capital flows
to the U.S. from Europe and oil producing countries mainly in the Middle
East and low interest rates during 2004-2006 led to relaxing of lending and
borrowing requirements which expanded credit offerings to those with less
quality of subprime credit scores. The subprime mortgage level historically
has been around 7-8% (1997), but this level reached little over 20% in 2007
amounting to 7.5 million first-lien subprime mortgages with the total value
of $1.3 trillion.1 7KH VXESULPH FULVLV¶ VSLOORYHUV WR WKH ILQDQFLDO PDUNHWV
resulted in massive sell-offs causing investors to suffer $8 trillion in losses.
The 2008 global financial crisis was waiting to strike due to huge financial
losses from the subprime mortgage crisis earlier, enormous debt exposure
(American homeowners, consumers, and corporations owed roughly $25
trillion during in 2008)2, substantial drop in capital inflows, high level of
unemployment and persisting recession, record number of foreclosures and
increased defaults on consumer loans (average household debt to
disposable income reached over 130% in 2008), and downturn in economy
along with much reduced trading volumes in the stock markets. The real
financial losses and decline of wealth on the paper in the United States had
reached as much as $20 trillion.

1
See MSNBC, http://www.msnbc.msn.com/id/17584725
2
See Wikipedia, http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
viii

DEFINITIONS
ASEAN-4 Indonesia, Malaysia, the Philippines, and Thailand.

Indonesia, Malaysia, the Philippines, Thailand, and
ASEAN-5
Singapore.
Asia Emerging Asia plus industrial Asia.
China, Hong Kong SAR, India, Indonesia, Korea,
Emerging Asia Malaysia, the Philippines, Singapore, Taiwan Province
of China, Thailand, and Vietnam.3
Industrial Asia Australia, Japan, and New Zealand.
Newly industrialized (NIEs) refers to Hong Kong SAR, Korea, Singapore,
economies and Taiwan Province of China.
Austria, Belgium, Denmark, Finland, France,
Germany, Greece, Ireland, Italy, Luxembourg, the
EU-15
Netherlands, Portugal, Spain, Sweden, and the United
Kingdom.
G-2 The euro area and the United States.
Canada, France, Germany, Italy, Japan, the United
G-7
Kingdom, and the United States.
Argentina, Australia, Brazil, Canada, China, the
European Union, France, Germany, India, Indonesia,
G-20 Italy, Japan, Korea, Mexico, Russia, Saudi Arabia,
South Africa, Turkey, the United Kingdom, and the
United States.
ABBREVIATIONS
ACU Asian Currency Unit

AIG American Insurance Group
ARM Adjustable Rate Mortgages
AsDB Asian Development Bank
ASEAN Association of Southeast Asian Nations
BCBS The Basel Committee on Banking Supervision
BRF Bank Recapitalization Fund
BRSA Regulation and Supervision Agency of Turkey

3
The IMF definitions are adopted.
ix

CAR Capital Adequacy Ratio
CD Certificate of Deposit
CDO Collateralized Debt Obligations
CCR Counter Party Credit Risk
CVA Credit Valuation Adjustment
The Depository Deregulation and Monetary
DIDMCA
Control Act
DJIA Dow Jones Industrial Average
EEA Export-dependent emerging Asia
EFSF European Financial Stability Facility
EFSM European Financial Stabilization Mechanism
EM Emerging markets
FDI Foreign direct investment
FDIC The U.S. Federal Deposit Insurance Corporation
FHLBB The Federal Home Loan Bank Board
FICO Fair Isaac Corporation, credit rating agency
FPI Foreign direct portfolio investment
FSLIC Federal Savings and Loan Insurance Corporation
GDP Gross domestic product
GNI Gross National Income
IBI Islamic banking institutions
International Bank for Reconstruction and
IBRD
Development
IMF International Monetary Fund
IPO Initial Public Offering
LCR Liquidity Coverage Ratio
LIC Low Income Countries
LGD Loss Given Default
M&A Merger & Acquisition
MBS Mortgage Backed Securities
MSCI Morgan Stanley Capital International
MTI Ministry of Trade and Industry (Korea)
NASDAQ American Stock Market
NBFI Non-bank Financial Institutions
NSFR Net Stable Funding Ratio
x

NPL Non-performing loans
OCC Office of the Comptroller of the Currency
Organization for Economic Cooperation and
OECD
Development
OTC Over the Counter Market
PD Probability of Default
PPP Purchasing power parity
REO Regional Economic Outlook
ROA Return on Assets
ROE Return on Equity
ROI Return on Investment
RBS Royal Bank of Scotland
SAR Special Administrative Region
SIB Systematically Important Banks
SIMEX Singapore International Monetary Exchange
S&L Savings & Loan
SME Small-Medium Enterprises
VaR Value at Risk
COUNTRY CODES
BEL Belgium
CHN China
EU European Union
FRA France
DEU Germany
GRC Greece
HKG Hong Kong
IND India
IDN Indonesia
IRL Ireland
ITA Italy
JPN Japan
KKTC Northern Cypress Turkish Republic
xi

KOR Korea
MYS Malaysia
PAK Pakistan
PHL Philippines
POL Poland
PRT Portugal
SGP Singapore
ESP Spain
TWN Taiwan
THA Thailand
TUR Turkey
UAE United Arab Emirates
GBR United Kingdom
USA United States
xii

ACKNOWLEDGEMENTS
I appreciate the financial support provided by Universiti Malaysia, Sarawak

Unimas. My indebted thanks go to my lovely wife Gazel for her generosity,
unselfish support, and understanding. Also special thanks go to Professor
Datun Dr. Khairuddin Ab Hamid and Professor Dr. Peter Songan for their
help and encouragement.
I would like to acknowledge the support of the following important people:

Professor Dr. Shazali Abu Mansor, Universiti Malaysia, Sarawak ± Unimas
Professor Dr. Abu Hassan Md. Isa, Universiti Malaysia, Sarawak ± Unimas
Professor Dr. Fredrick J. Putuhena, Universiti Malaysia, Sarawak ± Unimas
Associate Professor Dr. Mohamad Jais, Universiti Malaysia, Sarawak
Associate Professor Dr. Ali Uyar, Fatih University, Istanbul, Turkey
xiii

INTRODUCTION
The world has seen two major financial and economic crises in less than
two decades, which have shaken investor confidence in the financial
systems, resulted in several trillions of financial loss, and left behind
dislocated societies in many regions. Everything started in the summer
months of 1997 in East and Southeast Asia. All the way up to the end of
1996, in most part a remarkable success story to tell about the unequalled
economic progress that had been going on for at least past three or four
GHFDGHV:DVWKLVDWHVWLQJWLPHIRUWKHVRFDOOHG³$VLDQWLJHUVRUGUDJRQV"´
³$VLDQWLJHUV´ZHUHEHLQJWHVWHGIRUUHVLOLHQFHDQGUHGHPSWLRQWRSURYHWR
the rest of the world that the metaphor was not just a myth; around the
same time a serious of technological transformation marked the beginning
of the dot-com boom (1997) in the United States which lasted only three
\HDUV)URPWR0DUFKRIWKH,QWHUQHWDQGUHODWHGWHFKQRORJLHV¶
high-flying stocks in industrialized nations saw amazing appreciation in
equity-values most of which unfortunately was based on more speculative
assumptions rather than historic real valuations. Technology powerhouse
NASDAQ composite index, where a lot of the technology stocks including
those of dot-com companies were listed and traded, more than doubled its
level compared to a year ago. The bubble burst soon after NASDAQ passed
the critical 5000 mark and the crash of 2000-2002 (dot-come bust) cost
investors a mind blowing half of the U.S. GDP ($10.01 trillion in 2001).
Exactly a decade later, by the end of 2007 and early 2008, the United States
has shocked the investors again with yet another US-born financial crisis;
first, it started as a subprime mortgage crisis, and then quickly turned into a
full fledge global financial crisis which, by 2009-2010, led to sovereign-
debt crisis in the eurozone. Excessive liquidity in the markets forced the
1

banks indirectly to relax lending rules and encouraged them to engage in
riskier lending and borrowing practices which ultimately gave a rare
opportunity to the high-risk (subprime) barrowers qualifying for mortgages
that would have not been possible with a tighter or illiquid credit market.
Just prior to the real-estate market crash (2006), the percentage of lower-
quality subprime mortgages tripled in volume going over 20% which was
all time high in the U.S. history (three times of the historical trend of 7-8%).
The risk exposure of financial institutions had intensified enormously
during 2004-2006 due to the alarming level of adjustable rates financing
chosen for the new mortgages (3, 5, 7 year adjustable rates); furthermore,
Americans had become more indebted than ever before, owing 25% in
excess of their disposable incomes. So, the crisis was inevitable.
Turkey has been known or remembered as a country for political instability,

economic uncertainty and hyperinflation, but not anymore. The usual
storyline of Turkey for the past four decades has predominantly
concentrated around economic turmoil, high and variable inflation and
unstable political environment resulting from two-or-three party coalition
governments. As a result, Turkey had experienced major economic crises
in 1994, 1999 and 2001along with the massive earthquake in 1999 which
according to unofficial estimates took more than thirty thousand lives.
The 2001 financial crisis was the biggest economic shock in Turkish
history since 1923 causing a gigantic financial loss of more than $50 billion.
Political stability (one party government since 2002), relentless re-
structuring work through successful development and implementation of
prudential reforms and regulatory framework, creation of an independent
central bank, strong governance (remarkable work by the BRSA) along
with improved transparency in reporting of financial results and disclosures
2

have created a much envied resilient Turkish banking system capable of
absorbing financial and economic shocks during stress. Turkey is so proud
to see the fruits of its long and dedicated hard work as becoming the 16 th
largest economy in the world with over $1 trillion in GDP-PPP; in addition,
Turkey has recently ended its long-running partnership with IMF (1947).
IMF praised Turkish financial system for its resilience during the 2008-09
global financial crisis and FRQWULEXWHG LWV KXJH VXFFHVV WR ³WKH VLJQLILFDQW
capital buffers built up following the 2001 banking crisis, more effective
fiscal and monetary management, strengthened banking regulation and
VXSHUYLVLRQDQGFRQVHUYDWLYHEDQNLQJSUDFWLFHV´ 4
Turkey has experienced the biggest financial and economic shock in 2001
resulting in a massive overhauling of its entire banking system that
eventually cost the government over $50 billion. IMF was involved in the
recovery process from the very beginning providing Turkey nearly $24
billion of financial assistance between the fragile years of 1999 and 2002.
After 19 Stand-By arrangements, the Turkish government announced that it
had decided to end to its long-running partnership with the IMF since 1947
and said that it would not commit to another Standby arrangement after the
last payment of the existing loan is made in April 2013.
The resilient Turkish banking system, capable of absorbing shocks during

financial stress, thanks to the extraordinary work by the Banking
Regulation and Supervision Agency of Turkey (BRSA), and a decade long
political stability (one-party government since 2002) along with improved
global investor confidence enabled Turkey to become the 16 th largest
economy in the world with over $1 trillion in GDP (CIA World Factbook
list; $1.087 billion). Turkish government officials and the top banking

4
Turkey: Financial System Stability Assessment, IMF Country Report No. 12/261, Sep. 2012
3

H[HFXWLYHV EHOLHYH WKDW %DVHO ,,,¶V QHZ ULJRURXV FDSLWDO UHTXLUHPHQWV ZLOO
have either little or no adverse impact on Turkish banking sector; however,
most economists and recent studies indicate that there will be some impact.
The Turkish banking sector currently has a capital adequacy ratio (CAR) of
little over 16% that is higher than the minimum 7% effective January 1,
2013 or %DVHO,,,¶VZKLFKZLOOEH in full effect by January 2019.
³$ VWURQJ DQG UHVLOLHQW EDQNLQJ V\VWHP LV WKH IRXQGDWLRQ IRU VXVWDLQDEOH
economic growth, as banks are at the center of the credit intermediation
process between savers and investors. Moreover, banks provide critical
services to consumers, small and medium-sized enterprises, large
corporate firms and governments who rely on them to conduct their daily
business, both at a domestic and international level.´5
In order to understand and make any logical sense of the planned prudential
regulations and related future events by the Basel Committee on Banking
Supervision (BCBS), headquartered in Basel, Switzerland, in the context of
global banking standards; one really needs to understand clearly what had
occurred in the last four decades, especially in the last fifteen years since
1997 which had already witnessed two major global financial crises that
brought us to the present situation of global financial dismay.
Everything began nearly forty years ago when two critical events; one in
financial nature and the other one in warfare, paved the way to global
financial shock and gave birth to the creation of Basel Committee on
Banking Supervision at the end of 1974; first, oil crisis suddenly erupted in
1973 due to the Arab-Israeli Yom Kippur War of that year; then the
following year, the case of Germany's Cologne-based Bankhaus Herstatt
took place in 1974 when the German regulators misused their regulatory

5
See Basel III: Strengthening the resilience of the banking sector, p.9
4

power and liquidated the bank taking advantage of the time-zone
differences between New York ± USA and Cologne ± Germany, which
eventually led to dissolution of the bank.
Banks6, as an inextricable part of the economic growth iQWRGD\¶VPRGHUQ

business world, respond passively to economic growth and industrialization
through handling substantial volume of various financial transactions. The
OHYHO RI ILQDQFLDO GHYHORSPHQW LQ D FRXQWU\¶V EDQNLQJ VHFWRU FDQ SURYLGH
signs of stability and be a good predictor of future growth, quality and
quantity of capital, as well as technological advancements (Levine, 1997).
Banks are always in search for innovative products and services to better
deal with market frictions, specifically those resulting from information
and transaction costs. Some economists argue that there is really no need
for a financial system if these costs are absent (Arrow, 1964), therefore,
financial intermediaries exist to combat various information and transaction
related costs in the system. Greater market frictions in a way force financial
intermediaries to offer more innovative products and services; conversely,
less friction will lead to fewer basic services offered by the banks.
The primary function of financial systems is to facilitate and allocate funds

deposited by savings account customers, across space and time, in
uncertain environments (Merton and Bodie 1995). Research papers
covering cross country analysis suggest that when the opposite of that
exists, meaning banks are not facilitating and allocating funds and putting
them to good use, then it can adversely affect financial markets and hinder
future economic growth, or even potentially lead to crises. Levine (1997)

6
7KH WHUP ³EDQN´ KHUHRQ FRYHUV DOO W\SHV RI EDQNLQJ DQG YDULRXV ILQDQFLDO LQVWLWXWLRQV QRW
limited to federal reserve banks, commercial banks, and savings banks, savings and loan
associations, credit unions, insurance companies, investment banks, mortgage companies,
venture capitalists, and government lending institutions)
5

H[DPLQHV ³FDSLWDO DFFXPXODWLRQ´ DQG ³WHFKQRORJLFDO LQQRYDWLRQ´ DV WRROV
used by banks and explain how financial functions affect economic growth.
According to him, financial systems affect the flow of capital either by
shifting (increasing or reducing) the savings rate paid to money-savings
accounts, tightening capital or by funneling savings among different capital
generating technologies (selecting best possible investment projects with
positive cash flows). Banking functions put to use by financial systems
affect economic growth through invention-focused selection of
technological innovation that will ultimately yield to positive returns which
in turn will attract risk-thirsty investors willing to invest for higher returns.
Levine (1997) divides the primary function of financial systems of banks

into five basic but more specific roles; 1) facilitate trading, hedging,
diversification, and pooling of risk; 2) allocate resources and select best
matching entrepreneurs; 3) monitor managers and control corporate
governance; 4) mobilize savings and put them into more productive use
yielding better returns; and 5) facilitate exchange of goods and services
between producers and consumers for a favorable positive relationship.
Liquidity has to do with speed of conversion into cash; therefore, a land

without any structures on it would be extremely illiquid and a real estate
along the same line of logic would be considered less liquid than short-term
securities or equities (stocks, bonds, precious metals). 'HYHORSHGFRXQWULHV¶
equities are more liquid than those in underdeveloped or developing
financial markets; for instance, equities in the United States carry very little
liquidity risk compared to equities traded in South African Stock Exchange.
This leads us to think that liquidity risk is highly and closely associated
with uncertainties that exist in a particular financial system. Liquidity risk
is often linked to true cases of uncertainties, but sometimes it is more
6

LQYHVWRUV¶SHUFHSWLRQVWKDQDQ\WKLQJHOVHEHFDXVHLQYHVWLQJDQGDSSHWLWHIRU
risk are not always based on real facts. Investors prefer trading equities in
liquid markets because transactional costs are higher in illiquid stock
exchanges; moreover, liquid markets offer more certainty and less abrupt
fluctuations. One other important function of banks as intermediaries is
also to sustain appropriate level of liquidity in the markets and to create
investment opportunities for individuals and firms by channeling funds
from deposit accounts and putting them into more productive and effective
use for possible positive returns. Without financial instruments, risk avert
deposit holders would not commit their hard-earned savings for long
periods involving great deal of uncertainty or financial instability.
Economists are divided on the issue of importance of financial
intermediaries in economic growth and its sustainability.
Some argue that it played a vital role especially during the industrialization
period in England (Walter Bagehot, 1873; John Hicks, 1969). Along the
same line, Joseph Schumpeter (as cited in Levine, 1997) feels that banks
foster economic development and enable creation of innovative products
through careful selection of entrepreneurs who present best chances of
successful implementation of pioneering products and production processes
that will potentially generate positive cash flows for the investors.
Banks must ensure selection of best possible investment projects from the
available pool of choices. Also, Levine (1997) suggests that there is a
positive, first-order relationship between financial development and
economic growth. In contrast, others simply share the view that the
relationship between finance and economic growth is not important.
According to Robinson (1952), finance does not determine where money
goes, enterprises do; and as long as innovation continues, money will keep
7

flowing because some risk-thirsty entrepreneurs are willing to take risks for
high returns. Lucas (1988) feels finance plays an important role but he
thinks that the importance of finance is overly embellished by economists.
Technological innovation must be supported by continuous injection of

capital in order to lead to increased performance of sustainable economic
development; furthermore, high-return projects carry high risks and require
long-term commitments by the investors. However, savers are often
reluctant to release the control of their hard-earned savings for long periods
of time, plus they feel better when they have a great degree of autonomy to
withdraw their money or sell equities (i.e. stocks, bonds, CDs) they hold.
According to Hicks (1969), technological innovation did not lead to

sustained economic growth during the industrial revolution in England
primarily due to liquidity risk as a result of lack of improvements in the
financial system, which is strongly argued to be crucial for enhancing the
liquidity (funneling funds from savers to investors) in the marketplace for
long-term projects related to technological innovation.
The relationship between economic growth and a well-functioning

financial system can be better seen in developed or emerging economies
than poorly developed economies where weak infrastructure, premature
banking system, poor legal framework exist. Regardless of a geographical
location or demographics, industries and firms frequently need external
financing instruments to start operations (start-up firms), or for the existing
businesses to plan for increased productivity, expansion, or growth.
Ample country studies show that businesses have benefitted greatly and as
a result thrived considerably in countries where a good working financial
system has existed, where banks assisting firms with their special business
8

needs of investing, trading, hedging, diversifying, and pooling of risks.
Although, a well-functioning financial system is the foundation for
economic growth; by no means, it implies that success or size of growth
will be the same in every country that has it. 7RGD\¶V ILQDQFLDO V\VWHPV
definitely owe the existence of a wide range of products & services to
advancements in technology, development of personal computers along
with operating systems and software applications. Especially, breakthrough
invention of the Internet in 1990s and its related interactive web-interface
technologies and remarkable progress in telecommunications enabled a
huge leap for the banking sector.
Still not done though, even all that has been mentioned so far is present; a
well-functioning financial system may still not lead to a strong economic
development, unless the country possesses a well-supported working
judicial process (a legal system that is fair to everyone regardless of status,
power, or wealth) and a stable political environment (democratic elections).
When all the pieces of the puzzle are in perfect alignment, then a well-
functioning financial system could drive economic growth that can be
sustained for longer periods; however, the effects of macroeconomic
factors should not be ignored.
Levine (1997) believes that market frictions regarding information and

transaction costs create incentives and drive for the emergence of financial
markets and institutions which make up the financial system. Therefore, it
would be quite impossible for anyone or any firm regardless of its business
form (sole proprietorship, partnership, corporation), size (SMEs,
corporations, conglomerates), or revenue (thousands, millions, or billions)
to bypass these critically important financial intermediaries in order to
participate in the economic activity. HenceWKHODUJHUSDUWRIDQ\FRXQWU\¶V
9

(developed, developing, or emerging) total economic development revolves
around different financial institutions such as banks (federal reserve banks,
commercial banks, and savings banks), savings and loan associations,
credit unions, insurance companies, investment banks, mortgage companies,
venture capitalists, and government lending institutions helping consumers
and businesses to meet their acute financing obligations (Taskinsoy, 2012).
Internalization of finance and advances in web-based technologies (i.e.

online trading) enabled investors to engage in various financial transactions
which fostered further development of complex financial instruments. For
instance, in the past, investors were able to invest in equities markets
through financial brokers and they seldom checked on their positions to see
whether gain or loss realized, but today anyone who creates an online
account with an investment bank can immediately start trading within a
matter of hours; moreover, any information regarding account balance,
gains, or losses can be obtained as quickly as click of a button. The
inadvertent downside was that it drew large public participation in the stock
market, which peaked at close to 70% in the US in May 2000, then steadily
declined and fell substantially post 2008 crisis. According to Gallup (a U.S.
based research company), the percentage of Americans with stock
ownership hit eleven-year low,7 little over 50% of Americans today own
individual stocks, bonds, or mutual funds.
Häusler (2002) argue that globalization of finance were driven by four

primary factors; 1) increased popularity of personal computers; invention
of the Internet and its very fast progress, plus development of web-based
interactive applications made it easier for participants, investors, traders,
and authorities to access, execute, measure, and monitor financial

7
http://www.huffingtonpost.com/2011/04/21/stock-market-us-real-estate-gallup_n_851786.html
10

transactions and their risks; 2) quick and easier access to financial markets
worldwide has also led to the globalization of national economies in
developing and emerging markets. Nowadays, it is very unlikely that a
product is entirely built in a single country from start to finish; in fact, most
products today are built by multinational companies involving
PDQXIDFWXULQJSODQWVLQVHYHUDOGLIIHUHQWFRXQWULHV8QIRUWXQDWHO\µPDGHLQ
86$´LVDGLVWDQWPHPRU\, especially when everything nowadays is either
made by China, Mexico, Brazil, or India.
As a result, many countries have either eliminated cross-border trade

barriers or relaxed trading rules considerably; 3) Privatization of
government-owned institutions and companies (predominantly banks,
media outlets, and telecommunication companies) has gained significant
momentum in the past decade, which resulted in liberation of financial and
capital markets in national economies worldwide, that were once
considered conservative and protectionist.
³'XULQJWKHSDVWWZR GHFDGHV ILQDQFLDOPDUNHWs worldwide have become

increasingly interconnected. Financial globalization has brought
considerable benefits to national economies and to investors and savers,
but it has also changed the structure of markets, creating new risks and
challenges for market SDUWLFLSDQWVDQGSROLF\PDNHUV´8
Most developing and emerging economies are in constant need for large
amounts of capital inflows as in FDIs & FPIs to finance their enormous
current account deficits; this alone gave them enough incentive to liberate
domestic economies to attract global investors. According to Häusler
(2002), global gross capital flows in 1990 were nearly $2 trillion, and just a

8
See IMF, http://www.imf.org/external/pubs/ft/fandd/2002/03/hausler.htm
11

decade later, the amount increased to more than $7 trillion dollars. Also,
during the same period, cross-border capital movements more than doubled
bringing the total from $500 billion in 1990 to 1.2 trillion in 2000;
globalization of finance would have not been possible without the existence
of global players (investors); investment banks, insurance companies,
venture capitalist firms, hedge funds, brokerage firms, and IPO companies.
As globalization of finance offers numerous great benefits, it could also

have adverse domino effects as experienced during 2008 financial crisis.
Barrowers are not limited to inflexible high-cost national banks anymore;
thanks to internationalization of finance, firms now have many options to
choose from. Also, investors can reduce risks through diversification of
their portfolio across different markets and industries in various countries.
Besides benefits, globalization of finance could potentially increase market

volatility by contributing to heavy sell-offs of securities in a herd mentality.
Since other nations were willing to buy U.S. debt (more favorable interest
rates than those in the eurozone), globalization actually benefitted the
United States more than anybody and helped finance its wars in
Afghanistan and Iraq which cost between $3.7 and $4.4 trillion according
to a research titled "Costs of War" by Brown University's Watson Institute
for International Studies.9
Banks have been regulated, deregulated, let alone for self-regulation, and
now again re-regulation is in the works. Globalization of finance resurfaces
the question of consolidation of banking supervision and different
regulatory approaches across continents. The lessons of 2008 financial
crisis reminded WKHZRUOG¶Vimportant banking (financial) organizations (i.e.

9
See Reuters, http://www.reuters.com/article/2011/06/29/us-usa-war-
idUSTRE75S25320110629
12

the BCBS, World Bank) that international harmonization, transparency and
governance amongst various banking systems throughout the world were
extremely crucial in order to achieve a resilient banking sector worldwide
capable of absorbing shocks during global financial stress. Globalization of
finance does not necessarily present a huge problem for underdeveloped or
developing nations where the existing banking structures are poor,
insufficient, or unfledged to begin with; in addition, only a few banking
related products and services are provided in these weak banking structures.
However, it is not the same for developed countries where banking sectors
are dominated by financial conglomerates offering a wide range of
sophisticated and rather complex products and services such as insurance,
securities, investments, derivatives, options, mergers & acquisitions,
venture capital, and more.
To establish an effective program of banking supervision and prudential

regulation, the public policy role of bank supervision must be clearly
defined and understood and actions taken along several parallel tracks to
strengthen the bank supervisory process, the legal framework, accounting
and auditing, and the institutions themselves.ϭϬ
At first, economic deregulation and financial liberalization may be crucial

in order to develop a viable and robust financial system (Polizatto, 1990).
However, deregulation will mean that removing or relaxing some of the
previously set rules that were strictly imposed on banks. If the deregulation
phase is not proper managed, monitored, or controlled; then, increased
competition, the entrance of new players, misuse of the system and other
unethical business conduct will have to be considered as potential risk
factors, which will eventually cause financial instability. If other negative

10
3ROL]DWWR93³3UXGHQWLDO5HJXODWLRQDQG%DQNLQJ6XSHUYLVLRQ%XLOGLQJDQ
,QVWLWXWLRQDO)UDPHZRUNIRU%DQNV´'HYHORSPHQW(FRQRPLFV:RUld Bank WPS 340, 1990
13

events, as natural chain of reactions, follow as expected part of unstable
financial systems such as bank failures and bad corporate news; this could
easily create a panic situation and loss of confidence among investors. Thus,
heavy sell-offs in the equities markets and substantial withdrawals from
bank accounts could easily lead to contraction in the financial systems
causing illiquidity in the markets which could create more serious problems
when this spillovers from the weak financial sector to the real economy.
The reasons behind the prudential regulation or deregulation should be the
creation of a resilient banking system to foster sustained economic growth,
not necessarily hampering the existing financial performance by imposing
rigorous capital requirements which may potentially hinder any chances of
positive economic progress; in addition, establishing a well-functioning
regulatory framework is very costly which may create financial burden on
some smaller nations.
According to Polizatto (1990), prudential regulation and banking

supervision are designed to eradicate or minimize the threat of systemic
instability in financial sectors. Achieving this enormously challenging task
requires satisfying the following non-financial factors, without which it
would not be possible to establish a well-functioning banking system; the
government must share the same common goal of creating a resilient
banking system and ensure the pass of related laws; impartial judicial
framework must exist in the country to honor terms and conditions of
contracts between firms and customers (fair legal process to everyone
regardless of status); banks have to ensure transparency in disclosures and
reporting of financial statements reflecting actual financial results without
manipulation of any numbers; corporate governance must monitor
managers effectively and make sure for ethical business conduct at all
times without any exception; and accounting and auditing standards must
14

be internationally harmonized making necessary adjustments of any
remaining differences in accounting based on prudential regulation
requirements.
³7KLVLVQRWWKHILUVWLQWHUQDWLRQDOEDQNLQJFULVLVWKHZRUOGKDVVHHQ7KH
previous ones occurred without credit default swaps, special investment
vehicles, or even credit ratings. If crises keep repeating themselves, it
seems reasonable to argue that policy makers need to carefully consider
ZKDWWKH\DUHGRLQJDQGQRWMXVW³GRXEOHXSÉ\VXSHUILFLDOO\UHDFWLQJWR
WKH VSHFLILF IHDWXUHV RI WRGD\¶V FULVLV :KLOH ZH FDQQRW KRSH WR SUHYHQW
crises, we can perhaps make them fewer and milder by adopting and
implementing better regulation²in particular, more macro-prudential
UHJXODWLRQ´11
If the globalization of finance is the future direction, where financial

markets are interconnected across countries throughout the world with less
trade barriers and substantial amount of cross-border capital movements,
then various banking systems, processes, regulation approaches and
supervision which are significantly different in across nations must also be
harmonized; otherwise, as observed by the Basel Committee during 2008
crisis, countries varied substantially, undermining the consistency of the
regulatory capital base.
Also weak transparency gave an opportunity to banks to: disclose deficient

regulatory capital bases; and to provide insufficient details on the
components of capital. Moreover, the above situation made it extremely
difficult and challenging for the market participants and regulators to
accurately assess the quality and quantity of capital in the banking sector

11
6HH:RUOG%DQN³&ULVLV5HVSRQVH´
http://rru.worldbank.org/documents/CrisisResponse/Note6.pdf
15

during global financial stress and to make any meaningful comparison
across a wide range of banking systems worldwide. Furthermore,
reconciliation to the reported accounts was often absent.12
The World Bank argues that the most recent crisis did not happen because
of a severe case of insufficient regulation; and it would be total mistake if
policy makers focused on this element entirely. To refute the widely held
view of lack of regulation, the World Bank makes reference to highly-
regulated financial institutions Northern Rock, IKB, Fortis, Royal Bank of
Scotland, UBS, Citigroup, and adds that these banks were at the epicenter
of the crisis. The World Banks said that crisis would have occurred anyway
even if such incidents like mortgage fraud, tax secrecy, and conflicts of
interest did not take place. Some estimates suggest that 84 financial crises
happened prior to the 2008 global crisis. Based on World Bank analysis,
³WKH ODVW FULVHV RFFXUUHG ZLWKRXW FUHGLW GHIDXOW VZDSV DQG VSHFLDO
investment vehicles and the last 80 had nothing to do with credit ratings.´13
More may not always lead to desired outcomes, this is particularly true in
the case of banking regulation; instead of further regulation, maybe what
needs to be done is to ensure better management and monitoring of the
existing prudential rules and to make sure that strong governance exists in
the banking system along with transparency in financial reporting of the
results. The G-20 summit of April 2, 2009 concluded that prudential capital
requirements must have FRXQWHUF\FOLFDO HOHPHQW WR ³GDPSHQ UDWKHU WKDQ
DPSOLI\ WKH ILQDQFLDO DQG HFRQRPLF F\FOH´ E\ ³UHTXLULQJ EXIIHUV RI
UHVRXUFHV WR EH EXLOW XS LQ JRRG WLPHV´ In order for the prudential
regulation to be successful, probably this is more crucial than anything else,
banks have to be proactive in developing the necessary internal systems to

12
13
16

HQVXUH EDQNV¶ VROYHQF\ ZKLFK PD\ UHTXLUH banks to; build up additional
capital buffers above and beyond %DVHO¶V UHTXLUHPHQWs due to micro and
macroeconomic factors (i.e. uncertain business, political or economic
environment); implement prudential requirements in a timely manner to
influence development of right corporate financial policies; ensure codes of
business conduct to be written and signed by every manager; and
strengthen management through strong corporate governance.
According to the Committee, crisis prone mentality as a result of market

pressure has already forced the banking system to build-up additional
capital buffers to raise its liquidity base. The proposed changes under Basel
III will ensure that achieved liquidity base will be maintained over the long
run, resulting in a banking sector that is less leveraged, less procyclical and
more resilient to system wide stress.14 The Office of the Comptroller of the
Currency (OCC) in the United States lists four critically important
objectives for banking supervision:15
1. Ensure the safety and soundness of the national banking system.

2. Foster competition by allowing banks to offer new products.
3. Improve efficiency of OCC supervision with less regulatory burden.
4. Ensure fair and equal access to financial services for all people.
The list that Polizatto (1997) provided UHJDUGLQJWKH2&&¶VSXEOLFSROLF\

objectives is slightly different, but it would be useful to include them here:
a. Prevent undue concentration of power and promote competition;

b. Moderate banking instability, protect public against worst consequences;
c. Encourage and promote a high level of operating efficiency and
innovation in products, services, and the use of technology;

14
15
The Office of the Comptroller of the Currency, http://occ.gov/about/what-we-
do/mission/index-about.html
17

d. Meet the needs of the public through banking facilities and services;
e. Encourage and promote a high level of efficiency and equity in the
allocation of credit to various sectors of the economy; and
f. Promote an equitable distribution of costs and benefits among the
management, stockholders, creditors, and customers of banks.
The U.S. Federal Deposit Insurance Corporation Chair Sheila Bair

H[SODLQHGLQ-XQHWKDW³«ZLWKRXWSURSHUFDSLWDOUHJXODWLRQEDQNVFDQ
operate in the marketplace with little or no capital. And governments and
deposit insurers end up holding the bag, bearing much of the risk and cost
RIIDLOXUH´%ODLU 7KH:RUOG%DQNVDLGWKDW³0DUNHWGLVFLSOLQHKDV
an important role to play in the efficiency of the financial sector, but it
FDQQRWEHRQWKHIURQWOLQHRIGHIHQVHDJDLQVWFULVHV´
The World Bank also shed light onto the intensity of the crisis in the
IROORZLQJVWDWHPHQW³7KHKLVWRULFDOH[SHULHQFHLVUDWKHUGLIIHUHQWFUDVKHV
follow booms. In the boom almost all financial institutions look good, and
LQWKHEXVWDOPRVWDOOORRNEDG´ 16 The fundamental goal of the US public
policy regarding the banking system is not to rescue business failures
caused by individuals or firms; however, its primary objective is to ensure
that the overall banking system is stable and in good health. However, the
World Bank commented that increased capital requirement under Basel III
will not necessarily make the banking system more resilient and be prone
to crisis unless risks are better managed.17 Nevertheless, the unparalleled
intensity of 2008 financial crisis required unprecedented government
intervention, the largest bailout in US corporate history; the US
government stepped in with rescue packages totaling over a trillion.

16
6HH7KH:RUOG%DQN³&ULVLVUHVSRQVH´
17
6HH7KH:RUOG%DQN³&ULVLVUHVSRQVH´
18

RESCUE ATTEMPTS
Nearly four decades, the global economy has been battered by a number of
economic and financial crises; namely the Japanese property bubble and
the debt default of Latin American countries in the 1980s, 1987 US stock
market crash (Black Monday), the European Exchange Rate Mechanism
suffered crises in 1992±93, 1994 Turkish economic crisis, 1997±98 Asian
currency crises, the 1998 Russian financial crisis (devaluation of the ruble
and default on Russian government bonds), the US born crash of the dot-
com bubble in 2000±2001, subprime crisis of the U.S. in 2006, 2007-08
global financial crisis, and 2009-12 sovereign debt crisis in the eurozone.
All of these aforementioned crises in many ways have been associated with
significant events such as bank failures, stock market crashes, collapse of
the real estate markets, devaluation and default of currencies, and the
eurozone sovereign debt crisis as the latest addition to the list (contagion of
2008 crisis together with huge private debt).
A great number of economists and professionals in the financial sector

consider 2008 global financial crisis to be the worst ever since the World
War I era. The International Monetary Fund called it as ³WKH ODUJHVW
financial shock since the *UHDW'HSUHVVLRQRIV´3ULRUWRthe crisis, a
79 SHUVRQDOLW\ LQ 86 FDOOHG LW DQ HFRQRPLF ³$UPDJHGGRQ´ RQ DLU RQ
August 1, 2007 and accused the Fed Chairman Alan Greenspan not taking
any actions. )LQDOO\ WKH )HG &KDLUPDQ ZDUQHG RI µ¶ODUJH GRXEOH-digit
GHFOLQHV¶¶LQKRPHYDOXHV.XKQKHQQ10).
The crisis was the inevitable final product which was created in
combination of many things; primarily, excess liquidity in the markets
(cheap money, accompanied with all-time low interest rates, had to be lent
out to barrowers, even to those with lower sub-prime credit ratings), risky
19

lending practices by the financial institutions, government policies
encouraging home ownership therefore easier access to barrowing, relaxing
barrower requirements (as little as 5% or zero down payment in most cases
and little attention was paid to individual credit scoring), excessive equity
line of credit usage by homeowners making them owe more than the value
of their mortgages (Americans for the first time owed nearly 25% more
than their entire household incomes), an alarming rate of adjustable
mortgage re-financing (short-term debt which was also main reason behind
the previous crises), large number of corporate scandals and unethical
business conduct by executives (i.e. Enron, Worldcom, Nortel, Global
Crossing and many more), accounting frauds (i.e. Arthur Andersen, one of
the big five accounting firms providing auditing, tax, and consulting), great
influence of individuals in key positions (i.e. Alan Greenspan who, many
believe, was singly responsible for the real estate bubble in the United
States; he, himself said "I really didn't get it until very late in 2005 and
2006"18), last but not the least internalization of finance and advances in
web-based technologies (i.e. online trading) enabled investors to engage in
various financial transactions which in turn fostered further development of
complex financial instruments.
Before the crisis finally hit, there had been a number of small bank rescues
between 2007 and 2008 amounting close to $1 trillion; however, the
problem surfaced the water when Countrywide (specialized in sub-prime
lending) received more than $20 billion, which consisted $12 billion
bailout in September 2008,19 to continue its already troubled operations.
This was followed by Washington Mutual, another bank heavily involved

18
See Wikipedia, Guha, Krishna (September 17, 2007). "Greenspan alert on US house prices"
Financial Times, September 17, 2007, http://www.ft.com/cms/s/0/31207860-647f-11dc-90ea-
0000779fd2ac.html.
19
http://en.wikipedia.org/wiki/2007%E2%80%932009_recession_in_the_United_States
20

in riskier lending practices. 2008, by far, became the record year for most
corporate bankruptcies in US history and the biggest government
intervention ever in the financial system. The New York Times reported on
September 20, 2008 that the Treasury Department announced that it would
buy up to $700 billion (Wall Street bailout) in distressed mortgage-related
assets from the private firms.20 In addition, the Fed has lent nearly $345
billion to businesses and investors in an effort to restore credit to
consumers, banks and companies. The Fed also said that it would continue
buying more of those toxic assets for another six months making the total
purchases add up to $1.5 trillion.21
$WFRPSDQ\OHYHO,QG\0DF%DQN¶VELOOLRQLQGHSosits were placed into

conservatorship by the Federal Deposit Insurance Corporation (FDIC) on
July 11, 2008;22 Both Fannie Mae and Freddie Mac23, the government
sponsored enterprises (GSEs), were also placed in conservatorship in
September 2008 (the governPHQWLVEDFNLQJWKHFRPSDQLHV¶WULOOLRQLQ
unsecured debt and $3.5 trillion of mortgage guarantees, which is nearly
half of the total $12 trillion U.S. mortgage);24 AIG, American Insurance
Group, received $85 billion emergency loan from the Federal Reserve
which meant that the government would have 79.9% stake in the company,
but overall AIG mess cost the taxpayers close to $250 billion;25 In
November 2008, the U.S. government announced that it was purchasing

20
http://www.nytimes.com/2008/09/21/business/21cong.html?hp&_r=0
21
http://money.cnn.com/2009/10/08/news/economy/bernanke_fed_balance_sheet/index.htm
22
See Marketwatch, http://www.marketwatch.com/story/indymac-says-subprime-contagion-
into-alt-a-loans-overblown
23
)DQQLH 0DH¶V SULPDU\ EXVLQHVV LV WKH 86 VHFRQGDU\ PRUWJDJH PDUNHW ZKHUH LW SURYLGHV
funds to mortgage bankers, brokers, and other primary mortgage market partners for them to
make affordable loans directly to consumers. Freddie Mac has more strategic functions such
as; ensuring stability in residential mortgage market; responding to private capital market;
making sure that residential mortgage market is liquid and providing liquidity when necessary,
also ensuring appropriate distribution of investment capital; finally, promoting mortgage
credit to everyone nationwide. http://www.wikinvest.com/
24
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=adr.czwVm3ws&refer=home
25
http://www.time.com/time/business/article/0,8599,1841699,00.html
21

$27 billion of preferred stock in Citigroup on top of an earlier purchase of
$25 billion.26 Although 2009 marked the end of recession in the United
States, the recovery process however has been the slowest since the post
Great Depression era; furthermore, sovereign debt issues in the Euro zone
have been adversely affecting the speed of recovery process due to
interconnectedness.
On the contrary to some views amongst the European countries, a high

magnitude crisis could have not simply EHHQ DQ LVRODWHG FDVH RI WKH 86¶
own problem and it would have not spilled over across the Atlantic to the
eurozone. The sovereign debt crisis was also a victim of massive amount of
money from increased savings which became available for lending to
borrowers and investors; as a result, credit conditions were relaxed which
encouraged aggressive financial institutions to engage in riskier lending
and borrowing practices.
The size of global fixed-income securities one writer referred to it as "Giant

Pool of Money" nearly doubled reaching $70 trillion in 2007 compared
with $36 trillion in 2000.27 This colossal amount of money was put into
more productive use in several different ways; large portion of it was made
available for financial institutions to lend to barrowers and investors
(mainly for mortgage loans and equity line of credits), some of it was used
as FDIs and FPIs (largely short-term capital inflows) in emerging markets
where the interest rates were higher than those in developed nations.
The case of financial contagion and its detrimental effects were more
apparent for some countries in the Eurozone than in the U.S. due to
globalization of finance and subsequently interconnection of the major

26
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a957XI5bBv7g&refer=home
27
http://www.thisamericanlife.org/radio-archives/episode/355/the-giant-pool-of-money
22

systematically important banks (SIBs). Each Euro nation owes significant
debt to banks in other European countries. For instance, as of June 2011,
the UK¶V total foreign debt was incredible ¼7.3 trillion which translated to
436% of its ¼1.7 trillion GDP in that year; in addition, the UK had a very
large public debt, ¼1.38 trillion which came to 81% of its 2011 GDP.
Moreover, D ODUJH SRUWLRQ RI WKH 8.¶V IRUHLJQ GHEW ZDV RZHG WR EDQNV
(¼1.6 trillion, 21.92% of the total) in other countries (¼701.3 billion), but
more so to banks in eurozone (¼905.8 billion); ¼578.6 billion to the US
(7.93%), ¼379.3 billion to Germany (5.2%), ¼209.9 billion to France
(2.88%), ¼316.6 billion to Spain (4.34%), and ¼122.7 billion to Japan
(1.68%). Although the UK is heavily indebted to eurozone banks as well as
banks in Japan and the US, its high debt exposure does not create a huge
concern to investors because it holds high-value liquid assets.
Table 1 ʹͲͳͳǣǫ ȋ̀Ȍʹͺ
Countries US UK DEU FRA ESP JPN ITA GRC IRL PRT
US ϴϯϱ ϰϭϱ ϰϰϬ ϭϳϭ ϴϯϱ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ

UK ϱϳϵ ϯϳϵ ϮϭϬ ϯϭϳ ϭϮϯ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ
Germany ϭϳϰ ϭϰϭ ϮϬϲ ͲͲͲͲ ϭϬϴ ϮϬϯ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ
France ϮϬϮ ϮϮϳ ϭϮϯ ͲͲͲͲ ϴϬ ϯϴ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ
Spain ϱϬ ϳϱ ϭϯϮ ϭϭϮ ϮϬ ϮϮ ͲͲͲͲ ͲͲͲͲ ϮϬ
Japan Ϯϰϱ ϭϬϮ ϰϯ ϭϬϴ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ
Italy ϯϱ ϱϱ ϭϮϬ ϯϬϵ ϯϬ ϯϯ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ
Greece ϲ͘Ϯ ϵ͘ϰ ϭϲ ϰϭ ͲͲͲͲ ͲͲͲͲ Ϯ͘ϴ ͲͲͲͲ ϳ͘ϱ
Ireland ϰϬ ϭϬϱ ϴϮ Ϯϰ ͲͲͲͲ ϭϱ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ
Portugal ϯ͘ϵ ϭϵ Ϯϳ ϭϵ ϲϲ ͲͲͲͲ Ϯ͘ϵ ͲͲͲͲ ͲͲͲͲ
*DEU-Germany, FRA-France, ESP-Spain, JPN-Japan, ITA-Italy, GRC-Greece, IRL-Ireland,
PRT-Portugal

28
Source: BBC News Business, BIS, IMF, World Bank, UN,
http://www.bbc.co.uk/news/business-15748696
23

The above eight nations in the eurozone have accumulated ¼1.71 trillion
foreign debt from banks located in Japan and the US, ¼379 billion and
¼1.33 trillion respectively. However, the most concerning part of all this is
that eight mentioned countries owed a combined ¼3.14 trillion of debt in
2011 to banks in the Euro region, which means that any possibility of a
sovereign debt crisis in one of these nations could potentially cause a
contagion in the eurozone due to their extensive debt exposure and
interconnectedness to each other¶V V\VWHPatically important financial
system. Four countries (Greece, Ireland, Portugal, and Spain) with
sovereign debt issues had a total of massive ¼916 billion debt, of which
¼99.5 billion was from the US banks, ¼35.4 billion was owed to Japanese
banks, and the remaining ¼781.1 billion belonged to banks in Germany, the
UK, France, and Italy. Although Greece had the lowest amount of foreign
bank debt (¼75.4 billion) amongst the eight nations covered here, it is
however heavily indebted to eurozone countries; moreover, Greece is one
of the three countries that received bail-out money (other two countries are,
Ireland and Portugal).29
As of June 2011, Greece had about ¼400 billion foreign debt which
amounted to 252% of its annual GDP and the public debt came out to be
166% of the GDP in the same year. Portugal showed almost the same debt
picture as Greece; Portugal too had around ¼400 billion foreign debt which
ZDVRILWV*'3SOXV3RUWXJDO¶VJRYHUQPHQWGHEWWR*'3UDWLRZDV
106%. Ireland had the worst imaginable foreign bank debt scenario due to
the combination of both economic boom years leading up to 2008 and
subsequently uncontrolled fiscal budget during good times along with
massive government spending. In June 2011, Ireland saw enormously huge
¼1.7 trillion foreign debt which translated to amazing 1,093% of its GDP,

29
24

making Ireland one of the riskiest nations in the eurozone with potential
sovereign default on its external debt obligations; the public debt to GDP
ratio was 109%. In 2001, foreign debt per person in these three
economically troubled eurozone nations ZHUH*UHHFH ¼3RUWXJDO
¼DQG,UHODQG¼30
Besides the three countries, Spain has joined the group as the fourth nation
showing signs of sovereign debt crisis in recent years (2010-6SDLQ¶V
government debt to GDP ratio (67%) was so much better than Greece,
Portugal and Ireland; furthermore, it was actually even better than the
public debt to GDP ratio of the U.S. (100%)(YHQWKRXJK6SDLQKDG¼
trillion foreign debt which came out to be 284% of GDP and foreign debt
SHUSHUVRQZDV¼FRQYHUVHO\6SDLQZDVVWLOOFRQVLGHUHGDPHGLXP-
risk country to investors because it has more high-value assets than Greece,
Portugal, and Ireland which were all treated as high-risk to invest.
The United States would be an excellent example for illustration of having

both low risk and enormous foreign debt, more than any nation in the world.
$V RI -XQH WKH 86 KHOG ¼ WULOOLRQ WULOOLRQ LQ FXUUHQW
$USD) foreign debt and its government debt to GDP was 100% and foreign
GHEWSHUSHUVRQFDPHRXWWREH¼$PRQJWKHFRXQWULHV
in table 1, Japan is the only country that had far less foreign debt than its
2011 GDP; Japan¶V ¼ foreign debt ($2.63 trillion) was trillion compared
ZLWK ¼ WULOOLRQ *'3 ($5.4 trillion) and foreign debt per person was
¼KRZHYHUJRYHUQPHQWGHEWWR*'3ZDVPXFKKLJKHUWKDQ
those eurozone nations with sovereign debt crisis (Japan uses more
domestic financing than foreign); nonetheless, Japan is a low-risk country
for investors for the same reason mentioned before that Japan has high-

30
25

value liquid assets to cover its external debt obligations.31 A sovereign debt
can be defined as funds that are owed by the government of a sovereign
state and it becomes a sovereign default when the sovereign state refuses to
meet its external debt obligations when they are due.
Table 2 ʹͲȋ̈́Ȍ͵ʹ
Public % of Public % of
Countries Countries
debt GDP debt GDP
USA ϵ͕ϭϯϯ ϲϮ Spain ϴϮϯ ϲϬ

Japan ϴ͕ϱϭϮ ϭϵϴ Mexico ϱϳϳ ϯϳ
Germany Ϯ͕ϰϰϲ ϴϯ Greece ϰϱϰ ϭϰϯ
Italy Ϯ͕ϭϭϯ ϭϭϵ Netherlands ϰϮϰ ϲϯ
India Ϯ͕ϭϬϳ ϱϮ Turkey ϰϭϭ ϰϯ
China ϭ͕ϵϬϳ ϭϵ Belgium ϯϵϴ ϭϬϭ
France ϭ͕ϳϲϳ ϴϮ Egypt ϯϵϴ ϴϬ
UK ϭ͕ϲϱϰ ϳϲ Poland ϯϴϭ ϱϯ
South
Brazil ϭ͕Ϯϴϭ ϱϵ ϯϯϭ Ϯϯ
Korea
Canada ϭ͕ϭϭϳ ϴϰ Singapore ϯϬϵ ϭϬϲ
Back in history, when a sovereign state defaulted on its external debt

(usually in form of taxes), the consequences of that would have often
resulted in a declaration of war; however, in modern history, there has not
been really a war situation because a sovereign state refused to pay back its
debt in full. From 1779 to 2012, there have been about 300 sovereign debt
default or restructuring by 84 countries; 43 cases by 22 countries in Africa,
160 cases by 27 countries in Americas, 27 cases by 14 countries in Asia,
and 71 cases by 21 countries in Europe. Countries with most number of

31
32
See CIA World Factbook, https://www.cia.gov/library/publications/the-world-
factbook/rankorder/2186rank.html
26

occurrences in each continent are; Nigeria (5) in Africa, Venezuela (12) in
Americas, Indonesia (4) in Asia, and Spain (9) in Europe.33
The sovereign debt crisis in the eurozone has been going on since 2008, but
the situation got vastly worsened by 2009 and as a result the investors have
become increasingly concerned about the rapid rise of private and public
debt levels throughout the world which signaled rating companies and
triggered a wave of downgrades to be issued.
The crisis intensified by 2010 as several countries in the eurozone started

having difficulties of finding new capital to pay or re-structure their
existing sovereign debts which have increased substantially in recent years
due to rising nonperforming loans mainly arising from subprime mortgage
loans or consumer credit loans.
The European Union has really created its own sovereign debt crisis
because it was not very rational to have monetary union in force but not the
fiscal union. Therefore, this was going to happen sooner or later because it
did not make whole a lot of sense that economic stability in the eurozone
through monetary union alone without the integration of fiscal union (i.e.
tax, wages, pension, and government expenditure) in each member nation
would be successfully sustained for a long time, especially when
systemically important banks of the EU are very closely interconnected, not
to leave out the possible adverse effects of globalization of finance.
The locomotive nations of the Euro region; Germany and France, and the
UK outside of the Union probably have very closely similar fiscal policies,
EXWWKH8QLRQ¶VOHVVGHveloped and economically weaker member nations
(smaller, newly joined members) may have very different fiscal policies in

33
See Wikipedia, http://en.wikipedia.org/wiki/Sovereign_debt_crisis
27

place which may lead to undesired outcomes that may adversely affect the
whole European Union (i.e. Greece, Ireland, and Portugal).
The absence of a fiscal union in the eurozone has allowed some countries
to ignore rules and build massive levels of private and public debts without
any collateral (high-value liquid assets) or other means to pay for when
these external debt obligations became due. In this scenario, the inevitable
came little sooner than expected and caught nations impromptu to deal with
sovereign debt crisis.
Just like in the U.S., governments in the eurozone had to intervene to bail
out some of the systemically important banks in the financial system across
Europe. Besides severe adverse economic effects of the crisis and
dislocation of societies, the crisis also played a major political impact
instigating changes in the faith of 8 out of 17 ruling governments in
eurozone countries; ruling governments in power shifted in Greece, Ireland,
Italy, Portugal, Spain, Slovenia, Slovakia, and the Netherlands.34
After carefully monitoring the rescue attempts taken by the United States,
to restore LQYHVWRUV¶ confidence and to avoid spillovers to the broader
economy in the eurozone, the European Financial Stability Facility (EFSF)
announced similar size bailout packages to address massive private debt
defaults (nonperforming private loans), clean up balance sheets of some
systemically important financial institutions, help nations facing sovereign-
debt crisis and to preserve financial stability in the eurozone. The New
York Times reported in 2011 that the EFSF was authorized to barrow ¼
billion as a lending capacity which may be cRPELQHGZLWKORDQVXSWR¼
billion from the European Financial Stabilization Mechanism (EFSM).

34
http://en.wikipedia.org/wiki/Euro_sovereign_debt_crisis
28

Ireland was provided with ¼85 billion ($112 billion) and Portugal said that
it would need to raise ¼20 billion (little over $26 billion).35
Each European country contributed to the sovereign debt crisis little

differently; For instance, the Greek government massively inflated its
public debt through a politically motivated move of frequently increasing
the wages and pension benefits of government employees which doubled
over a decade. In Ireland, a huge property bubble was created when Irish
banks let property developers undertake enormous amounts of debt, and
when the bubble finally burst the government (tax payers) stepped in to
assume the private debt. Iceland¶VIDVWH[SDQGLQJEDQNLQJV\VWHPSURYLGHG
significant levels of credit to global investors which was three times in
excess of its GDP. The adverse effects of 2008 financial crisis and
downturn economy in Japan and the United States increased the number of
nonperforming loans in Iceland which resulted in tremendous exposure of
external debt default risk by investors.36
As the crisis deepened in Europe, IMF promised to provide financial

assistance that could total ¼120 billion, or $160 billion, over three years.37
British government announced on October 8, 2008 a rescue package
totaling £500 billion (close to $800 billion); £200 billion of that was going
to be made available for short-term loans.38 Through the Bank
Recapitalization Fund (BRF), the government will buy a combination of
ordinary shares and preference shares in affected banks.39

35
http://www.nytimes.com/2011/01/06/business/global/06euro.html?_r=1&src=busln
36
http://en.wikipedia.org/wiki/European_sovereign-debt_crisis
37
7KH(8ZDVXQDEOHWRDJUHHRQDVROXWLRQWRDGGUHVV*UHHFH¶VVKRUW-term debt issues.
http://topics.nytimes.com/top/reference/timestopics/organizations/i/international_monetary_f
und/index.html?
38
http://news.bbc.co.uk/2/hi/business/7658277.stm
39
http://en.wikipedia.org/wiki/2008_United_Kingdom_bank_rescue_package#cite_note-
Central-3
29

Various private banks in England took different actions to contend with
crisis based on their financial needs; for instance, HSBC issued a statement
saying that it had no plans to utilize WKH 8. JRYHUQPHQW¶V BRF; on the
FRQWUDU\+6%&VDLGWKDWLWZDVJRLQJWRLQMHFW¼PLOOLRQRIFDSLWDOWR
help ease the pain of the crisis.40 Royal Bank of Scotland (RBS), Lloyds
TSB and HBOS will have a total of £37 billion injected into them. In the
case of Barclays, the bank made an announcement that it would cancel
dividend payout providing a net saving of £2 billion.41
6 5DLKDQ =DPLO WKH ,0)¶V %DQNLQJ 3ROLF\ DQG 6XSHUYLVLRQ $GYLVRU WR
%DQN,QGRQHVLDVDLGWKDW³2YHUVLJKWRIV\VWHPLFDOO\LPSRUWDQWEDQNVPXVW
be reevaluDWHG´ When the U.S. government was scrambling to rescue some
large systemically important financial institutions and leaving other less
important banks fail, this raised serious questions and concerns regarding
integrity and trustworthiness of the regulatory framework. Mr. Zamil also
SRLQWHGRXWWKDW³Unprecedented actions by governments during the global
economic crisis to shore up financial institutions deemed too big to fail
underscore the critical role of large systemically important financial
institutions in economic development and in financial system stability.´
The biggest US government intervention in the financial system in history

introduced bail-out packages to restore confidence which included several
types such as; conservatorship (i.e. the debts of Fannie Mae and Freddie
Mac were backed by the US government; $1.7 trillion in unsecured debt
and $3.5 trillion of mortgage guarantees); injection of much needed capital
(i.e. AIG, American Insurance Group, received $85 billion from the Fed in
exchange for 79.9% stake in the company); SXUFKDVH RI ILUPV¶ EDG GHEWV

40
http://www.hsbc.com/1/2/newsroom/news/news-archive-2008/capital-base-of-hsbc-uk-
strengthened
41
30

(i.e. the U.S. government bought over $50 billion of Citigroup shares). If a
bank needs to be rescued due to extreme financial stress, it should not be
entirely done so just because a bank iVD³WRR- big-to-IDLOÍLUP Mr. =DPLO¶V
SDSHU SUHGRPLQDQWO\ IRFXVHV RQ WZR GLPHQVLRQV ³FULVLV SUHYHQWLRQ´
(strong corporate governance, effective risk management, efficient internal
processes, well-functioning regulatory framework, and proper supervision)
DQG ³UHVROXWLRQ´ (best possible course of action should be taken; for
instance, if a bank has not taken all necessary crisis-prevention steps, then
UHJDUGOHVV RI LWV ³WRR-big-to-IDLO´ ILUP VWDWXV LW VKRXOG EH OHIW WR IDLO
however, if the opposite case is true, then the bank should be supported by
capital injection or a government bailout through the challenging times.42
Zamil (200VXJJHVWVWKDW³$XWKRULWLHVZLOOKDYHWRDGRSWDFRPSUHKHQVLYH

set of crisis prevention measures to better regulate and suSHUYLVH 6,%V´
The IMF Managing Director Christine Lagarde had quoted a phrase by the
young Malaysian novelist Tan Twan Eng during an event in Kuala Lumpur
organized by the Malaysian Economic Association and the Bank Negara
Malaysia, which said; ³0RPHQWVLn time when the world is changing bring
out the best and the worst in people,´ then she added, ³May we always
choose the best!´$WWKHHQGLWLValways up to firms what route they want
to take, good or bad; companies can engage in risky or safe business
practices. The crisis in this magnitude usually calls for a total overhauling
of the existing system.
The invaluable lesson of the crisis has been realization and

acknowledgement of the fact that the financial system before the crisis had
major deficiencies that needed to be fixed and the only way to see them
was through the eyes of a crisis. When things are going well despite major

42
6HH,0)³7RR%LJWR,JQRUH´)LQDQFH 'HYHORSPHQW'HFHPEHU9ROXPH
31

hidden flaws, nobody (analysts, banks, governments, rating firms,
regulatory agencies, world organizations, and others) wants to be the first
to blow the whistle to signal or warn about concerning developments that
may produce negative implications which may ultimately trigger collective
actions (herd mentality) by the investors and that may eventually lead to
crises. Some of the crisis preventions measures suggested by Zamil (2009)
have been already introduced under Basel III; increased quality and
quantity of capital, better risk management, building-up capital buffers in
good times that can be used during domestic or global-scale financial stress.
The Basel Committee on Banking Supervision (BCBS) focused on five

fundamental areas; 1) Capital should be quality, transparent, and consistent.
This will enable banks to cover potential losses on both a going concern
and a gone concern basis; in addition, the quality of Tier 1 capital had to be
improved and harmonized internationally across different financial
institutions. 2) Risk coverage and the capital requirements for counterparty
credit risk exposures arising from derivatives should be strengthened. 3) A
leverage ratio is introduced to contain the build-up of excessive leverage in
the banking system; leverage build-up was a major issue in previous crises
as well as the most recent crisis. 4) Capital buffers are introduced to
encourage banks to build-up capitals to be used at times of financial stress.
Also forward-looking philosophy is being implemented; thinking more of
³H[SHFWHGORVV´LQVWHDGRI³LQFXUUHGORVV´$OLTXLGLW\FRYHUDJHUDWLRLV
introduced (LCR) which require banks to have enough liquidity (cash, or
short-term securities) to cover operation for at least a 30-day period.43
³8OWLPDWHO\ WKH LQWURGXFWLRQ RI PRUH VWULQJHQW UHJXODWLRQV VWURQJHU ULVN

management, and better board oversight must be underpinned by robust

43
See Bank for International Settlements ± BIS, http://www.bis.org/press/p091217.htm
32

FRQVROLGDWHG VXSHUYLVLRQ´ (Zamil, 2009). Zamil (2009) in his paper
explores a number of complex issues searching for answers, definitions, or
clarifications regarding systemically important banks (SIBs); he says that
moral hazard must be considered and addressed appropriately by the policy
makers or the governments (if governments keep rescuing SIBs to preserve
stability in the financial systems and to avoid any spillover effects to the
broader economy, and the SIBs are perfectly aware of this fact and use it to
their advantage, then this may encourage a systemically important bank to
engage in grossly riskier lending, borrowing or investment practices than
otherwise which in turn may call for a more destructive and a longer lasting
damages, followed by unimaginable size of bailout packages. Innocent
bystanders always get caught in the storm of a crisis; regardless of its size,
a failure is a failure no matter what and the consequences of risky
behaviors by the SIBs and their executives should be held liable for their
actions of any wrongdoing. For instance, just days before the Enron
FROODSVHLQWKH86WKHFRPSDQ\¶VH[HFXWLYHVZHUHGXPSLQJWKHLUVKDUHV
while regular devoted employees were blocked from making any sell
transactions until their hard-earned lifetime savings literally evaporated in
front of their eyes (a financial loss of more than $11 billion44).
The definition of an SIB and oversight of it, the rules, policies, and
governance that will have to apply will be broadly different across
countries or even regions. It may take years before any domestic or
international consensus have been reached due to the massively complex as
well as challenging nature of the task; in addition, tremendous amount of
bureaucratic steps and resistance to change or adopt may exist in some less

44
First time in US corporate history, company executives have received unprecedented prison
sentences. On July 13, 2005 Bernard Ebbers received a 25 year-sentence and at the time of
sentencing, Ebbers was 63 years old on Sept. 26, 2006. Jeffrey Skilling, former CEO of Enron
was convicted in 2006 of multiple federal felony charges relating to Enron's financial collapse,
and he is currently serving a 24-year.
33

developed nations that may be nearly impossible to overcome.
1HYHUWKHOHVVWKHLVVXHRIOHVVGHYHORSHGFRXQWULHV¶ILQDQFLDOV\VWHPVPD\
not create tremendous amount of risks because on one hand the banks in
these countries are poorly developed and their sizes are relatively very
small compared to those in industrialized nations; and on the other hand,
the chances are very small that these weak financial structures will have
any systemically important banks (SIBs).
The Basel Committee on Banking Supervision (BCBS) should formulate a

definition of what an SIB is in the context of a financial system that are
found in the U.S. or the EU and set appropriate parameters and standards to
follow so that other nations with differing financial systems could work on
developing their versions of the definition of an SIB along with country
specific parameters and rules. However, same as the development of Basel
III guidelines, the BCBS, through consultations with all 28 member-nations,
should create a template for financial systems across regions to follow to
meet the requirements, which would ensure a uniform process throughout
the world. =DPLOLVQRWFHUWDLQ³ZKHWKHUSROLFLHVFDQEHGHYHORSHG
that allow troubled SIBs to fail, but limit the effect of that failure on the
UHDOHFRQRP\DQGILQDQFLDOVWDELOLW\´
=DPLODUJXHVWKDW³$XWKRULWLHVPXVWGHYHORSDZRUNDEOHGHILQLWLRQ

RI D V\VWHPLFDOO\ LPSRUWDQW EDQN´ 7KH TXHVWLRQ LV KRZ" :KDW XQLTXH
characteristics of banks should be used in GHILQLWLRQ IRUPDWLRQ" ³6KRXOG
WKH EDQN¶V VWDWXV EH EDVHG RQ WKH VL]H RI LWV DVVHWV RU GHSRVLWV WKH
complexity of its activities, its role as counterparty in derivatives
WUDQVDFWLRQVRUVRPHRWKHUPHDVXUH"´=DPLO)LQDQFLDOPDUNHWVDUH
dynamic which tend to evolve through changing times (i.e. economic boom
or bust, recession or prosperity through strong economic progress).
34

Once the domestic and international consensus has been reached on the
definition of a systemically important bank (SIB), will this mean that the
same definition will be used in good, bad or worse economic times and
how will authorities choose what banks will require rigorous regulatory
supervision? ³$XWKRULWLHVZLOOKDYHWRDGRSWDFRPSUHKHQVLYHVHWRIFULVLV
prevention measures tREHWWHUUHJXODWHDQGVXSHUYLVH6,%V´=DPLO
The Basel Committee said that its main focus is to create a resilient
banking capable of absorbing shocks arising from financial and economic
stress, and the ultimate aim is to prevent spillover from the financial sector
to the real economy. The types of issues that had absolute crippling effects
in the financial system as well as the broader economy arising from the
current crisis were inefficient risk management, weak governance, lack of
transparency, and significant issues with disclosures which are intended to
be significantly improved through reforms introduced under Basel III.45
The Committee also aims to improve systemically significant cross-border

banks and its recommendations consist of three categories; 1)
³strengthening of national resolution powers and their cross-border
implementation´; 2) ³ex ante action and institution-specific contingency
planning which involves the institutions themselves as well as critical home
and host jurisdictions´; and 3) ³reducing contagion and limiting the impact
on the market of the failure of a financial firm, by actions such as further
strengthening of netting arrangements.´46
The Committee believes that its recommendations together with other

measures would reduce the likelihood of banks failures due to domestic and
international market impacts arising from pressure in the form of economic

45
Basel Committee on Banking Supervision, Strengthening the resilience of the banking sector
46
See BIS, Bank of International Settlements, http://www.bis.org/publ/bcbs162.htm
35

and financial shocks. The Basel Committee's recommendations relate to the
following areas:47
Recommendation Effective national resolution powers

Recommendation Framework for coordinated resolution of financial groups
Recommendation Convergence of national resolution measures
Recommendation Cross-border effects of national resolution measures
Recommendation Reduction of complexity and interconnectedness
Recommendation Planning in advance for orderly resolution
Recommendation Cross-border cooperation and information sharing
Recommendation Strengthening risk mitigation mechanisms
Recommendation Transfer of contractual relationships
Recommendation Exit strategies and market discipline
ASIAN EPIDEMIC
%DLJ DQG *ROGIDMQ QDPHG WKH FULVLV DV ³$VLDQ )OX´ DQG
FODLPHG WKH FULVLV ZDV D FDVH RI FRQWDJLRQ ZKHUH RQH FRXQWU\¶V LOO IDWH
quickly transmits to other neighboring countries like an epidemic. Bill
Clinton, the 42nd President of the United States, called the Asian crisis as a
PDMRU ³JOLWFK´ $V 1DQWR SRLQWHG RXW LQ -DQXDU\ WKH 86
Federal Reserve (Fed) Chairman Alan Greenspan indicated that due to the
financial crisis, foreign investors in Asian equities (excluding those in
Japan) lost an estimated $700 billion, $30 billion by the American investors.
As developing or emerging markets, financial institutions (banks) in Asia48

were practically unregulated and poorly governed; in addition, banks had

47
See BIS, Bank of International Settlements, http://www.bis.org/publ/bcbs169.htm
48
,0) GHILQLWLRQV DUH XVHG ³$VLD´ UHIHUV WR HPHUJLQJ $VLD SOXV LQGXVWULDO $VLD ³(PHUJLQJ
$VLDÚHIHUVWR&KLQD+RQJ.RQJ6$5,QGLD,QGRQHVLD.RUHD0DOD\VLDWKH3KLOLSSLQHV
Singapore, Taiwan Province of China, Thailand, and Vietnam.
36

excessive government ownership and questionable as well as riskier
lending practices which raised major concerns about transparency and
public disclosure of true financial results. This unpredictable situation
made it absolutely impossible for the industry participants, international
organizations, or regulatory agencies to assess the quality and quantity of
liquid capital or the banking system as a whole. All these issues and more
are covered under new Basel III prudential reforms, which aim to create a
resilient global banking system through strong governance, absolute
transparency, and international harmonization; in addition, the Committee
will make sure that all banks will comply and no banks will escape from
meeting the minimum capital requirements.
The Asian crisis was like a massive tsunami, hit without a warning and
retrieved so fast that only a year later Asia was already on its way for a
quicker and stronger recovery. In a way, the crisis barely made a dent on
$VLD¶VVWURQJVXVWDLQHGHFRQRPLFJURZWK+RZHYHURQO\WLPHZLOOSURYHLI
this is actually the case, meaning the quicker and stronger recovery can be
carried into coming years and beyond 2012 amid lingering effects of the
2008-2012 global financial crisis; economic downturn in the U.S.,
recession in Japan, and sovereign debt crisis in the eurozone, and other
external shocks (i.e. possible slowdown in China and India).
Except India and China &KLQD¶VJURZWKSHUIRUPDQFHKDVORVWVRPHVWHDP

in recent years, but it is still demonstrating strong growth numbers) where
the crisis did not cause any noticeable financial instability, full-fledged
recovery was apparent in affected countries in Asia; in newly industrialized
nations-NIEs (Hong Kong SAR, South Korea, Singapore, and Taiwan); in
ASEAN-5 (Indonesia, Malaysia, Philippines, Singapore, and Thailand).
Despite weak domestic demand, Japan is pulling out of prolonged recession.
37

Asian Flu ͳǤǡ Ͷͻ
Singapore intervenes to defend the baht against speculative

x May 14, 1997
attacks and spends billions of its foreign reserves.
The baht gets devalued, a massive 20% drop in value. IMF

x July 2, 1997
JHWVFDOOHGLQE\WKHJRYHUQPHQWIRU³WHFKQLFDODVVLVWDQFH´
Malaysia's central bank intervenes to defend its currency,

x July 8, 1997 ringgit against speculative attacks in foreign currency
markets.
The Philippine peso is devalued. Indonesia widens its trading

x July 11, 1997
band for the rupiah in a move to discourage speculators.
The IMF announces availability of more than a billion

x July 18, 1997
dollars to the Philippines to relieve pressure on the peso.
Singapore currency cracks from pressure, starts a slow

x July 24, 1997 decline. Malaysia accuses George Soros for attacks on
ringgit.
Thailand agrees to IMF measures in return for a $17 billion

x Aug. 5, 1997 loan. The Thai government closes 42 ailing finance
companies and raises taxes.
Indonesia abandons the rupiah's trading band and allows its

x Aug. 14, 1997 currency to float freely; rupiah massively plunges in the
value.
Indonesia asks the IMF and the World Bank for help after
x Oct. 8, 1997
rupiah depreciates more than 30% in two months.
Hong Kong's stock index falls 10.4% after it raises bank

x Oct. 23, 1997 lending rates to 300%. Shares lose $29.3 billion of their
value.
IMF agrees to a $40 billion loan package to Indonesia,

x Oct. 31, 1997
government agrees to close 16 insolvent banks.
The IMF approves a $57 billion bailout package to South

x Dec. 3, 1997
Korea; WKHODUJHVWLQ,0)¶VKLVWRU\DWWKHWLPH

49
See Frontline, http://www.pbs.org/wgbh/pages/frontline/shows/crash/etc/cron.html
38

Asia is highly dependent on positive economic performance of the
industrialized nations (mainly the US, Japan, and the EU), so the external-
macroeconomic environment has to be favorable arising from strong world
trade activities along with resilient and flexible financial markets.
Performing well domestically for Asia, in the midst of slowing exports, is
as crucial as existence of favorable external factors, maybe even more. Asia
cannot afford political instability that can easily wipe out everything that
Asia has worked for the last three decades (i.e. the case of political
instability in Indonesia).
Capital inflows play a significant role in the crisis-affected ASEAN-5 and

NIE nations to continue their forward economic progress; thus, Asia must
keep focused on improving issues related to governance, transparency,
regulatory, and disclosures. Moreover, Asia also needs to continue its
reform efforts on fiscal and monetary policy introduction, further opening
XS LWV EDQNLQJ VHFWRU WR IRUHLJQ LQYHVWPHQW DQG UHVWUXFWXULQJ EDQNV¶
products/services to include those offered in financial markets of developed
nations (i.e. derivatives, over the counter market). These alone would not
be sufficient to prevent future crises from happening if the firms
themselves do not develop their own internal systems to monitor, manage,
and govern the actions of managers and executives and hold them
accountable for any wrongdoing.
³7KH QHZO\ LQGXVWULDOL]HG HFRQRPies (NIEs) of Asia have achieved rapid

growth in large part through an astonishing mobilization of resources.
Economic growth seems to be driven by extraordinary acceleration of
performance in inputs like labor and capital rather than by gains in
HIILFLHQF\´ (Krugman, 1994). According to Krugman (1994), the
remarkable growth of the Singaporean economy (averaging 8.5%) between
39

1966 and 1990 was not really a miracle, it was merely mobilization of
UHVRXUFHV LQ RWKHU ZRUGV LW ZDV EDVHG RQ ³SHUVSLUDWLRQ UDWKHU WKDQ
inspiUDWLRQ´ (physical labor work).
Krugman feels that Singaporean growth was actually achieved through

³SHUVSLUDWLRQÉHFDXVHWKHZRUNSRSXODWLRQVXUJHGIURPWRKDOI
of which had no formal education. Furthermore, Krugman (1994) strongly
argues that SiQJDSRUH¶VSDVWJURZWKZDVDRQH-time event and it will not be
repeated again because further increase in performance from these levels
will require much more skilled and highly educated human capital;
therefore, it is very unlikely that RI 6LQJDSRUH¶V population will not
become employed or the education level of the current employees with no
formal education will not improve to university level in short time or in
near future $OWKRXJK 6LQJDSRUH¶V HFRQRP\ ZDV IDLUO\ HIILFLHQW LW
predominantly lacked sufficient capital and highly educated workforce.
2WKHU $VLDQ ³WLJHUV50´ KDYH LPSURYHG WKHLU UHVSHFWLYH HFRQRPLHV WKURXJK
innovation, improvements in education, and technological development;
nonetheless, no evidence of improvement in efficiency (Krugman, 1994).
Unlike the Asian tigers, the success story of Japan was fundamentally
different in several ways; Japan simply rose out of nuclear ashes after the
World War II to become the second-largest industrial power until losing
that position to China in recent years. Nevertheless, Japan, either as 2nd or
3rd largest economy in the world, still made it from nothing; Japan truly
achieved unparalleled growth during 1950s and 1960s through tremendous
amount of progress both in input and efficiency levels. By 1973, Japan was
still quite smaller and less developed than the US; the size of its GDP was

50
2ULJLQDO IRXU $VLDQ ³WLJHUV´ LQFOXGHG +RQJ .RQJ 6LQJDSRUH 6RXWK .RUHD DQG 7DLZDQ
Malaysia presents very compelling reasons to be included in that exclusive short list as the
fifth Asian tiger
40

DERXW DTXDUWHURI WKH 8QLWHG 6WDWHV $GHFDGH ODWHUE\ -DSDQ¶VSHU
capita income exceeded that of the United States, and just a few years later
by 1988, the US output was outpaced by Japan. When everyone thought
that Japan would outstrip the United States in GDP and per capita income
by as early as 1990s, unfortunately Japan fell short of that expectation and
grew moderately in the next decades just to keep its second position and its
output was still not close to half of the US. Persisting recession coupled
with minimal GDP growth caused Japan ($5.5 trillion) losing its 2nd largest
economy position to China ($5.9 trillion) in 2009.
As the 2nd largest economy in the ZRUOG -DSDQ¶V *'3 LQ ZDV
trillion which was almost half of the U.S. ($10 trillion); and by this time,
China was only the 6th largest economy with $1.2 trillion which was even
smaller than that of France ($1.3 trillion). It is shockingly unbelievable that
about a decade later&KLQD¶V*'3KDVJURZQPDVVLYHO\E\RUDOPRVW
in four folds; during the same time, the US added another 45% growth to
its GDP bringing the total from $10 trillion in 2000 to $14.5 trillion in 2010;
France doubled its GD3WRWULOOLRQZKLFKZDVHQRXJKWRWDNHWKH8.¶V
place as the 5th largest economy; -DSDQ¶V *'3 JUHZ D PHUH LQ
years; by 2017, Brazil and India are expected to be 5th and 6th.51
Krugman (1994) seems disappointed that Japan is not as overpowering

economic aptitude as once thought; however, one thing is clear that Japan
GRHV QRW EHDU D UHVHPEODQFH WR $VLDQ WLJHUV &KLQD¶V VWDUWLQJ SRLQW LV
somewhat same as Japan, meaning both started very poor; however,
&KLQD¶VDGYDQWDJHRYHU-DSDQLVLWVPDVVLYHSopulation which may lead to
productivity levels of developed nations if it is utilized effectively. China
has recorded impressive growth for the past three decades or so, annual

51
See CNN Money, http://money.cnn.com/news/economy/world_economies_gdp/
41

growth averaging 9-10%; if China keeps growing at this rate in the future,
World Bank estimates that China could pass the United States, but if it
grows at a more moderate level of 7%, then China would comprise about
87% of the United SWDWHV¶ GDP (Krugman, 1994).
The Asian crisis in 1997 had caused massive economic and financial
diVWXUEDQFHV LQ VR FDOOHG $VLDQ ³WLJHUV RU GUDJRQV´ NIEs: Hong Kong,
Singapore, South Korea, Taiwan) and the original five founding members
of the ASEAN (Indonesia, Malaysia, Philippines, Thailand and Singapore).
The high-magnitude crisis had prompted uncontrollable fast deterioration
in living standards in the region accompanied by record unemployment and
jolted society from its roots. In many ways, this seemed like an enormous
tsunami signaling earlier indications that worse was yet to come.
Table 3
ͷʹ
Country Exchange rate (per $1 USD) GNP ($ billion)
Currencies53 ϭϵϵϳ ϭϵϵϴ й ϭϵϵϳ ϭϵϵϴ й
Baht Ϯϰ͘ϱ ϰϭ Ͳϲϳ͘ϯ ϭϳϬ ϭϬϮ ͲϰϬ͘Ϭ

Rupiah Ϯ͕ϯϴϬ ϭϰ͕ϭϱϬ Ͳϴϯ͘ϵ ϮϬϱ ϯϰ Ͳϴϯ͘ϰ
Peso Ϯϲ͘ϯ ϰϮ Ͳϱϵ͘ϳ ϳϱ ϰϳ Ͳϯϳ͘ϯ
Ringgit Ϯ͘ϱ ϰ͘ϭ Ͳϲϰ͘Ϭ ϵϬ ϱϱ Ͳϯϴ͘ϵ
Won ϴϱϬ ϭ͕ϮϵϬ Ͳϱϭ͘ϳ ϰϯϬ Ϯϴϯ Ͳϯϰ͘Ϯ
When the crisis finally moved into real economy, it was explicit that the
affected Asian nations were in deep recession and the contagion effects of
which was threatening to create a much extensive global crisis. On the

52
Cheetham, R. (1998) Asia Crisis, Paper presented at conference, U.S.-ASEAN-Japan policy
Dialogue. School of Advanced International Studies of Johns Hopkins University, June 7±9,
Washington, D.C
53
Thai (baht), Indonesian (rupiah), Pilipino (peso), Malaysian (ringgit), Korean (won)
42

contrary to common views, Asian crisis did not just occur entirely due to
insufficient reserves in foreign currencies or substantial current account
imbalances; these deficiencies were certainly valid and they definitely
influenced emerging Asia¶V ability to cope with the crisis effectively, but
this time around, the crisis majorly differed from other previous crises.
Everybody pretty much saw the tip of the iceberg (currencies pegged to the
dollar, fiscal and current account imbalances, capital outflows, and
speculative currency trading in foreign markets), though what was hidden
beneath the water was much more serious than everybody had ever
imagined. The problem was rooted in the culture and ways of doing things.
Unparalleled growth for the past four decades has created a utopia belief
among the Asian tigers that their much praised and coveted economic
performance was going to continue forever regardless of numerous cases of
serious unethical business conduct, weak governance in all branches of the
economy, and inability to adopt quickly to changing external environment.
Interconnectedness and globalization of financial markets along with

considerable reduction in trade barriers have benefited developed and
emerging economies; however, when these conveniences are not well-
managed, as seen in Asia, the Asian economies and their financial systems
became excessively vulnerable to external shocks, downturn economy in
developed countries (mainly the U.S., Japan, and the EU) and various
macroeconomic events throughout the world.
How did the basic fundamentals, allowing in excess of 8-9% growth year
over year for the last three decades in Asia, change so quickly causing
massive financial disturbances which affected RWKHU FRXQWULHV¶ HFRQRPLHV
starting with Japan? Nothing major seemed to have changed. Some
economists point out the dangerous case of currency fixing (currencies
43

pegged to dollar) as the key factor behind Asian crisis and others believe
that substantial external debt, fiscal and current account imbalances, abrupt
reversal of capital flows led to the crisis.
The U.S. dollar appreciated substantially in value against currencies in Asia

in the 1990s, especially against Japanese yen, this in turn made other
currencies that pegged to the dollar also significantly increase in value,
which had a tremendous negative impact on exports that in turn adversely
affected external current account balance creating massive deficits.
Furthermore, large capital outflows, added deterioration in macroeconomic
factors, weak domestic economic activity, and poor consumer confidence
resulted in constant currency fluctuations forcing frequent revisions to be
made. Unsustainable ill-fated economic policies have affected all countries
in Asia; however, a few nations were more severely affected than others. In
the case of Philippines, as being the poorest and the least developed
amongst the five, the negative effects of crisis were felt deeper.
7KDLODQG¶V EDKW ZDV ILUVW WR FROODSVH among the newly industrialized
economies (NIEs) and ASEAN-5 nations as the direct results of huge short-
term foreign debt creating additional pressure on the government to cover
what became due in less than 12 months, ballooning current account deficit
(trying to avoid further attacks on currency depleted reserves resulting in
massive deficits), tougher to manage financial sector which became
enormously challenging (increase of insolvency among banks led to their
inability to cover significant losses which became the responsibility of the
Thai government as a result of bailouts); in addition, reduced revenue from
exports (losing price competitive advantage due to increased value of the
baht which was the direct result of pegging baht to the dollar), contraction
in the domestic economy (fear set in among consumers), increasing
44

commodity prices due to rising inflation, continued weaknesses in Japanese
economy (the effects of natural disasters; earthquake and tsunami thereafter,
DOVR GRZQWXUQ LQ WKH 86 HFRQRP\ LV DIIHFWLQJ -DSDQ¶V UHFRYHU\
negatively), and further deterioration of the external macroeconomic
factors (majorly affecting Thailand exports). All of these obvious early
signs made it evident that Thailand was moving towards a huge financial
crisis. In August 1997, Thailand agreed to a three-year Stand-By
Arrangement with IMF for $4 billion, but total financial assistance it got
amounted to $17.2 billion.
Growth plummeted in all affected Asian countries, but more so in Thailand,

Indonesia, South Korea, and Malaysia. Singapore was well contained
despite the severity of the crisis and seemed to have been least affected
thanks to its solid current account surplus along with its better developed
financial system than other ASEAN neighbors. Indonesian currency rupiah
got hit the hardest and devalued precipitously, depreciating almost 500%
against the dollar. Gross national product (GNP) of Indonesia also dropped
significantly, twice more than any other ASEAN or East Asian nations
(tumbling 83.4% compared to a year ago, from $205 billion in 1997 to $34
billion in 1998). Other currencies depreciated between 50% and 60% each
H[FHSW7KDLODQG¶VEDKWZKLFKORVWRILWVYDOXHDJDLQVWGROODU
Before the crisis in 1997, according to the BIS data, on average 62% of the
loans to Asian countries were in short-term (due in a year or less), putting
extra pressure on these countries to search for new funds to cover what
becomes due. Malaysia and Thailand received the largest net private capital
inflows from 1991 to 1996; on average 12% and 11.6% of GDP
UHVSHFWLYHO\ )RUHLJQ EDQNV¶ ILQDQFLDO H[SRVXUH LQ $VLD ZDV FORVH WR
trillion dollars as of 1997, which mainly came from banks in Japan, France,
45

the UK, Germany, and the United States. Japan had the greatest exposure
with little over $270 billion, which came to 34.26% of the total exposure of
approximately $790 billion. The U.S. banks had the smallest amount of risk,
5.46% amounting to $43.2 billion. The exposures of other countries
included: Germany ($112 billion), France ($65 billion), the UK ($80
billion), and other various European banks were exposed to $94 billion.54
Chart 1 Ƭ ȋ̈́Ȍͷͷ
Thailand Malaysia Singapore Indonesia Philippines S. Korea
12
10
8
6
4
2
0
1992 1993 1994 1995 1996
$W WKH HQG RI WKUHH RI WKH UHJLRQ¶V FRXQWULHV ZHUH DPRQJ WKH WRS
recipients of private foreign caSLWDO IORZV ,QGRQHVLD UHFHLYHG WKH ZRUOG¶V
third largest share ($17.9 billion), Malaysia the fourth ($16 billion) and
with $14.7 billion Thailand was the sixth (Beams, 2002).Globalization of
finance also contributed to the 1998 Asian crisis in a way that it enabled
investors from all over the world make unsafe and risky investment
practices in financial markets (in real time) with almost no constraint of
different time zones. Calvo and Mendoza (1997) argue that investors in
financial markets of developing countries and emerging markets make
buy/sell decisions concerning financial securities based on herd mentality,

ϱϰ
See BIS, Bank for International Settlements
ϱϱ
:RUOG%DQN³)RUHLJQGLUHFWLQYHVWPHQWQHWLQIORZVFXUUHQW86´SUHSDUHGE\WKHDXWKRU
46

which can be considered as an irrational approach where rumors or
incidents are not checked or confirmed. Unfortunately, this type of
behavior has become even more dangerously apparent and more frequent in
developing countries than developed countries thanks to globalization of
finance. Masson (1997) also claims that already once jittery investors will
have minimum threshold for the next bit of bad news which may be just
enough to trigger a collective sell-off and lead to a crisis. Globalization of
finance has supplied much need capital in form of inflows to the newly
industrialized economies (NIEs), emerging markets, and the ASEAN-5
nations. However, as Asia has greatly benefited from this phenomena in
good days during much of the 1980s and 1990s up to the crisis, it needs to
treat massive capital inflows with extra caution and make sure that it is well
prepared when the reversal occurs, meaning capital outflows.
Emerging and developing nations are in constant need of uninterrupted

capital inflows to continue their economic progress; however, FDIs & FPIs,
although FDI is more preferred than FPI, can be a double edge sword and
especially sudden shift in the direction of capital flows could be potentially
very hazardous if the exits of capital are not backed by a healthy balanced
current account (surplus), in other words, as Thailand had experienced
during the Asian crisis, large current account imbalances (deficits) can
VXEVWDQWLDOO\ UHGXFH WKH FRXQWU\¶V DELOLW\ WR PHHW H[WHUQDO REOLJDWLRQV,
especially if a large part of external debt is due in short-term or effectively
manage certain speculative attacks imposed on its currency in foreign
markets by international investors.
Cashin and McDermott (1996) studied possible adverse effects of chronic

current account deficits and investigated if they led to crises; in addition,
they further examined if the crisis situation would possibly be reversed
47

without a major cost. The outcome of the study showed that massive and
chronic current account imbalances reduce the chances of capital inflows
and raise the risk of capital outflows which in turn often times may create a
serious chain reaction of events that may eventually lead to a crisis.
A comprehensive study by Milesi-Ferretti and Razin (1997) has identified

ten indicators that may play an important role explaining ³reversals´56 due
to persistent current account imbalances; 1) current account deficit: large
current account imbalances will result in reversals to prevent insolvency
and to continue lending; 2) openness: open economies will experience a
lesser degree of reversals because external obligations in these economies
can be met with less difficulty (i.e. the U.S. is not even concerned about its
growing deficit); 3) reserves: countries holding insufficient levels of
reserves will be more likely to experience a reversal to keep foreign
investors interested because otherwise investors will have less confidence
LQWKHVHFRXQWULHV¶DELOLW\WRVXVWDLQJURZWKDPLGODUJHH[WHUQDOGHILFLWV
investment: investment/savings can help countries reduce their current
account imbalances (increased productivity, more exports); 5) Countries
with low GDP per capita will less likely see a reversal, countries on the
opposite end will see a reversal due to governments receiving higher tax
revenues based on more economic activity; 6) concessional debt: a higher
share of concessional debt as part of the total debt will limit the ability to
service external obligations and reduce the chances of a reversal as often
seen in poor countries; 7) fiscal balance: a reversal in current account
deficit cannot be achieved before cost-cutting efforts taking place in fiscal
policies; 8) terms of trade: the chances of reversals are usually higher in
post-FULVLV VLWXDWLRQV IRU LQVWDQFH 7KDLODQG¶V UHVHUYHV KDYH LQFUHDVHG E\

56
Milesi-)HUUHWWLDQG5D]LQ³UHYHUVDO´WRLQGLFDWHODUJHUHGXFWLRQLQFXUUHQWDFFRXQW
deficits
48

seven folds, going from $26.5 billion in 1997 to $174.9 billion in 2011; 9)
OECD growth: high growth in industrialized nations will benefit
developing countries and enable them to improve deficits through surge in
exports, therefore reversals in current account imbalances are more likely
to occur; 10) US interest rates: capital will flow to developing countries
when interest rates in industrialized nations start descending, this will
create reversals.
IMF in ASIA
³$ FHQWUDO REMHFWLYH RI ,0)-supported programs has typically been to

reduce external imbalances. The cornerstone of most IMF-supported
programs has in most cases been fiscal adjustment: first, current account
GHILFLW« VHFRQG « ILVFDO WLJKWHQLQJ PD\ EH QHHGHG´ The government
authorities are expected to make certain progress in various areas of the
economy because IMF conditionality affecting the release of funds is based
on implementation of solid policy or structural reforms.
During the 1980s, structural reforms were rarely part of an IMF-supported

program, however by 1990s structural reforms pretty much became a
standard IMF conditionality which has increased from two per program in
1987 to 16 per program in 1997 (Bulir and Moon, 2003, p.4). ³'LG WKH
involvement of the IMF significantly improve the macroeconomic
outcomes relative to what they would have been if the absence of an IMF-
VXSSRUWHG SURJUDP"´ %XOLU DQd Moon, 2003, p.15) The IMF was first
called in by the government of Indonesia to provide what they called
³WHFKQLFDO DVVLVWDQFH´ ZKLFK WXUQHG LQWR being massive bailout packages,
ODUJHVW LQ ,0)¶V KLVWRU\ ,0) KDG DJUHHG WR monetary assistance for the
region totaling well over $100 billion: $17.2 billion to Thailand, $40 billion
to Indonesia, and $57 billion to Korea. IMF involvement and its application
49

RI ³XQLYDULDWH VROXWLRQV WR PXOWLYDULDWH SUREOHPV´ 57 in crisis affected
countries have been more often criticized than praised; many have argued
that IMF should have paid closer attention to country specific measures.
Boughton (2001) has quoted a phrase appeared in the Economist in which

,0) ZDV DFFXVHG IRU EHLQJ ³DQ RYHUEHDULQJ RUJDQL]DWLRQ ZLWK D ZHOO-
thumbed book of macroeconomic-SROLF\QRVWUXPV´58 Martin Feldstein (as
cited in Boughton, 2001) feels that IMF followed an inappropriate course
of actions to deal with 1997 Korean crisis. He strongly argues that IMF,
LQVWHDG RI ZULWLQJ WKH XVXDO ³SUHVFULSWLRQ RI EXGJHW GHILFLW UHGXFWLRQ´
should have introduced measures to prevent massive capital outflows
EHFDXVHLQ0DUWLQ¶VYLHZWKHVLWXDWLRQRIIRUHLJQH[FKDQJHUHVHUYHOHYHOV
in Korea was just a temporary situation and things would have gotten back
to normal anyway once all the dust settled and the panic among the foreign
investors had evaporated.59
%RXJKWRQ TXRWHV 0DUWLQ )HOGVWHLQ¶V SRLJQDQW DUJXPHQW ZKLFK

GHPRQVWUDWHVDFOHDUGLVDJUHHPHQWZLWK,0)¶VKDQGOHRIWKH.RUHDQFULVLV
in 1997 during which foreign creditors were pulling out of Korea in great
numbers. Martin thought descending in growth was the last thing Korea
needed especially when the investor confidence was in free-fall at the
KHLJKW RI WKH FULVLV ³7UDGLWLRQDO«SUHVFULSWLRQ RI EXGJHW GHIicit
UHGXFWLRQ«DQGDWLJKWHUPRQHWDU\SROLF\«,which together depress growth
and raise unemployment. But why should Korea be required to raise taxes
and cut spending to lower its 1998 budget deficit when its national savings
rate is already one of the highest in the world, when its budget deficit will
rise temporarily because of the policy-induced recession, and when the

57
See James M. Boughton (2001), IMF Working Paper, WP/01/12
58
6HH³6LFN3DWLHQWV:DUULQJ'RFWRUV´7KH(FRQRPLVW6HSWHPEHU-24, 1999), p.81
59
6HH)HOGVWHLQ0³5HIRFXVLQJWKH,0)´)RUHLJQ$IIDLUV9ROS
50

combination of higher private savings and reduced business investments
are already freeing up resources needed to raise exports and shrink the
FXUUHQW DFFRXQW GHILFLW"´ It would be nearly impossible for anyone
including the IMF to predict how the investors will react to any measures
taken by the government as part of the IMF-supported program; even if
IMF followed a different course of action, instead of fiscal tightening and
reduction of external debt, still no guarantees of capital outflow stoppage.
Max Corden (1998)60, Steven Radalet and Jeffry Sachs (1998)61, Minton-
Beddoes (1995),62 Willem Buiter (1983, and reprinted in 1990), and Tony
Killick (1995) (as all cited in Boughton, 2001) all made similar arguments
which are in explicit disagreement with that of the IMF.
The view of IMF deteriorates real fast from being positive to negative
when people in developed, emerging, newly industrialized, developing, or
underdeveloped nations are asked to provide their opinion regarding the
role of the International Monetary Fund in crises. Furthermore, people
along with some governments in poor nations see IMF as more politically
oriented in its approaches than just providing monetary assistance;
therefore, people in some parts of the world hold demonstrations against
IMF and its policies, and they see the organization as an extension of
capitalism without any sincerity to their unique circumstances.
Tony Killick (1995) describes the predominantly held view of the IMF in
GHYHORSLQJ FRXQWULHV WKDW ,0)¶V XQLYDULDWH DSSURDFK WR PXOWLYDULDWH

60
Cordon (1998) thought that IMF had options to choose fiscal expansion or fiscal tightening,
and as expected, instead of choosing the first option to make up the gap from reduction in
investments, IMF chose the option of fiscal tightening overlooking the implementation of
solid fiscal policies by the governments in Asia, pp.5-6, 18
61
The argument provided by Steven Radalet and Jeffry Sachs (1998) sounded like a monetary
LQYDVLRQE\WKH,0)WKURXJKLWVVWUDWHJ\RI³RUGHUO\ZRUNRXWDUUDQJHPHQWV´ZKLFKSODFHVWKH
debtor country under the wings of the International Monetary Fund who then deals with the
creditors on the behalf of the debtor, pp.73-74.
62
Minton-%HGGRHV³DGKRFLPSURYLVDWLRQV´DQG³TXHVWIRUUHOHYDQFH´SS-29
51

balance of payments policy issues is not appreciated in aforementioned
countries due to the fact that IMF does not treat each country with specific
attention that it deserves in the context of its unique circumstances which
may widely differ from other countries. This inflexible method raises a lot
of concerns dealing with countries that have financial obligations in
arrangements where IMF plays the role of a creditor.
³7KHFHQWUDOUROHRILQYHVWRUSV\FKRORJ\LQILQDQFLDOFULVLVLVLOOXVWUDWHGE\
WKH LQIDPRXV FDVH RI WKH FORVLQJ RI ,QGRQHVLDQ EDQNV LQ ´
(Boughton, 2001, p.6). Unprecedented Financial meltdown arising from
Asian crisis deteriorated further when it was coupled with political unrest
in Indonesia; moreover, the impeachment of President Abdurrahman
Wahid was the final nail in the coffin.
IMF strongly suggested or indirectly demanded that all of the 16 insolvent

banks in Indonesia needed to be closed and liquidated. Despite of a strong
opposition against closure of the banks, the government of Indonesia had
QRFKRLFHEXWDFFHSWZKDW,0)UHFRPPHQGHGEHFDXVH,0)¶VODUJHEDLORXW
package to the country came with strings of certain reform measures to be
implemented before any funds would be made available. However, when
the time came to act upon the terms of the agreement, Indonesian
government refused to close all previously identified 16 banks as insolvent.
Many argue, especially those affected by the crisis in Indonesia, that IMF
played the role of a crisis intensifier when it left the negotiation table
denying a rare opportunity to Indonesia to gain back foreign investor
confidence. This also catalyzed a huge panic among bank depositors in
Indonesia fearing that the current financial turbulence may spill over into
other banks creating contagion effect in the broader economy.
52

Huge amounts of money, tens of billions of dollars disappeared during the
Asian crisis that was supposed to be used to keep ailing banks afloat and
when IMF was questioned whereabouts of the funds, it declined to provide
any answer. IMF said that "strengthening governance is an important
element of the Fund-supported programme for Indonesia."63 IMF always
defends its first line of approach to fiscal tightening and it argues that this
is necessary for initial contraction needed for stabilization of exchange rate
to restore confidence, which in turn helps improvement of reserves.
Over the years, IMF has developed a great number of models for policy
analysis, but Boughton (2001) particularly chose three that illustrate how
SROLF\ UHVSRQVHV DUH WDLORUHG WR LQWHUQDO RU H[WHUQDO VKRFNV -DFN 3RODN¶V
classic model of the monetary approach to the balance of payments, the
³PHUJHG´ PRGHO GHYHORSHG E\ 0RKVLQ .DKQ DQG WKH 0XQGHOO-Fleming
model. These three models have not been developed with the specific
purpose of generating performance criteria for IMF assisted programs, but
they have been utilized to provide useful data which can be incorporated
into development of actual programs.
Political unrest in Indonesia, falling exports in the newly industrialized

economies and ASEAN nations, and continued deterioration of external
markets required to call in IMF to rescue mainly the three hardest hit
economies; Indonesia, Korea, and Thailand (Philippines to a much smaller
extent). Under the helm of IMF, macroeconomic policy adjustments were
main concern of tackle; enormously challenging task was to prevent falling
asset prices and try to keep inflation tamed; moreover, fiscal policy was
pretty much reserved to provide limited support for capital outflows and to
finance, if needed, any bank re-structuring or assuming private debt of

63
6HH%%&1HZV³,QGRQHVLDHFRQRPLFFULVLVSRLQW´
53

ailing insolvent banks. These essential reforms could be seen as the first
phase in the long process of recovery and they need be taken immediately
with careful analysis to restore investor confidence and allow a sustainable
growth to resume without any speculation or doubt of its resilience.
Table 4 ȋ̈́Ȍ͸Ͷ
Countries Thailand Indonesia Korea
Approved (1997) August 20 November 5 December 4

Total Pledged Ψϭϳ͘Ϯ ΨϰϬ͘Ϭ Ψϱϳ͘Ϭ
IMF ϯ͘ϵ ϭϬ͘ϭ Ϯϭ͘Ϭ
USA Ϭ͘Ϭ ϯ͘Ϭ ϱ͘Ϭ
World Bank ϭ͘ϱ ϰ͘ϱ ϭϬ͘Ϭ
ADB ϭ͘Ϯ ϯ͘ϱ ϰ͘Ϭ
Bank of Japan ϰ͘Ϭ ϱ͘Ϭ ϭϬ͘Ϭ
Others ϲ͘ϲ Ϯϲ͘Ϭ ϳ͘Ϭ
IMF packages require certain measures to be taken immediately;

restructure of the financial system (transferring failed banks to the Savings
Deposit Insurance Fund-SDIF and liquidate insolvent financial institutions),
improving fiscal and current account imbalances (adjustment equaling
about 3% of GDP), and controlling intermediation process of domestic
credit through appropriate interest rates.65 Although IMF program was
made available to other ASEAN nations, Malaysia and Singapore refused
to participate in IMF-supported programs. Not to the same extend as
Thailand, Indonesia, or South Korea; Philippines too received IMF
financial support to deal with the adverse effects of contagion. From 1992
to 1998, Philippines used $6.7 billion IMF credit.

64
IMF, Dialogue Database, Wall Street Journal, Financial Times (as cited in Nanto, 1998)
65
6HH,0)2FFDVLRQDO3DSHU³,0)-Supported Programs in Indonesia, Korea, and
7KDLODQG$3UHOLPLQDU\$VVHVVPHQW´
54

ASEAN SCARE
The original five members of the Association of Southeast Asian Nations

(aka ASEAN-5) include Indonesia, Malaysia, Philippines, Singapore and
Thailand; in later years, the membership has extended to include five more
nations (economically less developed) in the region bringing the total
membership to 10 countries; Brunei, Burma (Myanmar), Cambodia, Laos,
and Vietnam.66 It consists of about 600 million people, which is more than
the combined population of the European Union with its 27 members.
$6($1¶VFRPELQHG*'3333ZDVWULOOLRQLQ67
During the post crisis era, the pace of recovery has been uneven across
Asia; the newly industrialized economies (NIEs), emerging markets, and
the ASEAN nations, but overall, in most parts, there has been a remarkably
good success story to tell up to the crisis period. Through valuable lessons
learned from the 1997-08 crisis, the region has developed rigorous macro
and microeconomic policies and achieved structural reforms in its financial
VHFWRUPDNLQJWKHUHJLRQ¶VILQDQFLDOV\VWHPPRUHUHVLOLHQWDQGHIIHFWLYHDV
compared to pre-crisis time. Improved banking system together with strong
governance and better risk management practices in place allowed the
banks to build-up capital buffers which gave the governments the
opportunity to; control spending, improve foreign exchange reserves, and
reduce current account and fiscal imbalances which were considered as the
fundamental issues behind the crisis.
Lack of foreign exchange reserves was one of the key factors behind the
Asian crisis; but today, World Bank report indicates that foreign exchange
reserves are at all-WLPH KLJKV 7KH UHJLRQ¶V EDQNLQJ V\VWHP VHHPV WR EH

66
See Wikipedia, http://en.wikipedia.org/wiki/ASEAN
67
See Wikipedia, http://en.wikipedia.org/wiki/ASEAN
55

more resilient than before and capable of absorbing financial and economic
shocks which may be concluded that this was a direct result of the prudent
fiscal and monetary policies which allowed banking systems to be better
monitored, governed, and regulated. A decade later from its deepest
recession, the number of profitable and competitive corporations in the
region has increased significantly that qualified the ASEAN as the region
of growth option when other popular industrial economies are entering into
slowing mode. Downturn in the U.S. economy, prolonged recession in
Japan, sovereign debt crisis in the eurozone, and signs of moderate
slowdown in India and China can have contagion effects due to
internationalization of finance and interconnectedness of major financial
markets in developed nations (industrialized) with those in the NIEs (Hong
Kong SAR, Korea, Singapore, and Taiwan), ASEAN (Indonesia, Malaysia,
Philippines, Singapore, and Thailand), Japan, and China.
The positive and negative effects of globalization of finance was covered in

great detail before, but it is probably a good idea to mention it here once
PRUH WKDW WKH UHJLRQ¶V JUHDWHU WKDQ EHIRUH LQWHJUDWLRQ LQ JOREDO ILQDQFLDO
markets will make ³Asian Tigers´ and the ASEAN nations that much more
vulnerable and exposed to external shocks arising from global economic
conditions which may sometimes lead to volatile equities markets resulting
in sporadic fluctuation of stock prices. The region is better prepared now
than before 1997 because it has successfully addressed the issue of massive
current account deficits through regulation of its banking systems,
diversification of trade and financial partners, reduction of external and
public debt, and creation of economic stability.68 There is one problem
though; ³Asian Tigers´, the NIEs, or the ASEAN nations are all highly
dependent on industrialized nations as their customers of exports, business

68
See World Bank, East Asia & Pacific Update April 2008, p.5
56

partners, or potential investors to continue growth. Without them, Asia
alone cannot sustain the kind of economic growth seen during the 1980s
and 1990s. Therefore, Asia does well when advanced nations are all
showing growth; it seems like marriage made in heaven, but irreconcilable
differences also surface when one starts hurting the other because of their
tightly interconnectedness; Asia more so on the U.S., Japan, and the EU.
Chart 2 Ǧͷ
ȋ̈́ǡʹͲͳͳȌ͸ͻ

Indonesia ϭ
ϭ͕ϭϮϱ
Thailand Ϯ
ϲϬϮ͘ϮϮ
Malaysia ϯ
ϰϲϯ͘ϲϵ
Philippines ϰ
ϰϭϭ͘ϵϬ
Singapore ϱ
ϯϭϰ͘ϵϭ
World
ϳϴ͕ϵϲϵ
$VLD¶V swift recovery process was once again interrupted by the 2008
global financial crisis (deep recession in US) and its extension into Europe
as the sovereign debt crisis in the eurozone. The World Bank contributed
the growth decline in aforementioned Asian countries to macroeconomic
factors supported by a weak external environment (recession in US,
earthquake and tsunami in Japan, and severe flooding in Thailand, Lao, and
Cambodia). Unlike pre-crisis period, instead of massive current account
and fiscal imbalances, this time around most countries in the region are
now in surplus position holding high levels of foreign UHVHUYHVDQGEDQNV¶
adequacy ratios are, at least at the moment, high enough to meet the first
round of minimum capital requirements of 7% under Basel III which

69
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)
57

becomes mandatory by January 1, 2013. +RZHYHU $VLD¶V VWURQJ F\FOLFDO
position may pose some risks in the near-term which could lead to
overheating in some economies in the region. Although the overall picture
of Asia today is entirely different than pre-crisis of 1997-98; specifically, in
terms of foreign reserve levels, current account and fiscal imbalances, but
nevertheless if the brighter future prospects together with further widening
interest rate differentials with industrialized nations continue to attract
more capital inflows, then the Asian nations need to stay prepared to handle
any reversal of capital flows arising from too much overheating of
economies as brutally experienced during the Asian crisis of 1997-98.70
Chart 3
ǡȋ̈́ǡʹͲͳͳȌ͹ͳ

Singapore ϭ
ϰϮ͕ϵϯϬ
Malaysia Ϯ
ϴ͕ϰϮϬ
Thailand ϯ
ϰ͕ϰϮϬ
Indonesia ϰ
Ϯ͕ϵϰϬ
Philippines ϱ
Ϯ͕ϮϭϬ
Three decades of unparalleled growth among the ASEAN nations have

created some very powerful economies in the region some of which are in
the top 20 largest economies of the world; South Korea (12 th with $1.554
trillion), Indonesia (15th with $1.125 trillion), and Taiwan (19th with $876
billion). Thailand came in 24th with $602 billion; Malaysia was 29th with
$464 billion; the Philippines made it in 32nd place with $412 billion; Hong
Kong with $351 billion came in 36th and Singapore was 38th place with

70
See International Monetary Fund (IMF), Regional Economic Outlook, 2010, p.ix
71
List of countries by GNI (nominal, Atlas method) per capita,
http://en.wikipedia.org/wiki/GNI_per_capita
58

ELOOLRQ &KLQD¶V XQLTXH Hconomic transformation for the last two
decades is going to start showing some noticeable changes in the way of
WKHFRXQWU\¶VGRPHVWLFFRQVXPSWLRQOHYHODQGSDWWHUQGXHWRULVLQJLQFRPH
levels leading to improved living standards with higher purchasing power.
As a result, going forward, China will probably begin to rely more on
domestic consumption and less on exports and investments which will
foster development and expansion of the services industry.72
&KLQD¶V HFRQRP\ LV HQRUPRXVO\ PDVVLYH LQ WKH UHJLRQ not to mention
EHLQJ WKH ZRUOG¶V VHFRQG ODUJHVW HFRQRP\ IROORZLQJ WKH 86 WKHUHIRUH
slowing China economy would only mean more devastating impact on
ORRPLQJHFRQRPLFVORZGRZQLQWKHUHJLRQ$VLD¶VPDLQH[SRUWLQJSDUWQHUV
the EU, the US, and Japan, are facing uncertainty accompanied by a slower
recovery and weak hopes of growth in the near future.
0RVWDQDO\VWVDQGHFRQRPLVWVDUH QRWRSWLPLVWLFDERXWWKH86HFRQRP\¶V
prospects to achieve a meaningful growth; many expect the GDP growth
figure to be anywherH EHWZHHQ DQG ,Q WKLV VFHQDULR WKH UHJLRQ¶V
economy will certainly be affected by all of these macroeconomic
developments, but the question of how much and how long will depend on
how fast and effectively countries in the region can adapt to changing
global business conditions and take the necessary steps to develop their
domestic economies accordingly.
Rising prices of oil and non-oil commodity items can create further
economic instability in Asia region; in fact, this problem has become a
more priority than worrying about financial turmoil in US. Possible
solutions to this problem may include fuel efficiency, stronger agricultural
development, and open global trading system, but none of these are near

72
http://www.worldbank.org/en/news/2012/05/23/east-asia-and-pacific-economic-update-may
59

term solution which will not provide any help to the poor who will be hurt
disproportionately. High food prices may help farmers, but rising oil and
fertilizer prices will probably erase all the profit margin. Some
governments in the region have provided subsidies as a solution to combat
the problem of high prices, but these subsidies have started becoming a real
burden on government fiscal budget.73
Rising oil and non-oil commodity prices are expected to impose a loss of
income on Asian nations as much as 1% of GDP. The US downturn and
financial market turmoil will mean less export for the region; in addition,
the US businesses have strong relations with counterparts in Japan and
Europe, which means that unfavorable economic conditions in US will
automatically affect them; that in turn means, a slowdown in US will
severely affect the region whose trade partners include the EU, the US, and
Japan all of which are closely and financially interlinked. Current account
surpluses will definitely help the region better cope with constant
fluctuations in capital inflows and outflows without forcing major domestic
changes as was the case during 1997-08 crisis.74
Asian nations (especially low income countries (LICs) in the region) are
now more concerned about rising commodity prices than macroeconomic
conditions because most prices of basic food items and energy products
have gone up so much in recent years that in some instances the prices are
PRUHWKDQGRXEOHG)XUWKHUPRUHWKHUHJLRQ¶VPDLQEXVLQHVVEHLQJH[SRUWV
to G-2, Japan, and China makes things more complicated due to severe
economic conditions in these advanced regions. Countries in Asia have
insignificant level of trading activity to each other in the region, but each
country on the other hand has substantial levels of exports to both Japan

73
74
See World Bank, East Asia & Pacific Update April 2008, pp.9-10
60

and the United States, which was not overly surprisingly that both these
countries pledged the largest financial support to the affected countries
during the crisis due to their large financial involvement and substantial
trade agreements in Southeast Asia.
Table 5 ͳͻͻ͹ȋΨȌ͹ͷ
Country76 THA MYS PHL IDN KOR USA JPN
Indonesia ϭ͘ϳ Ϯ͘ϰ ϭ͘ϰ ͲͲͲͲ ϳ͘ϭ ϭϲ͘ϯ Ϯϰ͘ϳ
Korea Ϯ͘Ϭ ϯ͘ϭ ϭ͘ϲ Ϯ͘ϵ ͲͲͲͲ ϭϲ͘ϲ ϭϬ͘ϲ
Malaysia ϯ͘ϳ ͲͲͲͲ ϭ͘ϯ ϭ͘ϱ ϯ͘Ϯ ϭϴ͘ϯ ϭϮ͘ϰ
Philippines Ϯ͘ϰ ϯ͘Ϭ ͲͲͲͲ Ϭ͘ϰ ϭ͘ϴ ϯϰ͘ϳ ϭϲ͘ϭ
Thailand ͲͲͲͲ ϰ͘ϲ ϭ͘Ϯ Ϯ͘Ϭ ϭ͘ϴ ϭϵ͘ϴ ϭϱ͘Ϭ
ǯ began to shape up after the World War II, which
was dominated by mainly five Sino-Thai banking groups that had expertise
in insurance services, trading and shipping activities (Suehiro, 1992).
Thailand had received significant levels of capital inflows from Japan,
North America, and Europe in the 1980s and 1990s from investors and
banks looking to earn better returns on their investments due to higher
interest rates (widened interest rate differentials between advanced nations)
in Thailand and the financial institutions used this fresh capital supply to
lend to local businesses (SMEs) and borrowers in general (the majority of
the private loans were mostly used for purchase of properties). Although
excess liquidity created a paradise for barrowers, it also resulted in risky as
well as questionable lending practices by the financial institutions (weak

75
Direction of Trade Statistics Quarterly: IMF, June 1998 (as cited in Baig and Goldfajn, 1998)
76
Thailand (THA), Malaysia (MYS), Philippines (PHL), Indonesia (IDN), South Korea (KOR),
the United States of America (USA), and Japan (JPN)
61

governance, lack of transparency and issues with disclosures). Influx of
capital inflows provided Thailand unprecedented growth opportunities
during the economic boom which lasted until 1995; just before the crisis hit,
7KDLODQG¶VORQJ-running success was even praised by the World Bank.
Thailand ͸Ǥ ͹͹
% of GDP 1992 1993 1994 1995 1996 1997 1998

Exports ϯϳ ϯϴ ϯϵ ϰϮ ϯϵ ϰϴ ϱϵ
Imports ϰϭ ϰϮ ϰϰ ϰϵ ϰϲ ϰϳ ϰϯ
Gross savings ϯϰ ϯϱ ϯϱ ϯϰ ϯϰ ϯϯ ϯϯ
Gross capital ϰϬ ϰϬ ϰϮ ϰϮ ϰϮ ϯϰ ϮϬ
Services ϱϬ ϱϭ ϱϬ ϱϬ ϱϬ ϱϬ ϱϬ
GDP growth % ϴ͘ϭ ϴ͘ϯ ϵ͘Ϭ ϵ͘Ϯ ϱ͘ϵ Ͳϭ͘ϰ ͲϭϬ͘ϱ
Stocks traded ϲϰ͘ϳ ϲϵ͘ϱ ϱϱ͘ϲ ϯϯ͘ϵ Ϯϰ͘ϰ ϭϲ͘Ϭ ϭϵ͘ϯ
$US billion 1992 1993 1994 1995 1996 1997 1998

Total reserves Ϯϭ͘Ϯ Ϯϱ͘ϰ ϯϬ͘ϯ ϯϲ͘ϵ ϯϴ͘ϲ Ϯϲ͘ϵ Ϯϵ͘ϱ
C. acc. balance Ͳϲ͘ϯ Ͳϲ͘ϰ Ͳϴ͘ϭ Ͳϭϯ͘ϲ Ͳϭϰ͘ϳ Ͳϯ͘Ϭ ϭϰ͘Ϯ
Ext. private debt ϭϯ͘ϴ ϭϱ͘ϯ ϮϬ͘Ϯ ϯϵ͘ϭ ϰϴ͘Ϯ ϰϳ͘ϭ ϰϯ͘ϵ
Ext. public debt ϭϯ͘ϯ ϭϰ͘ϳ ϭϲ͘Ϯ ϭϲ͘ϴ ϭϲ͘ϵ ϮϮ͘ϯ Ϯϴ͘ϭ
Short-term debt ϭϰ͘ϳ ϮϮ͘ϲ Ϯϵ͘Ϯ ϰϰ͘ϭ ϰϳ͘ϳ ϯϳ͘ϴ Ϯϵ͘ϳ
Ext. total debt ϰϭ͘ϴ ϱϮ͘ϲ ϲϱ͘ϱ ϭϬϬ͘Ϭ ϭϭϮ͘ϴ ϭϬϵ͘ϳ ϭϬϰ͘ϵ
GDP ($US) ϭϭϭ͘ϱ ϭϮϱ͘Ϭ ϭϰϰ͘Ϭ ϭϲϴ͘Ϭ ϭϴϭ͘ϵ ϭϱϬ͘ϵ ϭϭϭ͘ϴ
FDI inflows Ϯ͘ϭ ϭ͘ϴ ϭ͘ϰ Ϯ͘ϭ Ϯ͘ϯ ϯ͘ϵ ϳ͘ϯ
FPI inflows Ϭ͘ϰϲ Ϯ͘ϳ ͲϬ͘ϯϵ Ϯ͘ϯ ϭ͘ϭ ϯ͘ϵ Ϭ͘Ϯϵ
Use of IMF credit ͲͲͲͲͲ ͲͲͲͲͲ ͲͲͲͲͲ ͲͲͲͲͲ ͲͲͲͲͲ Ϯ͘ϰ ϯ͘Ϯ
The pattern of economic progress varied across Asia, but the elements that
have strongly supported the remarkable growth in Thailand were; openness

77
See World Bank, Economic Indicators, http://data.worldbank.org/indicator, table constructed
by the author (all the values are in current $US)
62

to change, being receptive to foreign investments, and willing to
interconnect its financial systems to the rest of the world. These positive
developments looked and sounded very promising, which were welcome
by the investors who felt there was money to be made; however, very same
HOHPHQWV ZHUH DOVR WKH NH\ UHDVRQV EHKLQG 7KDLODQG¶V FROODSVH 7KH
forward progress was made possible by two specific events; first, passage
of the Security Exchange Commission Act of 1992 which allowed
companies to issue corporate debt instruments in overseas markets, and
then the establishment of Bangkok International Banking Facility (BIBF) in
1993 through which the Thai government decided to liberalize its foreign
exchange policy by adopting a fixed exchange rate system. Fixed exchange
rate along with higher interest rates attracted substantial capital inflows,
according to the World Bank data, $31 billion of FDIs and FPIs poured into
Thailand between 1992 and 1998.
:RUOG¶VOHDGLQJRUJDQL]DWLRQVLH,0):RUOG%DQNKDYH before warned

about overheating of some economies due to significant capital inflows
which indirectly led to appreciation of equity assets and rise of property
values in the Asia region prior to the crisis, but no attention was paid
because everybody (foreign investors, governments, intermediaries, and
others) was literally enjoying massive liquidity in the markets; borrowers
DQG OHQGHUV DOLNH 7KH SDUW\ ZDV LQWHUUXSWHG E\ WKH ³$VLDQ IOX´ LQ
causing enormous financial meltdown in the region, which later turned into
deepest recession Asia had ever faced before. The panic was in the air,
investors were fleeing the country and the region to look for shelters.
Thailand was no exception to the massive currency attacks that took place
in the first few months of the crisis and the major adverse effects of
external shocks. Good times abruptly came to an end and Thailand had to
face the biggest nosedive in its GDP growth when the crisis hit in 1997,
63

GDP fell to -1.4% in that year from 5.9% a year ago. When everybody was
hoping that they had seen the worst, unfortunately the worst was yet to
come in the following year when the GDP hit literally ground zero, took a
free fall to negative 10.5% in 1998. The situation got massively intensified
with the spillovers from the tragic earthquake and tsunami along with the
PRVWGHVWUXFWLYHIORRGVLQ7KDLODQG¶VKLVWRU\LQKDOIDFHQWXU\
Thailand ͹Ǥ ͹ͺ
% of GDP 2005 2006 2007 2008 2009 2010 2011

Exports ϳϰ ϳϰ ϳϯ ϳϲ ϲϴ ϳϭ ϳϴ
Imports ϳϱ ϳϬ ϲϱ ϳϰ ϱϴ ϲϰ ϳϭ
Gross savings Ϯϴ ϯϬ ϯϯ ϯϭ ϯϬ ϯϭ ϯϮ
Gross capital ϯϭ Ϯϴ Ϯϲ Ϯϵ Ϯϭ Ϯϲ Ϯϲ
Services ϰϲ ϰϱ ϰϱ ϰϰ ϰϱ ϰϯ ϰϰ
GDP growth % ϰ͘ϲ ϱ͘ϭ ϱ͘Ϭ Ϯ͘ϱ ͲϮ͘ϯ ϳ͘ϴ Ϭ͘ϭ
Stocks traded ϱϬ͘ϲ ϰϴ͘ϳ ϰϯ͘ϴ ϰϮ͘ϴ ϱϭ͘Ϯ ϲϴ͘ϯ ϲϳ͘Ϯ
$US billion 2005 2006 2007 2008 2009 2010 2011

Total reserves ϱϮ͘ϭ ϲϳ͘Ϭ ϴϳ͘ϱ ϭϭϭ͘Ϭ ϭϯϴ͘ϰ ϭϳϮ͘Ϭ ϭϳϰ͘ϵ
C. acc. balance Ͳϳ͘ϲϱ Ϯ͘ϯ ϭϱ͘ϳ Ϯ͘Ϯ Ϯϭ͘ϵ ϭϯ͘ϭ ϭϮ͘ϭ
Ext. private debt ϭϱ͘ϳ ϭϱ͘ϱ ϭϲ͘ϭ ϭϵ͘ϭ ϭϵ͘ϳ Ϯϭ͘ϰ Ϯϯ͘ϰ
Ext. public debt ϭϰ͘ϳ ϭϮ͘ϲ ϭϬ͘ϵ ϭϭ͘ϲ ϭϭ͘Ϯ ϭϭ͘ϰ ϭϭ͘ϱ
Short-term debt ϭϲ͘Ϭ ϭϳ͘ϴ ϭϴ͘ϯ ϭϵ͘Ϯ Ϯϳ͘Ϭ ϯϴ͘ϱ ϰϬ͘Ϭ
Ext. total debt ϰϲ͘ϰ ϰϱ͘ϵ ϰϱ͘ϯ ϰϵ͘ϴ ϱϳ͘ϵ ϳϭ͘ϯ ϳϰ͘ϵ
GDP ($US) ϭϳϲ͘ϰ ϮϬϳ͘ϭ Ϯϰϳ͘Ϭ ϮϳϮ͘ϲ Ϯϲϯ͘ϱ ϯϭϴ͘ϵ ϯϰϱ͘ϲ
FDI inflows ϴ͘ϭ ϵ͘ϱ ϭϭ͘ϯ ϴ͘ϱ ϰ͘ϵ ϵ͘ϳ ϭϭ͘ϱ
FPI inflows ϱ͘ϭ ϱ͘Ϯ ϰ͘ϯ Ͳϯ͘ϴ ϭ͘ϳ Ϯ͘ϲ ϯ͘ϱ

78
by the author
64

The total external debt reached its peak at $112.8 billion in 1996 which was
62% of GDP in that year ($181.9 billion). Current account deficit has
increased year over year during 1992-1996 before it finally stabilized by
1997 and turned into surplus in 1998. However, short-term external debt
($47.7 billion), external payment obligation that becomes due in 12 months
or less, was even more concerning because it had more than tripled in five
years bringing the total from $14.7 billion in 1992 to $47.7 billion in 1996.
There was a major issue with the level of private debt as well which also
increased more than three times of the level in 1992, went from $13.8
billion in 1992 to $48.2 billion in 1996 (a 250% rise). This was a perfect
recipe for a disaster in the making; fast deterioration of external factors
(downturn economy in the U.S., prolonged recession in Japan, sovereign
debt crisis in the eurozone, and contagion effect in the region), collapse of
the currency, massive capital outflows (investors pulling out), falling asset
prices, and rising inflation. On top of all this, both private and short-term
external debts surged to record levels in just few years leading to the crisis.
Easier access to overseas funds by large corporations (external private debt

increased from $13.8 billion to $48.2 billion in just five years between
1992 and 1996, which later saw huge number of defaults) later saw the
crippling effects resulting in deepening non-performing loans (NPLs). The
statistics showed NPL ratios of 50.1% for Thailand (end of January 1999),
25% for Indonesia (April 1998), 14.6% for Malaysia (December 1998), and
7.4% for South Korea (December 1998).79 Substantial capital inflows
($113 billion between 1992 and 2011) together with optimism by foreign
investors willing to invest in Thailand, and liquid financial markets have
created an economy that was not sustainable for a long time. As a result,

79
http://www.jri.co.jp/english/periodical/rim/1999/RIMe199903npl/
65

the inevitable, the Asian crisis was at the door steps of the newly
industrialized economies (NIEs) and the ASEAN nations.
Favorable domestic economy as well as external factors gave boost to huge

increases in government spending during most of the 1990s, which more
than doubled reaching $64.6 billion in 1996 compared with $28 billion in
1992; moreover, external short-term debt during the same period more than
tripled putting extra pressure on the government to meet debt obligations
that became due in 12 months or less, bringing the total from $14.7 billion
in 1992 to $47.7 billion in 1996. The total external debt in five years
skyrocketed as well (62% of GDP in 1996), went up from $41.8 billion in
1992 to $112.8 billion in 1996.
The Southeast Asia region is not out of the woods yet; still heavily
dependent on advanced nations for exports revenues and its great need of
continuous capital inflows remains unchanged. This means that Thailand
must continue to display strong commitment to implementation of its
critical structural and fiscal measures intended to improve weak corporate
governance, lack of transparency and disclosures. The government of
Thailand must also introduce reforms to further improve the resilience of
its financial system through establishing a well-functioning regulatory
framework which is in compliance with the international banking standards
and its financial system is harmonized to match Basel III requirements.
Thailand must also introduce programmes to clampdown on corruption, to
improve poverty level in the country as well as to create other social
initiatives to benefit the society at large. Thailand seems to be managing
the recovery process well and the World Bank reported that Thailand has
grown averaging 5% from 2002-2007. However, some contraction in the
domestic consumption and weakness in infrastructure and construction
66

projects persists in Thailand due to global economic downturn (weak and
slow recovery in advanced economies, plus prolonged recession in Japan).
Thailand ʹǤ
x %%& 1HZV UHSRUWHG RQ -DQXDU\ ³Thailand: The crisis starts.´
IMF warned of overheating economy, but Thai officials totally ignored it
and were reluctant to take any actions. The collapse of Thai baht in July of
1998 triggered a chain of uncontrollable currency devaluations across the
region but more so amongst the original five ASEAN nations.80
x %%&1HZVUHSRUWHGRQ1RYHPEHU³IMF will help Thailand.´7KH

managing director of the International Monetary Fund, Michel Camdessus,
KDVVDLGWKDW³WKH7KDLJRYHUQPHQW
VFRPPLWPHQWWRDQ,0)UHVFXHSODQLV
WKHNH\WRHFRQRPLFUHFRYHU\´,0)DQQRXQFHGDELOOLRQSDFNDJH81
x BBC News repRUWHGRQ1RYHPEHU³Thai bank profits collapse.´

Increasing non-performing loans started affecting banks which had been hit
the hardest. Thailand's biggest bank had announced a significant drop in
profits and said all banks could be expected to release poor results.82
x 7KH :DOO 6WUHHW -RXUQDO UHSRUWHG RQ 1RYHPEHU ³Thai Economy
Grows More Than Expected.´ 7KH DUWLFOH VDLG WKDW WKH VHFRQG ODUJHVW
economy in Southeast Asia remained resilient despite challenging external
environment and downturn in economies in advanced nations.83
x 7KH 1DWLRQ UHSRUWHG RQ 2FWREHU ³External factors weigh down
Thai economy in Q3.´([SRUWVGHFOLQHGFRPSDUHGWRD\HDUDJR 84 The
latest data by Bank of Thailand (BOT) still showed weakening demand due
to global economic issues.

80
http://news.bbc.co.uk/2/hi/special_report/1997/asian_economic_woes/34487.stm
81
82
http://news.bbc.co.uk/2/hi/world/far_east/32017.stm
83
http://online.wsj.com/article/SB10001424127887323353204578128282599360730.html
84
http://www.nationmultimedia.com/business/External-factors-weigh-down-Thai-economy-in-
Q3-301934.html
67

7KDLODQG¶VFRQVHUYDWLYHJRYHUQPHQWVSHQGLQJIRUlarge construction related
projects (down about 30%, lowest level since 1993) and lower auto sales
are weighing on the economy. Despite slowdown in exports, household
consumption, and manufacturing output; tourism, private investment, and
commodity exports provided positive growth.
Even though poverty level has been improving steadily, it still continues to
be a serious concern in Thailand where nearly 5.5 million people are
subject to harsh living conditions of which close to 90% live in rural areas.
As highly anticipated, poverty has worsened in the last decade as the direct
result of the Asian crisis peaking at 21%, but then it has considerably
improved in recent years to be around 8% as of 2009. Without any
exception, countries around the world one way or another have been
affected by the 2008-JOREDOILQDQFLDOFULVLVDQG7KDLODQG¶VHFRQRPLF
indicators give clear signs of the adverse effects. Therefore, it is definitely
going to take some time for Thailand to get back to the glorious days of
high growth experienced prior to the Asian crisis. The World Bank
estimates Thailand to grow 4.5% in 2012 and 5% in 2013.85
ǯ had experienced the most crippling effects of the

1998 Asian crisis (Thailand and Korea were the other two highly impacted);
Malaysia, Philippines and Singapore were adversely affected as well due to
enormous contraction in economies across the region; however, Singapore
was well contained despite the severity of the crisis). Aftereffects of
7KDLODQG¶VEDKWFROODSVHcontagion spillovers moved into Indonesia where
further speculative currency attacks drove rupiah sky-high against the US
dollar and forcing it to depreciate 30% in one month and nearly 85% of its
value within the first year. By June 1997, $1 USD equaled Rp. 2,380, just a

85
See World Bank, http://www.worldbank.org/en/country/thailand/overview
68

year later by 1998; $1 amounted to Rp. 14,150 (the peak was close to
16,000). Currency depreciation in this magnitude naturally forced prices of
all consumer goods and commodities to increase substantially.
IMF strongly suggested or indirectly demanded that all of the 16 insolvent

banks in Indonesia needed to be closed and liquidated. Despite of a strong
opposition against closure of the banks, the government of Indonesia had
QRFKRLFHEXWDFFHSWZKDW,0)UHFRPPHQGHGEHFDXVH,0)¶VODUJHEDLORXW
package ($42.3 billion) to the country came with strings of certain reform
measures to be implemented before any funds would be made available.
However, when the time came to act upon the terms of the agreement,
Indonesian government refused to close all previously identified 16
insolvent banks as part of a politically oriented move claiming that some of
those banks would survive if they were allowed to operate. This was clearly
an ill-fated assumption on the government part because the consequences
of this political decision resulted in more panic among Indonesians that the
bank problem might have contagion effect on the broader economy leading
to more banks failures and thus a total financial meltdown.
)XUPDQDQG6WLJOLW]WKRXJKWWKDWWKHGHSWKRI ,QGRQHVLD¶VFROODSVH

could easily qualify as the largest post war contractions, at least since the
World War II era. Orden (1999) argues that currencies, especially those of
the emerging economies, have become increasingly volatile ever since
countries abandoned Bretton Woods system of monetary management (44
QDWLRQV¶ GHOHJDWHV VLJQHG WKH DJUHHPHQW LQ -XQH ZKLFK LQWHQGHG WR
govern monetary relations among member nations during challenging post-
war years). Actually, things have evolved since the World War II and the
same planners at Bretton Woods established two new organizations which
later became part of the World Bank Group; International Monetary Fund
69

(IMF) and the International Bank for Reconstruction and Development
(IBRD). The Bretton Woods system of monetary management came to an
end and the dollar became reserve currency when the United States decided
to terminate the practice of converting US$ to gold.86
Indonesia ͺǤͺ͹
% of GDP 1992 1993 1994 1995 1996 1997 1998
Exports Ϯϴ Ϯϳ Ϯϳ Ϯϲ Ϯϲ Ϯϴ ϱϯ

Imports Ϯϱ Ϯϰ Ϯϱ Ϯϴ Ϯϲ Ϯϴ ϰϯ
Gross savings Ϯϭ Ϯϵ ϯϬ Ϯϴ Ϯϴ Ϯϵ ϮϮ
Gross capital ϯϬ Ϯϵ ϯϭ ϯϮ ϯϭ ϯϮ ϭϳ
Services ϰϮ ϰϮ ϰϮ ϰϭ ϰϬ ϰϬ ϯϳ
GDP growth ϳ͘Ϯ ϳ͘ϯ ϳ͘ϱ ϴ͘ϰ ϳ͘ϲ ϰ͘ϳ Ͳϭϯ͘ϭ
Stocks traded Ϯ͘ϴ ϱ͘ϴ ϲ͘ϳ ϳ͘ϭ ϭϰ͘ϭ ϭϵ͘ϵ ϭϭ͘ϭ
$US billion 1992 1993 1994 1995 1996 1997 1998
Total reserves 11.5 12.5 13.3 14.9 19.4 17.5 23.6

C. acc. balance -2.8 -2.1 -2.8 -6.4 -7.7 -4.9 4.1
Ext. private debt 16.3 14.0 24.4 33.1 36.7 44.5 54.7
Ext. public debt 53.6 57.1 63.9 65.3 60.1 56.0 67.5
Short-term debt 18.0 18.0 19.5 26.0 32.1 35.8 29.3
Ext. total debt 87.9 89.1 107.8 124.4 128.9 136.3 151.5
GDP ($US) 139.1 158.0 176.9 202.1 227.4 215.7 95.4
FDI inflows 1.8 2.0 2.1 4.3 6.2 4.7 -0.2
FPI inflows 1.2 1.8 1.9 1.5 1.8 -5.0 -4.4
Use of IMF credit ---- ---- ---- ---- ---- 2.9 9.1

86
See http://en.wikipedia.org/wiki/Bretton_Woods_system
87
by the author
70

Indonesia had experienced credit and capital inflows boom during 1990s in
the same fashion as the other four ASEAN nations. The credit market of
Indonesia before the crisis in many ways looked very similar to the 2006
subprime mortgage crisis of the U.S. Excessive liquidity created lending
frenzy amongst the financial institutions and encouraged risky lending and
borrowing practices. Between 1995 (4.4% of GDP) and 1996 (5.7% of
GDP), total of $43.33 billion worth of credit was provided ($18.88 billion
in 1995 and $24.45 billion in 1996) to the private sector, little over one
third of which, $13 billion was in the form of mortgage loans.88
Similar fundamental issues as observed in Thailand were also present in

Indonesia; absence of structural elements in the financial system, enormous
private, public and short-term external debts, insufficient foreign reserves
along with massive fiscal and current account imbalances (huge deficits).
,QGRQHVLD¶VSULYDWHH[WHUQDOGHEWLQFXUUHQW86KDVLQFUHDVHGE\IRXUIROGV
from the level prior to the Asian crisis; the debt level skyrocketed from
$14.03 billion in 1992 to $56.78 billion in 2010. Furthermore, the private
external debt averaged $24.91 billion during 1992-1996, $44.41 billion
1997-2001, and $50.84 between 2007 and 2010. During the same period,
external public debt stocks had substantially increased as well which
increased from $56.02 billion in 1997 to $91.02 billion in 2010; the
average public debt was $67.12 billion during 1997-2001 and $82.19
billion 2007-,QGRQHVLD¶VWRWDOH[WHUQDOGHEWQHDUO\GRXEOHGEHWZHHQ
1992 ($87.98 billion) and 2010 ($169.06 billion), a massive increase of
92.16% when compared with the public debt level in 1992.89
,QGRQHVLD¶V FDVK VXUSOXVGHILFLW RI *'3 KDV LPSURYHG VLJQLILFDQWO\

since the crisis; though the level deteriorated fast between 1997, 1998 and

88
Source: BIS, Bank of International Settlements
89
See http://data.worldbank.org/country/indonesia
71

1999; 1.3%, -1.8%, -3.7% respectively. However, it got considerably better
after 1999, averaging -0.7% of GDP between 2007 and 2010. Enormous
current account deficit was one of the key factors behind the Asian crisis,
so Indonesia learned the hard way and improved its current account balance
of payments from negative -$7.66 billion in 1997 to $5.14 billion in 2010,
DQLPSURYHPHQWRIQHDUO\,QGRQHVLD¶VH[SRUWVRIJRRGVDQGVHUYLFHV
(% of GDP), experienced a huge decline from its highs of 39.4% of GDP
between 1992 and 1996, to 26.8% during 1997-2001, and 27.8% 2007-
2011. Indonesia experienced the biggest GDP contraction in 1998 by
negative -13.1%, and then averaged 4.4% growth between 2000 and 2001,
later improved further between 2007 and 2011, averaging 5.92%.90
Among the ASEAN nations, Indonesia was most severely affected from the
crisis and it was on the verge of a total collapse due to major economic
problems and significant political unrest which forced the government to
FDOOLQ,0)WRSURYLGHZKDWWKH\FDOOHG³WHFKQLFDODVVLVWDQFH´$IWHU.RUHD
ELOOLRQRI,0)EDLORXWODUJHVWLQ,0)¶VKLVWRU\DWWKHWLPH,QGRQHVLD
received the second biggest bailout package over $40 billion. The process
was not a smooth one for the parties involved because there had been many
disagreements between IMF and the Indonesian government some of which
even resulted in a walkout by the IMF from the negotiation table. The first
installment of the package was about $3 billion in 1997 which increased to
$9.09 billion in 1998 amounting to a little over 300% increase; in addition,
this was repeated three more times until 2002. Having insufficient levels of
reserves was a fundamental deficiency in all of the five ASEAN nations.
Indonesia has done an excellent job improving the level of its total reserves
(includes gold, current US$), from $17.49 billion in 1992 to $110.14 billion
in 2011, an increase of more than six folds. However, the levels of private,

90
See http://data.worldbank.org/indicator
72

public and short-term debts all increased significantly; in two decades time,
external private debt rose from $16 billion in 1992 to $58 billion in 2011,
and public debt went from $53 billion to $93 billion in the same period.ϵϭ
Indonesia ͻǤͻʹ
% of GDP 2005 2006 2007 2008 2009 2010 2011

Exports ϯϮ ϯϭ Ϯϵ ϯϬ Ϯϰ Ϯϱ ϯϭ
Imports ϯϬ Ϯϲ Ϯϱ Ϯϵ Ϯϭ Ϯϯ Ϯϱ
Gross savings Ϯϲ Ϯϴ Ϯϲ Ϯϲ ϯϭ ϯϮ ϯϳ
Gross capital Ϯϱ Ϯϱ Ϯϱ Ϯϴ ϯϭ ϯϮ ϯϯ
Services ϰϬ ϰϬ ϯϵ ϯϳ ϯϳ ϯϴ ϯϴ
GDP growth ϱ͘ϳ ϱ͘ϱ ϲ͘ϯ ϲ͘Ϭ ϰ͘ϲ ϲ͘Ϯ ϲ͘ϱ
Stocks traded ϭϰ͘ϳ ϭϯ͘ϰ Ϯϲ͘ϭ Ϯϭ͘ϳ Ϯϭ͘ϰ ϭϴ͘ϯ ϭϲ͘ϱ
$US billion 2005 2006 2007 2008 2009 2010 2011

Total reserves ϯϰ͘ϳ ϰϮ͘ϲ ϱϲ͘ϵ ϱϭ͘ϲ ϲϲ͘ϭ ϵϲ͘Ϯ ϭϭϬ͘ϭ
C. acc. balance Ϭ͘Ϯϴ ϭϬ͘ϵ ϭϬ͘ϱ Ϭ͘ϭϯ ϭϬ͘ϲ ϱ͘ϭ Ϯ͘ϭ
Ext. private debt ϰϯ͘ϯ ϰϰ͘ϴ ϰϲ͘ϰ ϰϳ͘ϰ ϱϮ͘ϴ ϱϲ͘ϴ ϱϴ͘Ϭ
Ext. public debt ϳϰ͘Ϯ ϳϬ͘ϱ ϳϮ͘Ϭ ϳϵ͘ϴ ϴϲ͘Ϭ ϵϭ͘Ϭ ϵϯ͘ϱ
Short-term debt ϵ͘Ϭ ϭϬ͘Ϭ ϭϱ͘ϰ ϮϬ͘ϱ Ϯϰ͘Ϭ ϯϭ͘ϯ ϯϯ͘ϱ
Ext. total debt ϭϮϲ͘ϱ ϭϮϱ͘ϯ ϭϯϯ͘ϴ ϭϰϳ͘ϲ ϭϲϮ͘ϵ ϭϳϵ͘ϭ ϭϴϱ͘Ϭ
GDP ($US) Ϯϴϱ͘ϵ ϯϲϰ͘ϲ ϰϯϮ͘Ϯ ϱϭϬ͘Ϯ ϱϯϵ͘ϲ ϳϬϴ͘Ϭ ϴϰϲ͘ϴ
FDI inflows ϴ͘ϯ ϰ͘ϵ ϲ͘ϵ ϵ͘ϯ ϰ͘ϵ ϭϯ͘ϴ ϭϴ͘Ϯ
FPI inflows ͲϬ͘ϭϳ ϭ͘ϵ ϯ͘ϲ Ϭ͘ϯ Ϭ͘ϴ Ϯ͘ϭ Ϯ͘ϱ
Government spending has increased significantly as well resulting in a

massive public debt which has gone up close to 70% from 1992 ($53.6

91
92
by the author (all values are in current $US)
73

billion) to 2010 ($91 billion). Average public debts were $60 billion (1992-
96), $67.1 billion (1997-01), and $82.2 billion (2007-10). Short-term debt
played as a crisis-intensifier, short-term debt went from $15.68 billion in
1992 to $31.3 billion in 2010.ϵϯ
Indonesia ͵Ǥ
x %%& 1HZV UHSRUWHG RQ -XO\ ³Indonesia economic crisis point.´
IMF left the negotiation table believing that Indonesia has not made enough
progress and said that "strengthening governance is an important element of
the Fund-supported programme for Indonesia." Indonesia saw $9 billion
capital outflows in 2000 amid staggering public debt.94
x %%& 1HZV UHSRUWHG RQ 1RYHPEHU ³World Bank sets Indonesia
deadline.´ ,Q RUGHU WR UHFHLYH ELOOLRQ IURP LQWHUQDWLRQDO OHQGHUV
Indonesia needed to show its commitment to rapid economic restructuring,
more privatization, and crackdown on corruption.95
x :RUOG1HZV$XVWUDOLDUHSRUWHGRQ-XQH³Can Greece learn from

Indonesia in the Asian financial crisis?´ $VLD GXULQJ -1998 has
experienced unprecedented declines, far greater than what Greeks
XQGHUZHQW ³7KH $VLDQ H[SHULHQFH FRXOG show countries like Greece that
RXWRIWKHSDLQWKHUHFDQEHDIXWXUHDIWHUDOO´96
x %%&1HZVUHSRUWHGRQ2FWREHU³Time to reform the IMF?´'XULQJ

Asian crisis, IMF opposed to the use of tax money to bail out ailing
financial institutions in the region, but quickly approved a $700 billion Wall
Street bailout plan. IMF said, "Korean and Indonesian financial institutions
were not quite as systemically important."ϵϳ

93
94
See http://news.bbc.co.uk/2/hi/business/1304820.stm
95
See http://news.bbc.co.uk/2/hi/business/1642437.stm
96
http://www.sbs.com.au/news/article/1659625/Can-Greece-learn-from-Indonesia-in-the-Asian
97
74

Despite challenging external factors such as economic slump in Japan,
recessionary economy in the United States, sovereign debt issues in Europe,
volatile flows of capital and other global disturbances, IMF said that
³,QGRQHVLD¶VHFRQRP\KDVSHUIRUPHGUREXVWO\ERRVWHGE\VWURQJFRQVXPHU
VSHQGLQJ DQG LQYHVWPHQW DW KRPH´98 ,QGRQHVLD¶V HFRnomic progress is
sometimes overshadowed by the high number of people living in poverty.
As of 2011, unfortunately 26.6 million people in Indonesia were still in
poverty, which amounted to 12.5% of 242.33 million people.
Although Indonesia, based on IMF 2011 data99, is the largest economy in

WKHUHJLRQDVZHOODVWKHZRUOG¶Vth largest economy with $1.125 trillion
GDP-333SXUFKDVLQJSRZHUSDULW\ZKLFKLVRIWKHZRUOG¶V*'3
nonetheless, it still remains to be the second lowest gross national income
per capita among the five ASEAN nations (Philippines is the lowest in the
region). IMF expects Indonesia to grow 6% in 2012 and maybe higher in
2013; however, growth more than 6% will largely depend on how
aggressively the government of Indonesia initiates growth projects.
To accelerate growth in the medium-term, Indonesia needs to reduce

government subsidies and increase taxes because subsidies have been a
serious burden on fiscal budget for some time now and tax revenues are
weak which need to be improved considerably; in addition, the government
needs to create large infrastructure building projects (i.e. bridges, highways,
sea, and air ports).100 ,0) HFRQRPLVWV FRQWULEXWH ,QGRQHVLD¶V HFRQRPLF
VXFFHVVWR³SUXGHQWPDFURHFRQRPLFSROLF\DQGVWUXFWXUDOUeforms over the
last decade, on top of solid fundamentals which convincingly placed

98
See http://www.imf.org/external/pubs/ft/survey/so/2011/int102111a.htm
99
6HH:LNLSHGLDKWWSHQZLNLSHGLDRUJZLNL/LVWBRIBFRXQWULHVBE\B*'3B333WKH:RUOG¶V
15th largest economy by (IMF list; $1.124 billion GDP-PPP), 16th largest economy by
(World Bank list; $1.131 billion GDP-PPP), 15th largest economy by (CIA World Factbook
list; $1.139 billion).
100
See http://www.imf.org/external/pubs/ft/survey/so/2011/int102111a.htm
75

Indonesia in a strong position to deal with the continuing uncertainty in the
JOREDOHQYLURQPHQW´101
ǯ has continued to grow steadily amid challenging

external factors such as economic slump in Japan, recessionary economy in
the United States, sovereign debt issues in Europe, volatile flows of capital
and other global disturbances. Along with other four ASEAN nations,
Malaysia too experienced the severe financial implications of capital
outflows, over-borrowing by the private sector and significant amount of
debt burden; consequently, some economies in the region began
overheating. Liberalizing Asian markets were swamped by profit thirsty
investors with lesVDWWHQWLRQSDLGWRWKHUHJLRQ¶VDELOLW\as well as capacity
to manage such undertaking of massive resources. Soon systemic problems
began surfacing one after another which made these premature economies
vulnerable to any reversal action which in this case meant a massive crisis.
Most economists and industry experts believe that the crisis was triggered
largely due to huge currency run-up against the US dollar which hurt the
export volume in a big way; in addition, unfavorable external environment
affecting WKHUHJLRQ¶VPDMRUH[SRUWLQJGHVWLQDWLRQVWKH86-DSDQ-DSDQ
and the eurozone) reduced demand for production related inventory,
especially electronic components which comprise nearly 50% of all exports.
When the crisis hit in 1997, it created a snowball effect in the whole Asia
region causing huge panics among the foreign investors and forcing them
to retreat from Asian assets for good. Asian currencies were under warlike
attacks from every direction in all financial markets testing breaking point
of each currency; pressure was so incredible that some currencies start off
with 7KDLODQG¶V EDKW FRXOG QRW take any more beating and surrendered.

101
See http://www.imf.org/external/pubs/ft/survey/so/2012/car092512a.htm
76

%DKW¶V GHYDOXDWLRQ ZDV VRRQ IROORZHG E\ RWKHU FXUUHQFLHV LQ WKH UHJLRQ
(Indonesian rupiah with the largest depreciation, Malaysian ringgit, Korean
ZRQ DQG 3KLOLSSLQHV¶ SHVR &RPSDQLHV¶ EDODQFH VKHHWV ZHUH DOVR
negatively affected by all of these currency devaluations (their debt burden
increased considerably) which resulted in further capital outflows from
investments in equities (FPIs) due to uncertain future prospects regarding
earnings. In some countries in the region, governments and their inability to
take prompt actions played some role in intensification of the crisis.102
According to the data from the World Bank and the IMF, in excess of $100
billion in capital inflows poured into five emerging Asian economies four
of which were considered the Asian gems in the region; Indonesia,
Malaysia, South Korea, and Thailand. Influx of foreign investors quickly
jumped (herd mentality) on the bandwagon to get a share of the irresistible
profits opportunity through investments in stocks and bonds. This favorable
business environment encouraged financial institutions in the West to lend
cheap money (waiting on the sideline) to corporations and banks in Asia
with expectation of positive earnings from high interest rates in the region.
One key problem, also one of the fundamental reasons behind the crisis,
was that an alarming portion of the capital inflows to aforementioned
countries were as short-term debt and highly volatile. The collapse of Thai
baht triggered a domino effect causing a massive fled of capital (outflows),
leaving already vulnerable four ASEAN nations on the verge of a total
financial dismay. Malaysia had accused developed nations and currency
speculators in foreign markets, especially the billionaire George Soros, for
attacking its currency ringgit. Therefore, the central bank of Malaysia
(Bank Negara Malaysia) intervened to defend its currency by re-imposing

102
6HH8QLWHG1DWLRQV³7KH$VLDQ&ULVLV7RZDUG5HFRYHU\DQG5HIRUP´3DSHUVIRU
Discussions, New York, 12-23 July, 1998, p.2
77

exchange control on the ringgit even though there was utterly strong
opposition by the West and possible adverse consequences for 0DOD\VLD¶V
bold decision0DOD\VLD¶VGHFLVLYHPRYHWULJJHUHGDVHULHVRIGRZQJUDGHV
by the investors and the financial institutions in the West signaling limited
chances of future investments. Countries practicing currency control
regimes, such as China and India, were not terribly affected. Regardless
how the investors in the West felt about its abrupt measures, Malaysia
believed that re-imposing exchange control on ringgit was the best possible
and only route to take at the time of attacks in order to mitigate speculative
trading on its currency which lost close to two third of its value (64%).
The main actors of the global financial system, the US Treasury, the IMF,
and the World Bank, are all against exchange controls together with
imposing of taxes; moreover, opponents of these measures argue that
imposing exchange control and taxes on currency transactions would only
bULQJKDUPDQGKDPSHUHFRQRPLFSURJUHVVLQWRGD\¶VKLJKO\JOREDOL]HGDQG
interconnected financial systems. Of course, the West and the international
organizations (i.e. IMF) have their rational reasons why they are against
such measures because daily currency trading comprises in excess of $1
trillion and 60% of all daily currency trading is executed in London, the
ZRUOG¶VODUJHVWFXUUHQF\H[FKDQJHPDUNHW
Malaysia has done quite well in diversifying its economy and focusing on
domestic demand to make up for the difference from downturn economy in
the U.S., persisting economic slump in Japan (effects of natural disaster)
along with challenging and uncertain external environment. The Bank
Negara Malaysia reported in its 2011 annual report that domestic demand
saw a strong growth of 8.2% in 2011 which was a 30.2% increase from a
year ago (2010: 6.3%). This noticeable rise in demand was driven by surge
78

in both household and business spending as well as higher public sector
consumption. Private sector continued its strength in 2011 too, which grew
6.9% translated to an increase of 6.15% from a year ago level of 6.5%.103
Malaysia ͳͲǤ ͳͲͶ
% of GDP 1992 1993 1994 1995 1996 1997 1998

Agriculture value ϭϱ ϭϰ ϭϰ ϭϯ ϭϮ ϭϭ ϭϯ
Exports ϳϲ ϳϵ ϴϵ ϵϰ ϵϮ ϵϯ ϭϭϲ
Imports ϳϱ ϳϵ ϵϭ ϵϴ ϵϬ ϵϮ ϵϰ
Gross savings ϯϮ ϯϱ ϯϱ ϯϰ ϯϳ ϯϳ ϰϬ
Gross capital ϯϱ ϯϵ ϰϭ ϰϰ ϰϭ ϰϯ Ϯϳ
Services ϰϰ ϰϲ ϰϲ ϰϲ ϰϱ ϰϰ ϰϯ
GDP growth % ϴ͘ϵ ϵ͘ϵ ϵ͘Ϯ ϵ͘ϴ ϭϬ͘Ϭ ϳ͘ϯ Ͳϳ͘ϰ
Stocks traded ϯϲ͘ϳ ϮϮϵ͘ϳ ϭϲϵ͘ϴ ϴϲ͘ϱ ϭϳϮ͘ϭ ϭϱϯ͘Ϭ ϰϭ͘ϰ
$US billion 1992 1993 1994 1995 1996 1997 1998

Total reserves ϭϴ͘Ϭ Ϯϴ͘Ϯ Ϯϲ͘ϯ Ϯϰ͘ϳ Ϯϳ͘ϵ Ϯϭ͘ϱ Ϯϲ͘Ϯ
C. acc. balance ͲϮ͘Ϯ Ͳϯ͘Ϭ Ͳϰ͘ϱ Ͳϴ͘ϲ Ͳϰ͘ϱ Ͳϱ͘ϵ ϵ͘ϱ
Ext. private debt ϰ͘Ϭ ϱ͘ϳ ϵ͘ϱ ϭϭ͘Ϭ ϭϮ͘ϵ ϭϱ͘ϱ ϭϱ͘ϴ
Ext. public debt ϭϮ͘ϰ ϭϯ͘ϱ ϭϰ͘ϳ ϭϲ͘Ϭ ϭϱ͘ϳ ϭϲ͘ϴ ϭϴ͘Ϯ
Short-term debt ϯ͘ϲ ϲ͘ϵ ϲ͘ϭ ϳ͘ϯ ϭϭ͘ϭ ϭϰ͘ϵ ϴ͘ϰ
Ext. total debt ϮϬ͘Ϭ Ϯϲ͘ϭ ϯϬ͘ϯ ϯϰ͘ϯ ϯϵ͘ϳ ϰϳ͘Ϯ ϰϮ͘ϰ
GDP ($US) ϱϵ͘Ϯ ϲϲ͘ϵ ϳϰ͘ϱ ϴϴ͘ϴ ϭϬϬ͘ϵ ϭϬϬ͘Ϯ ϳϮ͘Ϯ
FDI inflows ϱ͘Ϯ ϱ͘Ϭ ϰ͘ϯ ϰ͘Ϯ ϱ͘ϭ ϱ͘ϭ Ϯ͘Ϯ
0DOD\VLD¶VSXEOLFGHEWLQFUHDVHGVXEVWDQWLDOO\LQ as a direct result of

WKH JRYHUQPHQW¶V continuous efforts to SURYLGH VXSSRUW IRU WKH QDWLRQ¶V
economy. Increase in government services, procurement of various

103
See Bank Negara Malaysia Annual Report 2011, Ref. No.: 03/12/07, p.2
104
79

supplies, and one-time bonus were enough to create a 21.7% surge in
public debt bringing the total to $25.8 billion in 2010.ϭϬϱ
Malaysia ͳͳǤͳͲ͸
% of GDP 2005 2006 2007 2008 2009 2010 2011

Agriculture value ϴ ϵ ϭϬ ϭϬ ϭϬ ϭϭ ϭϭ
Exports ϭϭϳ ϭϭϳ ϭϭϬ ϭϬϯ ϵϲ ϵϳ ϭϬϬ
Imports ϵϱ ϵϰ ϴϵ ϴϬ ϳϱ ϳϵ ϴϬ
Gross savings ϯϱ ϯϳ ϯϳ ϯϳ ϯϭ ϯϯ ϯϱ
Gross capital ϮϬ ϮϬ ϮϮ ϭϵ ϭϰ Ϯϭ ϮϬ
Services ϰϮ ϰϮ ϰϮ ϰϮ ϰϳ ϰϱ ϰϲ
GDP growth % ϱ͘ϯ ϱ͘ϴ ϲ͘ϱ ϰ͘ϴ Ͳϭ͘ϲ ϳ͘Ϯ ϱ͘ϭ
Stocks traded ϯϲ͘Ϯ ϰϮ͘ϳ ϴϬ͘ϯ ϯϴ͘ϯ ϯϳ͘ϴ ϯϳ͘ϵ ϰϲ͘ϯ
$US billion 2005 2006 2007 2008 2009 2010 2011

Total reserves ϳϬ͘ϱ ϴϮ͘ϵ ϭϬϮ͘Ϭ ϵϮ͘Ϯ ϵϲ͘ϳ ϭϬϲ͘ϱ ϭϯϯ͘ϲ
C. acc. balance ϮϬ͘Ϭ Ϯϲ͘Ϯ Ϯϵ͘ϴ ϯϴ͘ϵ ϯϭ͘ϴ Ϯϳ͘ϯ ϯϮ͘Ϭ
Ext. private debt ϭϲ͘ϰ ϮϬ͘ϲ ϮϬ͘Ϭ Ϯϭ͘ϵ Ϯϭ͘ϯ ϮϬ͘ϲ ϮϬ͘Ϭ
Ext. public debt ϮϮ͘ϯ ϮϮ͘ϱ ϭϴ͘ϯ Ϯϭ͘ϰ Ϯϭ͘Ϯ Ϯϱ͘ϴ Ϯϲ͘Ϭ
Short-term debt ϭϯ͘Ϯ ϭϭ͘ϴ Ϯϯ͘ϭ ϮϮ͘ϴ Ϯϯ͘ϳ ϯϱ͘ϭ ϯϴ͘Ϭ
Ext. total debt ϱϭ͘ϵ ϱϰ͘ϵ ϲϭ͘ϰ ϲϲ͘ϭ ϲϲ͘ϯ ϴϭ͘ϱ ϴϰ͘Ϭ
GDP ($US) ϭϯϴ͘Ϭ ϭϱϲ͘ϲ ϭϴϲ͘ϴ ϮϮϮ͘ϳ ϭϵϮ͘ϵ Ϯϯϳ͘ϴ Ϯϳϴ͘ϳ
FDI inflows ϰ͘Ϭ ϲ͘ϭ ϴ͘ϲ ϳ͘ϰ ϭ͘ϰ ϵ͘Ϯ ϭϬ͘ϴ
FPI inflows Ͳϭ͘Ϯ Ϯ͘ϰ ͲϬ͘ϳ ͲϭϬ͘ϳ ͲϬ͘ϰ Ͳϭ͘Ϭ Ͳϭ͘Ϭ

Malaysia¶V *'3 JURZWK by percentage tumbled in 1998 (-7.4%), a jaw-

dropping 200% decline compared to a year ago level of 7.3%. The gross

105
106
80

domestic product also saw a huge reduction in total value which dropped
about 28%, sliding from $100.2 billion in 1997 to $72.2 a year later. Debt
levels in all accounts kept increasing year over year; Private debt almost
quadrupled, going from $4 billion in 1992 to $15.8 billion in 1998. The
story in total external debt was more depressing which was more than half
RI0DOD\VLD¶V*'3LQIn 1997 just before the crisis hit, the exchange
rate for Malaysian ringgit was $1 equaling RM2.5, but by 1998, $1 equaled
RM4.1, and currently trading around $1 = RM3.12.
0DOD\VLD¶V SULYDWH QRQJXDUDQWHHG H[WHUQDO GHEW LQ FXUUHQW 86 KDV

increased from $4.01 billion in 1992 to $20.63 billion in 2010, which was a
huge increase of slightly more than five folds. The average debt in periods
of 1992-1996 and 1997-2001 were $8.63 billion and $16.09 billion
respectively. 0DOD\VLD¶VSublic and publicly guaranteed debt also increased
averaging $14.45 billion between 1992 and 1996, $19.39 during 1997-2001,
and $21.67 billion in the years of 2007 and 2010. Largest rise in public
debt occurred in 2001 (increased from $19.12 billion in 2000 to $24.05
billion in 2001, a 25.78% climb) and in 2010 (rose from $21.25 billion in
WR ELOOLRQ LQ DQ LQFUHDVH RI 0DOD\VLD¶V WRWDO
debt including private, public, and short-term debt has gone up
dramatically, risen from $20.02 billion in 1992 to $81.5 billion in 2010.
0DOD\VLD¶V FDVK VXUSOXV RU GHILcit position has terribly deteriorated post
Asian crisis; the only times it had cash surplus were in 1996 (1.5% of GDP)
and in 1997 (2.9%). The years following the Asian crisis predominantly
had witnessed cash deficits; -0.8% (1998), -3.8% (1999), -4.1% (2000), and
-3.5% in 2001. The average cash deficit was a negative -4.93% between the
years of 2007 and 2011. Malaysia had large current account deficits from
1992 to 1997, on average of $4.79 billion; however, the biggest deficit
81

occurred in 1995 which was $8.6 billion. The severe financial
consequences of the Asian crisis taught an invaluable lesson to every
ASEAN nation including Malaysia; thus, Malaysia realized that having
strong current account balance was very crucial.
Malaysia ͶǤ
x %%&1HZVUHSRUWHGRQ$XJXVW³Malaysia sinks into recession´

0DOD\VLD¶V RQFH ERRPLQJ HFRQRP\ VKUDQN VKRZLQJ VLJQV RI
UHFHVVLRQ 7KLV PDUNHG WKH ZRUVW VOXPS LQ \HDUV 0DOD\VLD¶V %DQN
Negara reported that the construction sector has shrunk by 22% in 1998
compared to 12% growth in 1997.107
x %%&1HZVUHSRUWHGRQ6HSWHPEHU³Japan offers lifeline to South

East Asia´ 7KH -DSDQHVH JRYHUQPHQW SOHGJHG KHOS WR WKH PHPEHUV RI WKH
Association of South East Asian Nations (ASEAN) battered by currency
turmoil. The package included a ¥70bn loan ($519m) to Malaysia.108
x %%& 1HZV UHSRUWHG RQ 0D\ ³Malaysia and Indonesia build
bridges´ %RWK FRXQWULHV DW D MRLQW FRQIHUHQFH VDLG WKDW WKH\ VKRXOG GR
everything possible to avoid deWULPHQWV WR HDFK FRXQWU\¶V HFRQRP\
Malaysia had proposed a $1billion loan to its neighbor in 1998, but
withdrew it this year; the reason behind this decision is not clear.109
x %%&1HZVUHSRUWHGRQ6HSWHPEHU³Malaysia lifts cash controls´

As of September 1, investors were able to withdraw cash without paying
any additional taxes. Malaysia had placed controls to protect its currency
ringgit from speculative attacks and to protect Malaysia from significant
capital outflows.110

107
See BBC News, http://news.bbc.co.uk/2/hi/business/159508.stm
108
109
See BBC News, http://news.bbc.co.uk/2/hi/asia-pacific/348754.stm
110
82

The encouraging growth in services, manufacturing, and construction
sectors have helped the Malaysian government improve its current account
and fiscal imbalances considerably in recent years, especially by a huge
margin since aftermath of the Asian crisis. Therefore, Malaysia has been
able to increase its current account balance tremendously bringing the
current account surplus total to $32.02 bilOLRQ LQ 0DOD\VLD¶V H[SRUW
on average was 86% of GDP between 1992 and 1996; however, the US
economic slowdown has slightly affecWHGWKHFRXQWU\¶VH[SRUWVDQGPDGHLW
drop about 12%, which fell from 112% of GDP during 1997-2001 to 101%
of GDP between 2007 and 2010. Unlike Indonesia and Philippines,
Malaysia refused to utilize IMF financial assistance even though the help
was readily made available for Malaysia to use.
Although external demand from developed countries remains to be weak

which is still adversely affecting the export-based industries; however,
Malaysia saw a solid growth in domestic industries which recorded a more
modest pace in 2011 (4.5%) compared with 11.4% in 2012. Nonetheless,
healthy domestic demand makes up for some of the reduced external
demand from industrialized economies (G-2). The construction sector also
experienced a modest expansion in 2011 (3.5%), but it was nowhere near
the level in 2010 (5.1%).
The reasons behind the slowdown in construction sector were contributed

to slower activity in civil engineering and non-residential fields together
with oversupply of office spaces (some believe that construction slowdown
PD\ UHODWH WR D UHDO HVWDWH EXEEOH LQ VRPH DUHDV 0DOD\VLD¶V KRXVLQJ
market is heating up; the government reported that the average national
house price has substantially increased in recent years. The average price
increase in 2011 (8.6%) was already more than twice the national average
83

of 3.7% during 2000-2010; furthermore, 2011 average rise in house prices
was 28.4%, more than the average house price increase of 6.7% in 2010.111
³$ QHZ ,0) VWXG\ FRPSDUHV WKH SHUIRUPDQFH RI ,VODPLF EDQNV Dnd
conventional banks during the recent financial crisis, and finds that Islamic
banks, on average, showed stronger resilience during the global financial
FULVLV´112 Solé (2007) claimed that Islamic banking has been experiencing
growth rates of 10-15 percent annually for several years, and has been
penetrating into conventional financial systems at such a rapid pace that
Islamic banking institutions (IBIs) are now present in close to 60 countries.
Currently, there are 16 Islamic banks in Malaysia of which Maybank is the

largest with close to RM65 billion ($20.7 billion) in market capitalization
and RM344.1 billion in assets ($110.3 billion). According to a study
conducted by PCW, Price Waterhouse Coopers (May 2009), the total
Islamic banking sector in Malaysia by asset size has reached an amazing
RM203 billion (US $58 billion).
Today, there are close to 500 Islamic banks worldwide with assets and
deposits are estimated to reach $1 trillion dollar mark by the end of 2012
(currently close to $900 billion dollars). Islamic banking has been
traditionally concentrated in countries where Muslim population is a
majority, but now some conventional banks located in countries where
Muslim population is a minority have been considering opening windows
or branches to enable Muslim customers to enjoy various banking
transactions (Taskinsoy, 2012). As of 2009, more than one third (36%) of
WKHZRUOG¶V,VODPLFEDQNVDUHIRXQGLQ,UDQLQ6DXGL$UDELDLQ

111
112
Islamic Banks: More Resilient to Crisis?
http://www.imf.org/external/pubs/ft/survey/so/2010/res100410a.htm
84

Malaysia, another 10% in United Arab Emirates (UAE), 8% in Kuwait, 6%
in Bahrain, 3% in Qatar, 2% in UK, 2% in Turkey, and remaining 7% in
spread out in other countries throughout the world.113 The eight top major
commercial banks in 2012 in Malaysia have a total market capitalization of
massive RM233.4 billion ($74.8 billion) and incredible RM1.22 trillion in
assets ($390 billion).114
ǯ was very similar to that of Thailand both of

ZKLFKJRWKLWQRWRQO\E\WKHVHYHULW\RIWKHFULVLVEXWDOVRE\WKHQDWXUH¶V
unbiased destructive force. The timing of the crisis could have not been
perfect to cause the most damage when it was coupled with the El Nino
phenomenon that took a heavy toll on the Philippines which was going to
take years to clean up the financial mess as well as the environmental.
The crisis was already huge on its own, and now with the El Nino, there
ZHUH VHULRXV FRQFHUQV DERXW WKH FRXQWU\¶V VXVWDLQDEOH HFRQRPLF
development. The crisis in this magnitude could have not developed purely
on macroeconomic factors alone, so the main fundamentals behind the
crisis were a combination of macro and microeconomic shocks.
In the case of Asia region, it seems like the crisis was more fueled by the
microeconomic factors (prematurely developed financial systems, inability
to manage huge capital inflows, corruption, transparency and disclosure
issues) specific to the region than by the macroeconomic influences. It is
true that the initial development was probably fostered by macroeconomic
engagements (significant capital inflows to the region by foreign investors
searching for profits (widening interest rate differentials between Asia and
industrialized nations) , favorable external environment (economic boom in
G-2, Japan and other advanced nations which led to record consumption

113
http://www.btimes.com.my/Current_News/BTIMES/articles/Babyx/Article/index_html
114
Bank Negara Malaysia (The Central Bank of Malaysia),
85

that in turn significantly increased exports from Asia), large financial firms
in the West were interested in lending record amounts of money to banks in
Asia). 5DGHOHWDQG6DFKVDUJXHWKDW,0)¶VLQLWLDOUHVSRQVHZDVVDGO\
inappropriate which had caused more harm than good.
Philippines ͳʹǤͳͳͷ
% of GDP 1992 1993 1994 1995 1996 1997 1998

Agriculture value ϮϮ ϮϮ ϮϮ ϮϮ Ϯϭ ϭϵ ϭϱ
Exports Ϯϵ ϯϭ ϯϰ ϯϲ ϰϭ ϰϵ ϰϱ
Imports ϯϰ ϰϬ ϰϬ ϰϰ ϰϵ ϱϵ ϱϰ
Gross savings ϭϵ ϭϵ ϮϮ ϭϵ ϮϬ Ϯϭ Ϯϯ
Gross capital Ϯϭ Ϯϰ Ϯϰ ϮϮ Ϯϰ Ϯϱ Ϯϯ
Services ϰϱ ϰϲ ϰϱ ϰϲ ϰϳ ϰϵ ϱϭ
GDP growth % Ϭ͘ϯ Ϯ͘ϭ ϰ͘ϰ ϰ͘ϳ ϱ͘ϴ ϱ͘Ϯ ͲϬ͘ϲ
Stocks traded ϱ͘ϳ ϭϮ͘ϰ Ϯϯ͘ϯ ϭϵ͘ϵ ϯϬ͘ϴ Ϯϰ͘ϴ ϭϰ͘Ϭ

$US billion 1992 1993 1994 1995 1996 1997 1998
Total reserves ϱ͘ϯ ϱ͘ϵ ϳ͘ϭ ϳ͘ϴ ϭϭ͘ϴ ϴ͘ϳ ϭϬ͘ϴ
C. acc. balance Ͳϭ͘Ϭ Ͳϯ͘Ϭ ͲϮ͘ϵ ͲϮ͘Ϭ Ͳϰ͘Ϭ Ͳϰ͘ϰ ϭ͘ϱ
Ext. private debt ϭ͘Ϭ Ϯ͘Ϯ ϯ͘ϲ ϰ͘ϴ ϴ͘ϲ ϭϭ͘ϳ ϭϳ͘Ϭ
Ext. public debt Ϯϱ͘ϴ Ϯϳ͘ϳ Ϯϵ͘ϵ Ϯϴ͘ϱ Ϯϳ͘ϭ Ϯϲ͘ϰ Ϯϵ͘Ϯ
Short-term debt ϲ͘ϯ ϲ͘Ϯ ϲ͘ϴ ϲ͘ϭ ϴ͘ϯ ϭϮ͘ϲ ϳ͘ϰ
Ext. total debt ϯϯ͘ϭ ϯϲ͘ϭ ϰϬ͘ϯ ϯϵ͘ϰ ϰϰ͘Ϭ ϱϬ͘ϳ ϱϯ͘ϲ
GDP ($US) ϱϯ͘Ϭ ϱϰ͘ϰ ϲϰ͘ϭ ϳϰ͘ϭ ϴϮ͘ϴ ϴϮ͘ϯ ϳϮ͘Ϯ
FDI inflows Ϭ͘Ϯ ϭ͘Ϯ ϭ͘ϲ ϭ͘ϱ ϭ͘ϱ ϭ͘Ϯ Ϯ͘ϯ
FPI inflows Ϭ͘ϯ Ϭ͘ϰ Ϭ͘ϯ ϭ͘Ϯ Ϯ͘ϭ ͲϬ͘ϰ Ϭ͘ϯ
Use of IMF credit ϭ͘ϭ ϭ͘Ϯ ϭ͘Ϭ Ϭ͘ϳ Ϭ͘ϰ Ϭ͘ϴ ϭ͘ϲ

115
86

Burgeoning literature on the topic indicate that the crisis would have had
probably less impact if some economies in the region were not hugely
overheated through massive capital inflows and excessively invested stock
market (overvalued equities), which also led to the development of a real
estate bubble where property values rose on speculative assumptions. The
LPSOLFLWJRYHUQPHQWJXDUDQWHHVDQGPRUDOKD]DUGDULVLQJIURP³WRRELJWR
IDLO´HQFRXUDJHGVRPHILQDQFLDOLQVWLWXWLRQVWRHQJDJHLQULVN\OHQGLQJDQG
borrowing practices (see Krugman, 1998).
Although the Asian crisis battered the original ASEAN-5 nations in similar
fashion (Thailand and Indonesia were hit the hardest), the aftereffects were
more severe for the Philippines as being the economically least fortunate
nation of the ASEAN-5 group; moreover, the Philippines had insufficient
natural resources of any kind to overcome the burden of the crisis and it
lacked of sufficient high-value assets (i.e. foreign reserves, gold) to use in
the case of reversal of capital flows took place or its currency faced attacks.
When Thailand, Singapore, Indonesia, and Malaysia had spent tens of
hundreds of billions from their reserves to fight against the currency attacks
to avoid further depreciation, the Central Bank of the Philippines was only
able to spend $1.5 billion which was a small drop in a pool of water; thus,
the exchange rate rose from P30 to as high as P45 per dollar before it
stabilized around P38 per US dollar in April 1998.
Furthermore, unlike the other four member neighbors, the Philippines had
the lowest per capita income ($2,210 in 2011). Philippines had poor
infrastructure, prematurely developed financial system, substantial current
account deficit ($4.4 billion in 1997), and fast increasing external total debt
which reached enormous $53.6 billion in 1998, amounting to 61.9% rise
compared to $33.1 billion in 1992. On top of all this, private debt increased
87

year over year between 1992 ($1 billion) and 1998 bringing the total to $17
billion, which meant an astounding increase of 1,600%.
Philippines ͳ͵Ǥͳͳ͸
% of GDP 2005 2006 2007 2008 2009 2010 2011

Exports ϰϲ ϰϳ ϰϯ ϯϳ ϯϮ ϯϱ Ϯϵ
Imports ϱϮ ϰϴ ϰϯ ϯϵ ϯϯ ϯϳ ϯϯ
Gross savings Ϯϳ Ϯϲ Ϯϲ Ϯϲ Ϯϱ Ϯϳ ϮϬ
Gross capital ϮϮ ϭϴ ϭϳ ϭϵ ϭϳ Ϯϭ ϭϲ
Services ϱϰ ϱϰ ϱϰ ϱϰ ϱϱ ϱϱ ϱϳ
GDP growth % ϰ͘ϴ ϱ͘Ϯ ϲ͘ϲ ϰ͘Ϯ ϭ͘ϭ ϳ͘ϲ ϯ͘ϳ
Stocks traded ϲ͘ϳ ϵ͘Ϯ ϭϵ͘ϲ ϵ͘ϵ ϭϬ͘Ϯ ϭϯ͘ϰ ϭϰ͘ϲ
$US billion 2005 2006 2007 2008 2009 2010 2011

Total reserves ϭϴ͘ϱ Ϯϯ͘Ϭ ϯϯ͘ϳ ϯϳ͘ϱ ϰϰ͘Ϯ ϲϮ͘ϯ ϳϱ͘ϭ
C. acc. balance Ϯ͘Ϭ ϱ͘ϯ ϳ͘ϭ ϯ͘ϲ ϵ͘ϰ ϴ͘ϵ ϳ͘ϭ
Ext. private debt ϭϵ͘ϱ ϭϴ͘ϱ ϮϬ͘ϵ ϭϴ͘ϴ ϭϳ͘Ϯ Ϯϭ͘ϰ ϮϮ͘Ϭ
Ext. public debt ϯϱ͘ϰ ϯϲ͘ϵ ϯϴ͘ϭ ϯϵ͘Ϯ ϰϭ͘ϵ ϰϰ͘ϲ ϰϱ͘ϲ
Short-term debt ϲ͘ϰ ϱ͘Ϭ ϳ͘ϭ ϳ͘Ϭ ϰ͘Ϭ ϲ͘ϯ ϳ͘Ϭ
Ext. total debt ϲϭ͘ϯ ϲϬ͘ϰ ϲϲ͘ϭ ϲϱ͘Ϭ ϲϯ͘ϭ ϳϮ͘ϯ ϳϰ͘ϲ
GDP ($US) ϭϬϯ͘ϭ ϭϮϮ͘Ϯ ϭϰϵ͘ϰ ϭϳϯ͘ϲ ϭϲϴ͘ϯ ϭϵϵ͘ϲ ϮϮϰ͘ϴ
FDI inflows ϭ͘ϵ Ϯ͘ϵ Ϯ͘ϵ ϭ͘ϱ Ϯ͘Ϭ ϭ͘ϯ ϭ͘ϯ
FPI inflows ϭ͘ϱ Ϯ͘ϱ ϯ͘Ϯ Ͳϭ͘ϯ Ͳϭ͘ϭ Ϭ͘ϱ ϭ͘Ϭ
The Philippines had seen sizable appreciation in its currency (peso) during
the 1990s which came to halt due to the contagion effects of devalued
currencies of its neighbors in the region. Things got worse for the
Philippines when this highly fragile situation was coupled with major

116
88

current account and fiscal imbalances in the country. The external total
debt increased substantially between 2005 and 2011, from $61.3 billion to
$74.6 billion of which, $45.6 billion was the public debt in 2011 (61.1% of
the total debt). During the same period external private debt kept rising to
new highs, went from $19.5 billion in 2005 to $22 billion in 2011 which
amounted to 29.5% of the total external debt. By 2011, the total external
debt accounted for 33.2% of the GDP ($224.8 billion).
As a first line of defense, the Central Bank of the Philippines raised

overnight bank lending rates, set limits to avoid excessive bank exposures
to foreign exchange positions, applied tighter rules on lending and
borrowing, and tightened monetary policy. 7KH 3KLOLSSLQHV¶ EDQNLQJ
system was more resilient than most people would have expected thanks to
structural and fiscal reforms undertaken by the government since 1980s.
When Indonesia identified 16 insolvent banks as the direct result of the
crisis, the Philippines had only one very small bank failure, which was used
as a channel to finance real estate projects of the owners.
The economy remains strong but developing East Asia & Pacific region is
already showing some signs of contraction providing evidence that the
UHJLRQ¶V HFRQRP\ VXIIHUHG GHFOLQH LQ FRPSDUHG WR
growth in 2010. Although possible adverse effects of the recent global
financial crisis are still expected to continue for unforeseeable period; the
region may have easier time navigating through global uncertainties thanks
to wide-ranging macroeconomic policies and fundamental reforms over the
last decade which has added economic resilience and flexibility.117
However, nothing is over yet and therefore, the region must direct its focus
to stimulating household consumption, enhancing construction investments

117
See World Bank, East Asia & Pacific Update April 2008
89

(infrastructure), and finding more innovative ways to expand the domestic
economy into niche growth areas rather than ongoing reliance on exports to
the EU, the US and Japan which account for nearly half of all exports.118
Philippines ͷǤ
x %%& 1HZV UHSRUWHG RQ $SULO ³Hope for Philippine recovery´
The Philippines is highly affected by the US economic downturn because it
VKLSVDERXWRILWVH[SRUWVWRWKH867KHFRXQWU\¶VH[SRUWVIHOOVKDUSO\
from 17% in 1999 to 8% in 2000, and expected to slide to a mere 4% in
2001. The Philippines saw significant capital outflows between January and
September of 2001, 18.6 billion pesos ($341 million).119
x %%& 1HZV UHSRUWHG RQ -DQXDU\ ³Philippine economic crisis
deepens´ 7KH SHVR SOXPPHWHG WR D QHZ ORZ RI WR WKH GROODU EHIRUH
regaining some ground to 50.90 on Tuesday, January 2. The total national
debt grew 2% in just 8 months to reach 2.009 trillion pesos ($39.5
billion).120
x )LOLSLQR-RXUQDOUHSRUWHGRQ-DQXDU\³Philippines less vulnerable

to financial crisis ± Fitch´)LWFKVDLGWKDWWKH3KLOLSSLQHVLVOHVVYXOQHUDEOH
to the global financial crisis than other ASEAN nations in the region thanks
to its sound banks and external financial position. Fitch said that agency has
QRSUREOHPRIFKDQJLQJWKH3KLOLSSLQHV¶SUHVHQW%%UDWLQJ121
x %%& 1HZV UHSRUWHG RQ 2FWREHU ³Philippines profile´ 7KH
3KLOLSSLQHV¶HFRQRP\ZDVRQHRIWKHUHJLRQ
VEHVW-performing in the 1990s,
experienced some slowdown at the turn of the 21st century but has managed
to recover steadily since 2004.122

118
See World Bank, East Asia and Pacific Economic Update, May 2012
119
120
121
http://filipinojournal.com/v2/index.php?pagetype=read&article_num=01092009234037
122
http://www.bbc.co.uk/news/world-asia-15521300
90

ǯ was envisioned back in 1960s of becoming a major
financial hub in the Asia; therefore, it has introduced the kinds of policies
WR DWWUDFW IRUHLJQ LQYHVWPHQWV 7KH FRXQWU\¶V HFRQRPLF SHUIRUPDQFH LV
largely based on financial activities. The first order of business in the
direction of drawing capital inflows to the country was the establishment of
Asian Currency Unit (ACU) which exempted nonresident deposit holders
from paying taxes, then the second thing on the agenda was to develop an
OTC (over the counter) market for stock trading, and finally Singapore
opened SIMEX (Singapore International Monetary Exchange) in 1984.
2QH WKLUG RI 6LQJDSRUH¶V *'3 FRPHV IURP LWV ILQDQFLDO VHFWRU ZKLFK
doubled its share in the GDP from 15% in 1980s to 31% as it stands today.
6LQJDSRUH¶VFRPSOHPHQWLQJWime-zone with New York also played a factor
in the huge progress and expansion of the financial sector which replaced
Switzerland as the number 4 largest foreign exchange market in the world.
All the right elements that made Singapore successful (introduction of right
policies in the past) in the past were now considered main fundamental
LVVXHV EHKLQG VHYHULW\ RI WKH FULVLV 6LQJDSRUH¶V ILQDQFLDO VHFWRU ZDV
overcrowded by banks offering similar products and services which led to
underperformance arising from inefficiently operated banks. Therefore,
consolidation (M&A activity) in the banking industry became necessary to
increase productivity.
Singapore saw a sharp decline of 8.41% in its GDP in 1998 ($95.8 billion)
compared to 1997 ($104.6 billion). FDI inflows were also considerably
reduced (contagion effect of the crisis). Exports increased prior to the crisis,
but then saw a slight drop in 1998. GDP percentage growth experienced the
biggest fall in 1999. After the GDP plummeted in 2009 (-8.4%), it
rebounded back and reached all-time high of 19.8% in June 2010. Annual
91

GDP growth averaged 5% between 2007 and 2012.123 Public debt to GDP
ratio increased substantially to 100.8% in 2011. Singapore averaged 84.9%
during 1990-2011 and the lowest government debt to GDP ratio was 68.1%
in December 1995.124 The government spending in 2010 was $6.26 billion
compared to $5.91 billion as of third quarter in 2012. The lowest spending
was $538.7 million in 1975.ϭϮϱ
Singapore ͳͶǤͳʹ͸
% of GDP 1992 1993 1994 1995 1996 1997 1998

Exports ϭϲϮ ϭϲϮ ϭϲϳ ϭϴϯ ϭϳϴ ϭϳϮ ϭϲϵ
Imports ϭϱϬ ϭϱϮ ϭϱϭ ϭϲϲ ϭϲϮ ϭϱϳ ϭϰϳ
Gross savings ϰϲ ϰϯ ϰϴ ϱϬ ϰϵ ϱϯ ϱϮ
Gross capital ϯϱ ϯϲ ϯϮ ϯϯ ϯϰ ϯϳ ϯϬ
Services ϲϲ ϲϲ ϲϳ ϲϳ ϲϳ ϲϳ ϲϲ
GDP growth % ϳ͘Ϭ ϭϭ͘ϱ ϭϬ͘ϲ ϳ͘ϯ ϳ͘ϲ ϴ͘ϱ ͲϮ͘Ϯ
Stocks traded Ϯϴ͘ϳ ϭϯϲ͘ϭ ϭϭϳ͘ϭ ϳϰ͘ϴ ϰϱ͘ϭ ϲϭ͘Ϯ ϱϮ͘ϵ
$US billion 1992 1993 1994 1995 1996 1997 1998

Total reserves ϯϵ͘ϵ ϰϴ͘ϰ ϱϴ͘ϯ ϲϴ͘ϴ ϳϳ͘Ϭ ϳϭ͘ϰ ϳϱ͘ϭ
C. acc. balance ϱ͘ϵ ϰ͘Ϯ ϭϭ͘ϰ ϭϰ͘Ϯ ϭϰ͘Ϭ ϭϱ͘ϯ ϭϴ͘ϱ
GDP ($US) ϰϵ͘Ϭ ϲϬ͘Ϭ ϲϵ͘Ϯ ϴϴ͘ϴ ϭϬϬ͘ϵ ϭϬϰ͘ϲ ϵϱ͘ϴ
FDI inflows Ϯ͘Ϯ ϰ͘ϳ ϴ͘ϲ ϭϭ͘ϱ ϵ͘ϳ ϭϯ͘ϴ ϳ͘ϯ
FPI inflows ϭ͘ϰ Ϯ͘ϴ Ϭ͘Ϯ ͲϬ͘Ϯ Ϭ͘ϳ ͲϬ͘ϰ ϭ͘Ϭ

The aftermath of the crisis was short lived and the effects were milder in
Singapore thanks to the excellent crisis-management approach taken by the

123
http://www.tradingeconomics.com/singapore/gdp-growth-annual
124
http://www.tradingeconomics.com/singapore/government-debt-to-gdp
125
http://www.tradingeconomics.com/singapore/government-spending
126
92

government and implementation of all the necessary processes, government
programs, and precautionary steps at the right time. The Monetary
Authority of Singapore let its currency (SGD) slide as much as 20% to
prevent hard landing of its economy. Singapore also introduced
construction and infrastructure related projects to stimulate the domestic
economy and its labor market. Unlike Thailand, Malaysia, and Indonesia,
Singapore did not make any real attempts to intervene in the capital
markets; consequently, the Straits Times Index (STI) plunged massive 60%,
however the economy got back on track the following year.
The Asian crisis of 1997-98 brought the vulnerable side of Singapore to

external shocks during a global scale financial stress out into daylight;
moreover, transparency issues continued to be a dragging matter in the
whole region, especially in Indonesia and Thailand.127 Over the years,
DOWKRXJK 6LQJDSRUH¶V SXEOLF GHEW WR *'3 UDWLR KDV JRQH XS VXEVWDQWLDOO\
(from averaging 70% in 1992-1998 to 100.8% in 2011); its total reserves
likewise have increased considerably as well (close to $244 billion in 2011);
therefore, the current situation (significantly improved financial position) is
YHU\OHVVOLNHO\JRLQJWRDIIHFW6LQJDSRUH¶VDELOLW\WRPDNHIXWXre payments
on its external debt obligations; in addition, country borrowing costs and
government bond yields will not be affected either.128
GDP ($) saw a 7.63% increase from a year ago reaching $239.7 billion in
2011, this represents 0.39% of the world WRWDO *'3 6LQJDSRUH¶V *'3
averaged $51.84 billion during 1960-2011, reached all-time high of $239.7
billion in December and the lowest GDP of $650 million was recorded in
1960.129 Singapore has no external debt as of 2012. External debt averaged

127
6HH,0)6WDII&RXQWU\5HSRUW1R³6LQJDSRUH6HOHFWHG,VVXHV´S
128
Data by the IMF, http://www.tradingeconomics.com/singapore/government-debt-to-gdp
129
http://www.tradingeconomics.com/singapore/gdp
93

$7.3 million during 1990-2012. All time high external debt was recorded in
March 1990, $107 million (exchange rate of $1 = S$1.2196 was used for
conversion).130 Gross National Product (GNP) increased to $262.2 billion
in June 2011which was a 4.96% improvement from a year ago ($249.8
billion in 2010). The GNP averaged $71.9 billion during 1960-2011; $1.8
billion of GNP in 1960 was the lowest, and the highest was in 2011.
Singapore ͳͷǤͳ͵ͳ
% of GDP 2005 2006 2007 2008 2009 2010 2011

Exports ϮϯϬ Ϯϯϯ Ϯϭϴ Ϯϰϭ ϮϮϱ ϮϬϳ ϮϬϵ
Imports ϮϬϬ ϮϬϰ ϭϴϳ Ϯϭϵ ϭϵϳ ϭϳϵ ϭϴϮ
Gross savings ϰϭ ϰϲ ϰϴ ϱϭ ϱϮ ϰϳ ϰϵ
Gross capital ϮϬ Ϯϭ ϮϮ Ϯϵ Ϯϯ ϮϮ ϮϮ
Services ϲϴ ϲϵ ϳϭ ϳϯ ϳϮ ϳϮ ϳϯ
GDP growth % ϳ͘ϰ ϴ͘ϴ ϴ͘ϵ ϭ͘ϳ Ͳϭ͘Ϭ ϭϰ͘ϴ ϰ͘ϵ
Stocks traded ϵϳ͘Ϭ ϭϯϮ͘ϱ ϮϮϴ͘ϭ ϭϲϮ͘ϰ ϭϰϯ͘ϰ ϭϯϮ͘ϰ ϭϬϱ͘ϵ
$US billion 2005 2006 2007 2008 2009 2010 2011

Total reserves ϭϭϴ͘ϭ ϭϯϴ͘ϳ ϭϲϲ͘Ϯ ϭϳϳ͘ϱ ϭϵϮ͘ϭ Ϯϯϭ͘ϯ Ϯϰϯ͘ϵ
C. acc. balance Ϯϲ͘ϰ ϯϲ͘ϭ ϰϴ͘ϰ Ϯϳ͘ϵ ϯϱ͘Ϯ ϰϵ͘ϲ ϱϯ͘ϲ
GDP ($US) ϭϮϬ͘ϵ ϭϰϱ͘ϯ ϭϳϳ͘ϯ ϭϴϵ͘ϰ ϭϴϯ͘ϯ ϮϮϮ͘ϳ Ϯϯϵ͘ϳ
FDI inflows ϭϱ͘ϱ Ϯϵ͘ϯ ϯϳ͘Ϭ ϴ͘ϲ ϭϱ͘ϯ ϯϴ͘ϲ ϰϭ͘Ϭ
FPI inflows ϰ͘ϵ ϭϬ͘ϭ ϭϴ͘ϯ Ͳϭϭ͘ϳ ͲϬ͘ϯ ϯ͘ϲ ϰ͘Ϭ
The profitability of banks fell by 28-50% during the first half of 1998
relative to 1997. In addition, the total of non-performing loans (NPLs) was
5% in June 1998. The toSIRXUEDQNV¶H[SRVXUHZDV6ELOOLRQLQ
Risk-weighted capital ratio of 12% was adopted at the end of 1997. 132

130
http://www.tradingeconomics.com/singapore/external-debt
131
132
Ostry, J., Stone, M., Sarel, M., & Lee, J. (199³6LQJDSRUH6HOHFWHG,VVXHV´,0)6WDII
Country Report No. 99/35, April 1999.
94

ASIA TODAY
The exceptional economic growth in Asia for the past three decades was
brusquely interrupted in 1997 and soon it turned into a deep recession by
1998. The pace of growth has been already a remarkable story to tell, but
the amazingly quick recovery from its abysmal recession is even more
UHPDUNDEOH³One year after the deepest recession in recent history, Asia is
leading the global recovery. The pace of the recovery in advanced
economies has been held back by high unemployment rates, weak
household balance sheets, and anemic bank credit, and it remains heavily
dependent on macroeconomic policy support.´133
Although the swift recovery has been slightly different from country to
country in Asia, nonetheless the growth pace has exceeded that of the
industrialized nations (more than 2%). Moreover, Asia region for the first
time contributed to the recent global recovery more than any other regions
(sluggish US economy, persisting recession in Japan due to earthquake and
tsunami, slow recovery in the eurozone together with sovereign debt crisis).
Asia has learned invaluable lessons from their 1997-1998 crisis experience
which gave them an opportunity to diversify their economies from being
heavy exports dependent to more domestic consumption focused; strong
household consumption along with solid growth in large infrastructure and
construction related projects helped them to make up for the loss arising
from reduced exports to advanced economies (the US economic slowdown,
prolonged recession in Japan, and sovereign debt crisis in eurozone).
Healthy capital inflows to the Asia region have always been enormously
critical for the regioQ¶V KLJKO\ FRPPLWWHG HIIRUWV WR GHPRQVWUDWH DPD]LQJ

133
95

economic growth and the return of increased net capital inflows to the
UHJLRQ LV D FOHDU VLJQ RI IRUHLJQ LQYHVWRUV¶ FRQILGHQFH However, capital
inflows is a double edged sword, any abrupt reversal could easily cause
unwanted chain of event which in turn potentially cause financial and
economic stress. Over the near term, ,0)¶V 5HJLRQDO (FRQRPLF 2XWORRN
2010 (REO) expects Asia to lead the global recovery in the coming years
for two reasons. First, as the global recovery will be more robust in near
future, domestic household consumption along with increased exports to
advanced QDWLRQVZLOOVXSSRUW$VLD¶VLQGXVWULDOSURGXFWLRQLQEH\RQG
Second, once the recovery is in the fast lane, then macroeconomic policies
will have less impact; however, the demand in domestic private sector will
remain VWURQJ ³,Q PDQ\ UHJLRQDO HFRQRPLHV KRZHYHU SULYDWH GRPHVWLF
demand appears to have sufficient momentum to sustain near-term growth,
as high asset values, strong consumer confidence, and a gradual
improvement in employment conditions are expected to sustain
consumption, while the return of capacity utilization to more normal levels
LVH[SHFWHGWRERRVWLQYHVWPHQW´134
China, the heavyweight of the region, is expected to record double digit

growth in 2010 which means that contagion in a positive way can help the
rest of the region. Strongly growing China translates to increased imports
of commodities and capital goods from other nations in the region. Despite
recovery LQWKHH[SRUWVHFWRU-DSDQ¶VSULYDWHVHFWRUstill experiences major
challenges and the inflation in the country is back in the red. IMF sees
VRPHFRQFHUQVUHJDUGLQJ$VLD¶VVWURQJF\FOLFDOSRVLWLRQLIWKHLQWHUHVWUDWH
gap between the region and advanced nations grow larger which may in
turn lead to massive capital inflows similar to the situation prior to 1997.
As it happened during 1997-98, significant capital inflows could have a

134
96

heating effect on the economy and any abrupt reversal (capital outflows)
could trigger other unwanted chain of events.ϭϯϱ
Asia Today ͸Ǥ ͳ͵͸
x Asia is leading the global recovery. China and Indonesia are barely affected
from recession in 2009, and they enjoy strong domestic demand. Recovery
varies in the region, exports have improved and net capital inflows surged.
x In China, growth is expected to be in double digits in 2009. Japan is
showing improved exports but demand remains weak as inflation is back in
the red territory.
x Brighter future prospects coupled with strong capital inflows due to
widening interest rate differentials between the region and the advanced
HFRQRPLHVKDYHLQFUHDVHG$VLD¶VF\FOLFDOSRVLWLRQVXEVWDQWLDOO\ZKLFKPD\
SRVHULVNVWRWKHUHJLRQ¶VRXWORRNLQQHDUIXWXUH
x The export volume of electronics (one-third of all exports) in newly
industrialized economies (NIEs) has not gotten back to the pre-FULVLV¶OHYHO
x Large firms and SMEs (small-medium size enterprises) still largely depend
on bank lending. Improved business environment encouraged private firms
take advantage of the domestic bond market which saw smaller amount of
corporate issuances. Private investments still show weakness.
x Currencies in Asia have appreciated against the U.S. dollar. With the
exception of Japanese Yen (up about 17% against the dollar since 2008),
.RUHD¶VZRQUHPDLQVWREHVWLOOEHORZOHYHO
x In 2009, economies in Asia have increased official reserves by $800 billion
bringing the total to $5.2 trillion; China ($2.9 trillion in 2010).
x The current account surplus had declined 11% in 2007 and 6% in 2009.
However, despite cyclical decline, massive accumulation of reserves
helped the current account surplus to increase by $400 billion in 2009.
x Economic recovery in emerging Asia outpaced thDW LQ $VLD¶V ORZ-income
countries (LICs). Economies suffered due to global crisis and its adverse
effects on wages, government run programs, unemployment and tourism.
x Each percentage drop in the US inventory-to-shipment ratio translates to
1.5% rise in AsLD¶V H[SRUWV WR WKH 86 ,Q WKH 86 ZDV UXQQLQJ
which meant an export level of 7% or more from Asia to the U.S. in 2010.

135
136
See International Monetary Fund (IMF), Regional Economic Outlook, 2010, pp.3-14
97

Although China is a superpower in the region, it cannot possibly be
expected to compensate the weaker demand from advanced economies with
LWV LPSRUW IURP WKH UHJLRQ EHFDXVH &KLQD¶V LPSRUW PL[ rather consists of
mainly consumer products than electronics (one-third of total exports),
machinery, or other manufacturing related supplies. Countries in the region
will have to introduce structural reforms to create new or increase the
existing domestic demand which may call for increase of consumption or
LQYHVWPHQWV 7KH VHUYLFH VHFWRU¶V VKDUH LQ WKH RYHUDOO HFRQRP\ PXVW EH
improved including a wide range of reforms should be introduced in
product, labor, and financial markets (i.e. flexible exchange rate).137
7KH,0)¶V5(2VKRZVWKDWH[SRUWYROXPHVLQQHZO\LQGXVWULDOL]HG
economies (NIE; Hong Kong SAR, Singapore, Korea, Taiwan) and China
returned back to the pre-crisis levels. However, export volumes have not
totally recovered in ASEAN-5 nations. Advanced nations import serious
volume of electronics components from Asia, which comprises one-third of
all exports, so when the recovery began electronics sector because of its
massive size naturally rebounded first in 2009. But as the global recovery
has gained speed, nonelectronics exports have also picked up momentum.
Exchange rates in the region have continued their appreciation (particularly

in Korea, Indonesia, and Philippines) against the dollar since 2009 thanks
to perpetuation of healthy capital inflows and improved exports which have
given enough confidence to foreign investors to return their investments to
the region. However, China still kept its currency renminbi pegged to the
GROODU RQ WKH RWKHU KDQG .RUHD¶V ZRQ DQG 0DOD\VLD¶V ULQJJLWV DUH VWLOO
below their highs of pre-Asian crisis levels or before the 2008 global
financial crisis. Although the volume varies from country to country,

137
See International Monetary Fund (IMF), Regional Economic Outlook, 2010, p.x
98

business activities are picking up in the region as concerns or uncertainty
regarding the future of Asia is dissipating. Consequently, the private sector
spending shows capital utilization is getting back to normal levels.138
Growth opportunities coupled with healthy fiscal balances continue to

attract capital inflows as in foreign direct investments (FDIs) or portfolio
inflows (FPIs slowed down a bit due to concerns regarding the euro area
sovereign credit, but improved in recent months). Domestic bond markets
are expanding as more Asian firms are encouraged to take advantage of
good rates. In Asia, banks are still main financial intermediaries (lenders)
to larger firms and SMEs (small-medium enterprises).139
Positive business environment along with recent surge in consumer prices

of foods, oil, and non-oil commodities due to strong domestic demand have
enticed inflation. More export oriented nations (Hong Kong, Singapore) in
emerging Asia pulled out of recession quicker than others in the region.
China and Indonesia were barely affected from recession and enjoyed
continued growth; In Indonesia case, fiscal and structural reforms together
with a number of other measures implemented under the IMF helm have
greatly benefited the country to improve its fiscal and current account
imbalances which resulted in tremendous accumulation of reserves. Japan
saw a rebound in its exports but unfortunately it did not amount to any
noticeable rising effect on domestic demand which still happens to be
sluggish moving interest rates into the red zone.140
Asia has had historically more stable employment levels than emerging
markets or industrialized nations. Firms in ASEAN economies reduced

138
See International Monetary Fund (IMF), Regional Economic Outlook, 2010, p.11
139
140
See International Monetary Fund (IMF), Regional Economic Outlook, 2010, pp.7-9
99

wages and working hours as a way of dealing with the huge adverse effects
of crisis instead of just simply laying off employees. Once the recovery has
gained momentum, earlier taken preventive measures were adjusted back to
their pre-crisis levels (first, work hours were back to normal, and then
wages started to pick up). Japan is an exception to the whole recovery
process taking place in the rest of Asia due to its lethargic economy.141
Private investment in Asia saw sharp declines, especially in heavy export

dependent countries (i.e. Japan and Korea). This was not totally surprising
because private investments in these nations have naturally concentrated in
export related sectors which comprise close to half of GDP in some cases.
When export volumes significantly dropped as contagion effects of the
2008 global financial crisis along with tragic earthquake and tsunami in
Japan, private investment took a massive blow. The situation intensified
further when sovereign debt crisis began circulating through eurozone by
2010 and already hurting private investment got hit hard again because
FRXQWULHV LQ WKH HXUR]RQH DUH $VLD¶V important exporting destinations.142
Corporate bankruptcies were limited in contrast with those in advanced
nations due to aggressive introduction of right financial and credit policies.
Direct contribution of lower interest rates probably varied across countries
in the region particularly because of differences in the financial systems in
each Asian nation.143
As exports saw positive signs of recovery in 2009, private investment

picked up as well especially when the sales of big-ticket items returned (i.e.
more automobile sales in Korea and increased level of semiconductor
manufacturing in Taiwan). The investment climate was supported by lower

141
142
143
100

interest rates thanks to aggressive central bank policy rate reductions;
nevertheless, corporate barrowing had still remained flat in 2009 which is
in contrast with 2001 where both investments and credit cycles returned.144
Chart 4 ͳͶͷ
Domestic demand on average

contributed around 40% to ͷͺͼ
GDP growth in Asia. Besides
Japan, private demand has
been a strong driver in
growth. IMF staff estimates
show that fiscal policy may
have helped private demand
improve in these economies.
Large capital inflows drove
asset prices higher. Inflation
risk rises due to recent hike in
prices and massive capital
inflows (overheating).
͸ͶͶͿ
ȋάȌ

144
145
146
Source: IMF staff estimates, International Monetary Fund (IMF), Regional Economic
Outlook, 2010, p.17, slightly modified (fiscal factor direct or indirect through employment)
101

ǯ was no different in treatment, the crisis had major
bearing on its economy when external demand contracted significantly and
as a result, its currency Hong Kong dollar faced the same misfortune as the
other currencies in the region; QDPHO\7KDLODQG¶VEDKW,QGRQHVLD¶VUXSLDK
0DOD\VLD¶V ULQJJLW .RUHD¶V ZRQ DQG WKH 3KLOLSSLQHV¶ SHso. Economic
activity weakened dramatically due to massive capital outflows, falling
asset values, rising consumer prices, declining property rentals, and rising
unemployment. Consequently, Hong Kong's stock index plummeted 10.4%
in a single day after the government raised bank overnight lending rates to
300% which caused the shares to shave off $29.3 billion of their value.
Hong Kong ͳ͸Ǥ ͳͶ͹
% of GDP 1992 1993 1994 1995 1996 1997 1998

Exports ϭϯϴ ϭϯϱ ϭϯϰ ϭϰϯ ϭϯϳ ϭϮϴ ϭϮϱ
Imports ϭϯϯ ϭϮϵ ϭϯϯ ϭϰϴ ϭϯϴ ϭϯϭ ϭϮϰ
Gross savings Ϯϴ Ϯϳ ϯϭ ϯϰ ϯϮ ϯϰ Ϯϵ
GDP growth % ϲ͘ϭ ϲ͘Ϭ ϲ͘Ϭ Ϯ͘ϯ ϰ͘Ϯ ϱ͘ϭ Ͳϲ͘Ϭ
Stocks traded ϳϱ͘ϲ ϭϬϵ͘ϳ ϭϬϴ͘ϲ ϳϰ͘ϭ ϭϬϰ͘ϳ Ϯϳϳ͘ϲ ϭϮϯ͘ϰ
$US billion 1992 1993 1994 1995 1996 1997 1998

Total reserves ϯϱ͘Ϯ ϰϯ͘Ϭ ϰϵ͘ϯ ϱϱ͘ϰ ϲϯ͘ϴ ϵϮ͘ϴ ϴϵ͘ϳ
C. acc. balance ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ ͲͲͲͲ Ϯ͘ϱ
GDP ($US) ϭϬϰ͘Ϭ ϭϮϬ͘Ϭ ϭϯϱ͘ϱ ϭϰϰ͘Ϯ ϭϱϵ͘Ϭ ϭϳϲ͘ϯ ϭϲϲ͘ϵ
When Hong Kong market collapsed (October 1997), seven out of the nine
countries in the region posted heavy losses averaging about 9%. By 1998,
the markets rebounded swiftly in mid-January and seven out of the nine

147
102

countries this time posted large gains on January 14 and six out of nine on
January 19. Markets remained jittery to some degree until February,
calming somewhat after mid-February 1998 (Kaminsky & Schmukler,
1999). Hong Kong has been heavily dependent on exports to Japan, the
United States, and The Europe and capital inflows from foreign investors.
Both capital outflows and substantial deterioration in external demand
caused GDP o plummet in 1998 (-6.0%), the largest drop since 1980s.
Hong Kong ͳ͹ǤͳͶͺ
% of GDP 2005 2006 2007 2008 2009 2010 2011

Exports ϭϵϵ ϮϬϲ ϮϬϴ ϮϭϮ ϭϵϱ ϮϮϯ ϮϮϬ
Imports ϭϴϲ ϭϵϰ ϭϵϳ ϮϬϮ ϭϴϴ ϮϬϮ ϮϬϬ
Gross savings ϯϮ ϯϰ ϯϯ ϯϰ ϯϬ ϯϬ ϯϭ
Gross capital Ϯϭ ϮϮ Ϯϭ ϮϬ Ϯϭ Ϯϰ Ϯϯ
Services ϵϭ ϵϮ ϵϮ ϵϮ ϵϯ ϵϮ ϵϯ
GDP growth % ϳ͘ϭ ϳ͘Ϭ ϲ͘ϰ Ϯ͘ϯ ͲϮ͘ϳ ϳ͘Ϭ ϱ͘Ϯ
Stocks traded ϭϲϱ͘ϰ ϮϭϮ͘ϲ ϰϰϮ͘ϴ ϳϱϱ͘ϭ ϳϭϭ͘ϴ ϳϭϭ͘ϳ ϲϯϲ͘ϴ
$US billion 2005 2006 2007 2008 2009 2010 2011

Total reserves ϭϮϰ͘ϯ ϭϯϯ͘Ϯ ϭϱϮ͘ϳ ϭϴϮ͘ϱ Ϯϱϱ͘ϴ Ϯϱϴ͘ϳ Ϯϴϱ͘ϰ
C. acc. balance ϮϬ͘Ϯ ϮϮ͘ϵ Ϯϱ͘ϱ Ϯϵ͘ϱ ϭϴ͘Ϭ ϭϮ͘ϰ ϭϮ͘ϵ
GDP ($US) ϭϳϳ͘ϴ ϭϵϬ͘Ϭ ϮϬϳ͘ϭ Ϯϭϱ͘ϰ ϮϬϵ͘ϯ ϮϮϰ͘ϱ Ϯϰϯ͘ϳ
FDI inflows ϯϯ͘ϲ ϰϱ͘Ϭ ϱϰ͘ϰ ϱϵ͘ϲ ϱϮ͘ϰ ϳϭ͘ϭ ϴϯ͘Ϯ
FPI inflows ϭϬ͘Ϭ ϭϰ͘ϱ ϰϯ͘ϲ ϭϳ͘ϰ ϵ͘ϱ ϭϴ͘ϱ Ϯϭ͘Ϭ
Hong Kong largely depends on private consumer spending which accounts

for about two thirds of its GDP (around 60%). The collapse of enormously
overvalued assets in 1998 caused an enormous contraction in the domestic

148
103

economy where sales of products excluding food plummeted during the
first few months of the crisis by as much as 20% from a year ago levels.
Steep correction in the stock market, falling property values, and rising
interest rates gave investors more than they could handle which led to
significant capital outflows. As a small special administrative region, large
infrastructure projects through public investment are limited, therefore
government investment saw little over 5% drop in 1997 and contracted
further in 1998 as the airport came close to completion. Private investment
is oriented towards trade related businesses in export dependent countries
in the Asia region (i.e. Japan, Korea), so in Hong Kong the majority of
investments concentrated around financial activities as well as exports.
As an important financial center, Hong Kong has to attract substantial

levels of capital inflows to continue its economic growth, mostly in
SRUWIROLR LQYHVWPHQWV DQG VWRFN PDUNHW DFWLYLW\ $VLD¶V UHPDUNDEO\ IDVW
recovery from its deepest recession has encouraged investors to return back
to Hong Kong. Lower policy interest rates than before gave boost to private
consumption and gave households greater access to credit. Brighter future
prospects coupled with strong capital inflows due to widening interest rate
differentials between the region and the industrialized nations (G-2) have
LQFUHDVHG$VLD¶VF\FOLFDOSRVLWLRQVXEVWDQWLDOO\ZKLFKPD\SRVHULVNVWRWKH
UHJLRQ¶VRXWORRNLQQHDUIXWXUH149
Lower interest rates together with relaxed barrowing conditions have

increased the debt burden on households extensively due to greater and
easier access to credit. Housing credit in Hong Kong makes up about little
over three quarters of all credit. Housing and non-housing credit together
comprise close to 60% of GDP, which explains the reason behind the

149
104

excessive burden when the property prices collapsed in 1997. Local
currency bond issuance picked up in 2009 provided by lower cost and
longer-term maturity. Manufacturing sector, housing market, and
government sponsored infrastructure projects gave boost to bank lending
activities which rose as much as 30% in some regions.ϭϱϬ
ǯ with Park Chung Hee, former president (election
of 1963), as the General, led the military coup in 1961 and became the
president in the following election; however, his presidency short lived due
to his assassination in 1979. Park had closely observed the post-war
Japanese economic model (protectionism of domestic market, and creation
of few very large family-owned interconnected corporations) and tried to
replicate it. In the process, all banks in Korea were nationalized and
³FKDHERO151ÍDPLO\-controlled multinational conglomerates like Samsung,
LG, Daewoo International, and Hyundai) system was enforced.
In the chaebol system, growth was highly encouraged and extensively

supported by the state-owned banks for any financing needs that the firms
had for production, investment or expansion. All these powerful companies
were family owned and each company held shares in each other. The
FRXQWU\¶V EXVLQHVV RSHUDWHG OLNH D PLOLWDU\ VW\OH LQ ZKLFK YLUWXDOO\
everything (loans of any financial means, licenses, investments, and
projects) had to be approved by the government authorities. Post Park era
saw specifically two important reforms in order to adapt to fast changing
global and domestic business environments, two new Ministries were
formed; Ministry of Trade and Industry (MTI), and Ministry of Finance.152

150
151
7KHWHUP³FKDHERO´ was first used in 1984 which means huge multinational corporations
(large family-controlled conglomerates) owning a great number of enterprises in many
different sectors. See Wikipedia, http://en.wikipedia.org/wiki/Chaebol
152
See http://www.olemiss.edu/courses/pol387/koreacrs.ppt
105

Foreign iQYHVWRUVORYHG.RUHD¶VILQDQFLDOV\VWHPEHFDXVHRILWV flexibility
and openness to outside investors because they were able to move in and
out as they pleased based on the direction and volatility of global financial
markets and their risk appetite. However, this situation had explicitly
exposed Korea to extensive amount of risks and vulnerability in relation to
sporadic moves of capital flows with a great deal of uncertainty.
South Korea ͳͺǤ ͳͷ͵
% of GDP 1992 1993 1994 1995 1996 1997 1998

Exports Ϯϳ Ϯϳ Ϯϳ Ϯϵ Ϯϴ ϯϮ ϰϲ
Imports Ϯϴ Ϯϲ Ϯϳ ϯϬ ϯϭ ϯϯ ϯϯ
Gross savings ϯϲ ϯϲ ϯϲ ϯϲ ϯϱ ϯϱ ϯϳ
Gross capital ϯϳ ϯϲ ϯϳ ϯϴ ϯϵ ϯϲ Ϯϱ
Services ϱϭ ϱϭ ϱϮ ϱϮ ϱϯ ϱϯ ϱϰ
GDP growth % ϱ͘ϲ ϲ͘ϭ ϴ͘ϱ ϵ͘Ϯ ϳ͘Ϭ ϰ͘ϳ Ͳϲ͘ϵ
Stocks traded ϯϱ͘Ϯ ϱϴ͘ϱ ϲϳ͘ϲ ϯϱ͘ϴ ϯϭ͘ϴ ϯϯ͘ϯ ϰϮ͘ϭ
$US billion 1992 1993 1994 1995 1996 1997 1998

Total reserves 17.2 20.4 25.8 32.8 34.2 20.5 52.1
C. acc. balance -2.2 3.0 -3.5 -8.0 -22.9 -8.2 42.6
GDP ($US) 49.0 60.0 69.2 80.8 94.7 104.6 95.4
FDI inflows 0.7 0.6 0.8 1.8 2.3 2.8 5.4
FPI inflows 2.5 6.6 3.6 4.2 6.0 2.5 3.9
Increasing exports and its expansion into international markets became a

national pride therefore export related businesses were given the top
priority IRU FUHGLW DSSURYDOV DQG RWKHU EHQHILWV WR VSHHG XS WKH LQGXVWU\¶V

153
106

progress. Although the couQWU\¶VLPSRUWDQGH[SRUWOHYHOVZHUHYHU\FORVH
to each other between 1985 and 1997, there was always a trade imbalance
where import exceeded that of export. This changed in 2000 and 2002
when the export level first time passed the import level by about 8%.
South Korea ͳͻǤͳͷͶ
% of GDP 2005 2006 2007 2008 2009 2010 2011

Exports ϯϵ ϰϬ ϰϮ ϱϯ ϱϬ ϱϮ ϱϮ
Imports ϯϳ ϯϴ ϰϬ ϱϰ ϰϲ ϱϬ ϱϭ
Gross savings ϯϮ ϯϭ ϯϯ ϯϰ ϯϬ ϯϬ ϯϭ
Gross capital ϯϬ ϯϬ Ϯϵ ϯϭ Ϯϲ Ϯϵ Ϯϴ
Services ϱϵ ϲϬ ϲϬ ϲϭ ϲϬ ϱϴ ϱϴ
GDP growth % ϰ͘Ϭ ϱ͘Ϯ ϱ͘ϭ Ϯ͘ϯ Ϭ͘ϯ ϲ͘ϯ ϯ͘ϲ
Stocks traded ϭϰϮ͘ϰ ϭϰϬ͘ϴ ϭϴϴ͘ϭ ϭϱϳ͘ϰ ϭϴϵ͘ϲ ϭϲϬ͘ϯ ϭϴϮ͘ϭ
$US billion 2005 2006 2007 2008 2009 2010 2011

Total reserves ϮϭϬ͘ϲ Ϯϯϵ͘ϭ ϮϲϮ͘ϱ ϮϬϭ͘ϱ ϮϳϬ͘ϰ ϮϵϮ͘ϭ ϯϬϲ͘ϵ
C. acc. balance ϭϴ͘ϲ ϭϰ͘ϭ Ϯϭ͘ϴ ϯ͘Ϯ ϯϮ͘ϴ Ϯϵ͘ϰ Ϯϲ͘ϱ
GDP ($US) ϴϰϰ͘ϵ ϵϱϭ͘ϴ ϭ͕Ϭϰϵ ϵϯϭ͘ϰ ϴϯϰ͘ϭ ϭ͘Ϭϭϱ ϭ͕ϭϭϲ
FDI inflows ϲ͘ϯ ϯ͘ϲ ϭ͘ϴ ϯ͘ϯ Ϯ͘Ϯ ͲϬ͘ϭϱ ϰ͘ϳ
FPI inflows ϯ͘ϯ Ͳϴ͘ϰ ͲϮϴ͘ϳ Ͳϯϯ͘ϲ Ϯϰ͘ϵ Ϯϯ͘Ϭ Ϯϱ͘Ϭ
South Korea experienced severe economic downturn in 1997 followed by a

deep recession. 7KHFRXQWU\¶VFXUUHQF\ZRQVKDUHGWKHVDPHIDLWKDVWKH
other ASEAN nations in the region, the exchange rate plummeted from 900
won per dollar before the crisis to nearly 1,500 per dollar in just few
months in the crisis (-67% drop in value). As a result, IMF provided the

154
107

largest bailout package at the time, a colossal $57 billion. GDP growth
pretty much collapsed in 1998; significant declines in export revenues,
massive capital outflows along with a major contraction in the domestic
demand caused the GDP to plunge from 4.7% in 1997 to -6.9% in 1998.
South Korea pulled out of recession remarkably fast and its recovery has
displayed some impressive numbers in fiscal fundamentals as well as
economic performance. For instance, South Korea had little over $20
billion of foreign exchange reserves at the end of 1997 which was
insufficient to respond properly to external shocks or speculative attacks on
its currency, but as of 2012 South Korea is sitting on amazing $322 billion
of foreign reserves. SouWK.RUHD¶VZRQKDVDOVRDSSUHFLDWHGLQUHFHQW\HDUV
against the dollar, according to Bloomberg survey, 5.7% in 2012 and it is
estimated to strengthen another 1% by the end of third quarter of 2013.
Gross national income (GNI) per capita has improved significantly as well,
$20,870 as of last year. Private investment returned in a big way, investors
held 88 trillion won of local currency debt, easily doubled 2009 amount.155
ǯ saw no influence from the strong rebound in Asia which
is leading the global recovery regardless of unfavorable external factors.
The positive effects of strong economic activity has not spilled over into
Japan whose economy still remains sluggish due to weak domestic demand,
prolonged recession (also deflation), and severe financial burden of the
earthquake and tsunami. ͞In Japan, private sector demand continues to face
severe headwinds despite the recovery in the export sector, and inflation
has fallen back into negative territory, requiring the authorities to reiterate
WKHLUFRPPLWPHQWWRSURORQJHGSROLF\DFFRPPRGDWLRQ´156 Transformation

155
http://www.businessweek.com/news/2012-10-30/south-korea-best-in-asia-as-investors-show-
confidence-in-economy
156
108

of Japanese financial market was slow compared to that of The U.S. or the
UK; therefore, it had taken much longer time to develop certain financial
instruments in the domestic capital market (i.e. derivatives, bonds).
Japan ʹͲǤ ͳͷ͹
% of GDP 1992 1993 1994 1995 1996 1997 1998

Agriculture value Ϯ Ϯ Ϯ Ϯ Ϯ Ϯ Ϯ
Exports ϭϬ ϵ ϵ ϵ ϭϬ ϭϭ ϭϭ
Imports ϴ ϳ ϳ ϴ ϵ ϭϬ ϵ
Gross savings ϯϯ ϯϮ ϯϭ ϯϬ ϯϬ ϯϬ Ϯϵ
Gross capital ϯϭ Ϯϵ Ϯϴ Ϯϴ Ϯϵ Ϯϴ Ϯϲ
Services ϲϮ ϲϯ ϲϱ ϲϱ ϲϱ ϲϲ ϲϲ
GDP growth % Ϭ͘ϴ Ϭ͘Ϯ Ϭ͘ϵ ϭ͘ϵ Ϯ͘ϲ ϭ͘ϲ ͲϮ͘Ϭ
Stocks traded ϭϲ͘ϱ Ϯϭ͘ϲ Ϯϯ͘ϭ Ϯϯ͘ϭ Ϯϲ͘ϲ Ϯϴ͘ϵ Ϯϰ͘Ϯ
$US billion 1992 1993 1994 1995 1996 1997 1998

Total reserves ϳϵ͘ϳ ϭϬϴ͘Ϭ ϭϯϱ͘ϭ ϭϵϮ͘ϲ ϮϮϱ͘ϲ ϮϮϲ͘ϳ ϮϮϮ͘ϰ
C. acc. balance ϭϭϮ͘ϲ ϭϯϭ͘ϲ ϭϯϬ͘ϯ ϭϭϭ͘Ϭ ϲϱ͘ϴ ϵϲ͘ϴ ϭϭϴ͘ϳ
GDP ($US) ϯ͕ϴϱϯ ϰ͕ϰϭϱ ϰ͕ϴϱϬ ϱ͕ϯϯϰ ϰ͕ϳϬϲ ϰ͕ϯϮϰ ϯ͕ϵϭϱ
FDI inflows Ϯ͘ϴ Ϭ͘ϭ Ϭ͘ϵ Ϭ͘Ϭϰ Ϭ͘Ϯ ϯ͘Ϯ ϯ͘ϯ
FPI inflows ϴ͘ϵ ϮϬ͘Ϭ ϰϴ͘ϵ ϱϬ͘ϲ ϰϵ͘ϱ Ϯϳ͘Ϭ ϭϲ͘ϭ

Japan has lagged the rest of Asia region in many of the economic indicators.
Although the pace and nature of recovery varied among the newly
industrialized economies (NIEs) and the ASEAN-5 nations; however,
countries across the region have enjoyed solid growth thanks to return of
foreign investments (capital inflows), rebound in exports, and acceleration

157
109

in private domestic consumption. Japan as well saw its export volume
picking up which has not translated to any noticeable increase in domestic
demand, or the spillover effect is extremely slow or not in existence.158
Japan ʹͳǤ ͳͷͻ
% of GDP 2005 2006 2007 2008 2009 2010 2011

Agriculture value ϭ ϭ ϭ ϭ ϭ ϭ ϭ
Exports ϭϰ ϭϲ ϭϴ ϭϴ ϭϯ ϭϱ ϭϲ
Imports ϭϯ ϭϱ ϭϲ ϭϴ ϭϮ ϭϰ ϭϱ
Gross savings Ϯϲ Ϯϳ Ϯϴ Ϯϲ ϮϮ Ϯϯ Ϯϯ
Gross capital ϮϮ Ϯϯ Ϯϯ Ϯϯ ϮϬ ϮϬ Ϯϭ
Services ϳϭ ϳϭ ϳϭ ϳϭ ϳϯ ϳϭ ϳϮ
GDP growth % ϭ͘ϯ ϭ͘ϳ Ϯ͘Ϯ Ͳϭ͘Ϭ Ͳϱ͘ϱ ϭ͘ϴ Ϭ͘ϰ
Stocks traded ϭϬϵ͘ϯ ϭϰϯ͘ϱ ϭϰϵ͘ϭ ϭϮϭ͘Ϯ ϴϯ͘ϯ ϳϴ͘Ϭ ϳϬ͘ϵ
$US billion 2005 2006 2007 2008 2009 2010 2011

Total reserves ϴϰϲ͘ϵ ϴϵϱ͘ϯ ϵϳϯ͘ϯ ϭ͕Ϭϯϭ ϭ͕Ϭϰϵ ϭ͕Ϭϵϲ ϭ͕Ϯϵϲ
C. acc. balance ϭϲϱ͘ϴ ϭϳϭ͘ϭ Ϯϭϭ͘ϳ ϭϱϵ͘ϰ ϭϰϳ͘Ϭ ϮϬϯ͘ϵ ϭϭϵ͘ϭ
GDP ($US) ϰ͕ϱϳϮ ϰ͕ϯϱϳ ϰ͕ϯϱϲ ϰ͕ϴϰϵ ϱ͕Ϭϯϱ ϱ͕ϰϴϴ ϱ͕ϴϲϳ
FDI inflows ϯ͘Ϯ Ͳϲ͘ϴ ϮϮ͘Ϯ Ϯϰ͘ϲ ϭϭ͘ϴ Ͳϭ͘ϰ Ͳϭ͘ϳ
FPI inflows ϭϯϭ͘ϯ ϳϭ͘ϰ ϰϱ͘ϱ Ͳϲϵ͘ϳ ϭϮ͘ϰ ϰϬ͘ϯ ϰϮ͘Ϭ

Continuation of healthy capital inflows has benefited the region and had
considerable positive effects on currency appreciation. Although currencies
in Asia have not been back to the levels seen before 1997; but they are
nonetheless significantly higher than during the crisis. For instance,
,QGRQHVLD¶V UXSLDK .RUHD¶V ZRQ DQG WKH 3KLOLSSLQHV¶ SHVR DOO KDYH

158
159
110

DSSUHFLDWHGDERXWDJDLQVWWKH86GROODUVLQFHKRZHYHU.RUHD¶V
won is still substantially lower than pre-crisis level (20% lower). In spite of
its economic problems, Japanese yen has performed surprisingly well
against the dollar, up about 20% since 2008 (weakness of the dollar).160
-DSDQ¶VSULYDWHLQYHVWPHQWKDVH[SHULHQFHGVHULRXVGHWHULRUDWLRQVLQFH
and the investment activity has declined a massive 15%, which was about
1.5 times faster decline than in advanced regions. Relative to other Asian
economies, Japan began the recovery process at a disadvantaged position;
Japan was already perceived as safe haven for capital inflows and yen had
appreciated significantly against the dollar, plus the interest rate differential
between the U.S. and the euro was all-time low. The picture in other crisis
affected countries in the region was exactly the opposite; their currencies
were hit pretty hard and they experienced massive capital outflows.
The situation of domestic demand absenteeism in Japan is in accordance

with its past historical developments and it is somewhat expected as it was
the case in 1992 crisis and 2000-01 recession where private investment
showed recovery after little over 4 quarters. Deflation still remains to be an
issue, core inflation has kept falling and it is now in the red territory.161
ǯ plays a dual role as the regional hub (import of supplies)
and source of finDOGHPDQG H[SRUW RI ILQLVKHGJRRG WKHUHIRUH ³LPSRUWV
RI ERWK LQWHUPHGLDU\ DQG ILQDO JRRGV KDYH LQFUHDVHG LQ UHFHQW PRQWKV´
$OWKRXJK &KLQD¶V VWURQJ JURZWK JHQHUDWHV KXJH GHPDQG LW LV KRZHYHU
nowhere close to making up the demand difference arising from advanced
HFRQRPLHV (YHQ WKRXJK &KLQD¶V LPSRUW KDV EHHQ JURZLQJ DERYH WKH
average level for the past 15 years, its import has only accounted 3% of

160
161
111

WRWDO JOREDO LPSRUWV DV RI 7KH 8QLWHG 6WDWHV DV &KLQD¶V ODUJHVW
customer, is responsible for more thDQ KDOI RI &KLQD¶V H[SRUWV ZKLFK
increased from a mere 10% in 1990s to 60% in 2006-2008.162 Private
domestic consumption along with public demand has been the key factors
EHKLQG$VLD¶VUHVLOLHQWUHFRYHU\
China ʹʹǤͳ͸͵
% of GDP 1992 1993 1994 1995 1996 1997 1998
Exports ϭϵ ϮϬ Ϯϭ ϮϬ ϮϬ ϮϮ ϮϬ

Imports ϭϳ ϮϮ ϮϬ ϭϵ ϭϴ ϭϳ ϭϲ
Gross savings ϯϵ ϰϮ ϰϯ ϰϮ ϰϭ ϰϮ ϰϬ
Gross capital ϯϳ ϰϰ ϰϮ ϰϮ ϰϬ ϯϴ ϯϳ
Services ϯϱ ϯϰ ϯϰ ϯϯ ϯϯ ϯϰ ϯϲ
GDP growth % ϭϰ͘Ϯ ϭϰ͘Ϭ ϭϯ͘ϭ ϭϬ͘ϵ ϭϬ͘Ϭ ϵ͘ϯ ϳ͘ϴ
Stocks traded ϰ͘Ϭ ϵ͘ϵ ϭϳ͘ϰ ϲ͘ϴ Ϯϵ͘ϵ ϯϴ͘ϴ Ϯϳ͘ϵ
$US billion 1992 1993 1994 1995 1996 1997 1998
Total reserves Ϯϰ͘ϵ Ϯϳ͘ϯ ϱϳ͘ϴ ϴϬ͘ϯ ϭϭϭ͘ϳ ϭϰϲ͘ϰ ϭϱϮ͘ϴ

C. acc. balance ϲ͘ϰ Ͳϭϭ͘ϲ ϲ͘ϵ ϭ͘ϲ ϳ͘Ϯ ϯϳ͘Ϭ ϯϭ͘ϱ
Ext. private debt Ϭ͘Ϯ Ϭ͘ϲ Ϭ͘ϲ ϭ͘ϭ ϭ͘ϭ Ϯ͘ϰ Ϯϳ͘Ϯ
Ext. public debt ϱϴ͘ϱ ϳϬ͘ϭ ϴϮ͘ϰ ϵϰ͘ϳ ϭϬϮ͘ϯ ϭϭϮ͘ϴ ϵϵ͘ϰ
short-term debt ϭϯ͘ϴ ϭϱ͘ϯ ϭϳ͘ϱ ϮϮ͘ϯ Ϯϱ͘ϰ ϯϭ͘ϱ ϭϳ͘ϰ
Ext. total debt ϳϮ͘ϰ ϴϱ͘ϵ ϭϬϬ͘ϱ ϭϭϴ͘ϭ ϭϮϴ͘ϴ ϭϰϲ͘ϳ ϭϰϰ͘Ϭ
GDP ($US) ϰϮϮ͘ϳ ϰϰϬ͘ϱ ϱϱϵ͘Ϯ ϳϮϴ͘Ϭ ϴϱϲ͘Ϭ ϵϱϮ͘ϳ ϭ͕Ϭϭϵ
FDI inflows ϭϭ͘Ϯ Ϯϳ͘ϱ ϯϯ͘ϴ ϯϱ͘ϴ ϰϬ͘Ϯ ϰϰ͘Ϯ ϰϯ͘ϴ

162
163
112

$VWKHSRZHUKRXVHLQWKH$VLDUHJLRQ&KLQD¶VUROHLQWKHZKROHUHFRYHU\
process is quite significant for few reasons; first, China is a major player in
high-tech manufacturing, especially electronics (i.e. Taiwan Province of
China); second, domestic demand supported recovery efforts; third, Asian
exporters were able to gain market share even during the challenging times;
and finally, in the absence of the U.S. and the euro as the growth markets,
investors returned back to the region in great numbers.164
Table 23

ȋΨȌͳ͸ͷ
Numbers are in % 2006 2007 2008 2009 2010 2011

Indonesia ϱ͘ϱ ϲ͘ϯ ϲ͘Ϭ ϰ͘ϲ ϲ͘Ϯ ϲ͘ϱ
Malaysia ϱ͘ϴ ϲ͘ϱ ϰ͘ϴ Ͳϭ͘ϲ ϳ͘Ϯ ϱ͘ϭ
Philippines ϱ͘Ϯ ϲ͘ϲ ϰ͘Ϯ ϭ͘ϭ ϳ͘ϲ ϯ͘ϳ
Singapore ϴ͘ϴ ϴ͘ϵ ϭ͘ϳ Ͳϭ͘Ϭ ϭϰ͘ϴ ϰ͘ϵ
Thailand ϱ͘ϭ ϱ͘Ϭ Ϯ͘ϱ ͲϮ͘ϯ ϳ͘ϴ Ϭ͘ϭ
Vietnam ϴ͘Ϯ ϴ͘ϱ ϲ͘ϯ ϱ͘ϯ ϲ͘ϴ ϱ͘ϵ
Average of 6 countries ϲ͘ϰ ϳ͘Ϭ ϰ͘ϯ ϭ͘Ϭ ϴ͘ϰ ϰ͘ϰ
China ϭϮ͘ϳ ϭϰ͘Ϯ ϵ͘ϲ ϵ͘Ϯ ϭϬ͘ϰ ϵ͘ϯ
India ϵ͘ϯ ϵ͘ϴ ϯ͘ϵ ϴ͘Ϯ ϵ͘ϲ ϲ͘ϵ
Average Emerging Asia ϭϭ͘Ϭ ϭϮ͘Ϭ ϲ͘ϴ ϴ͘ϳ ϭϬ͘Ϭ ϴ͘ϭ
&KLQD¶V LQYHVWPHQW LV PDVVLYH E\ any measurement which happens to be

the largest in the world with $2 trillion per annum, not only this is twice the
size of investment by Japan, but it also makes up 18% of the whole global
FDSLWDOIRUPDWLRQ&KLQD¶VLQYHVWPHQWVL]HHYHQGRXEOHVWKDWRIWhe OECD
(Organization for Economic Cooperation and Development) economies.166

164
165
Source: Slightly modified, World Bank East Asia Region; March 2008 Consensus Forecasts
for NIEs (Newly Industrialized Economies).
166
113

³&KLQD¶V LPSDFW RQ WKH UHJLRQDO H[SRUW F\FOH DSSHDUV WR KDYH FKDQJHG
UHODWLYH WR SUHYLRXV GRZQWXUQV´ &KLQD¶V H[SRUWV WR WKH *-2 were far less
affected during 2000-01 recessions than this time around during the 2008
global financial crisis. China took a step in early 2000 towards becoming
PRUHLQWHJUDWHGLQ$VLD¶VVKDUHRIWKHJOREDOVXSSO\FKDLQZKLFKPHDQWD
ODUJHU VKDUH RI WKH UHJLRQ¶V H[SRUWV RI ILQDO JRRGV ,QWHUHVWLQJO\ DW the
EHJLQQLQJRIWKHFULVLVWKHUHJLRQ¶VH[SRUWVWR&KLQD fell faster and greater
WKDQ&KLQD¶VH[SRUWVWRDGYDQFHGQDWLRQV*-2), but conversely during the
UHFRYHU\ $VLD¶V H[SRUWV WR &KLQD RXWSDFHG &KLQD¶V H[SRUWV WR DGYDQFHG
economies by three to one ratio.
Table 24 ͳ͸͹
GDP Growth % 2007 2008 2009
World ϯ͘ϲ Ϯ͘ϰͲϮ͘ϴ Ϯ͘ϴͲϯ͘Ϯ

High-Income OECD Ϯ͘ϱ ϭ͘ϭͲϭ͘ϲ ϭ͘ϰͲϮ͘Ϭ
USA Ϯ͘Ϯ Ϭ͘ϱͲϭ͘ϰ ϭ͘ϬͲϮ͘Ϭ
Euro-zone Ϯ͘ϳ ϭ͘ϯͲϭ͘ϳ ϭ͘ϱͲϭ͘ϵ
Japan Ϯ͘ϭ ϭ͘ϯͲϭ͘ϳ ϭ͘ϲͲϮ͘Ϭ
World Trade (%) ϳ͘ϱ ϰ͘ϬͲϱ͘Ϭ ϱ͘ϬͲϲ͘Ϭ
Oil Prices ($/bbl) ϳϭ͘ϭ ϴϬ͘ϬͲϵϬ͘Ϭ ϴϬ͘ϬͲϵϬ͘Ϭ
$VLD¶VVWURQJJURZWKLVH[SHFWHGWRFRQWLQXHLQQHDUIXWXUH,QGRQHVLDKDV
been performing better than other ASEAN nations and it is estimated to
grow between 6% and 6.5% in 2012 and 2013. In the region, governments
have introduced different fiscal measures to support private consumption;
VRPHRIWKRVHPHDVXUHVLQFOXGHGLUHFWLQFHQWLYHV³WKURXJKSXEOLFVHUYLFHV¶
subsidies in Thailand; fuel price subsidies in Malaysia; rural home
appliance subsidies in China; and tax incentives for the purchase of motor

167
Slightly modified, World Bank East Asia and Pacific Region Interim scenario March 2008
114

YHKLFOHVRURWKHUGXUDEOHVLQ.RUHD-DSDQDQG7DLZDQ3URYLQFHRI&KLQD´
Indirect incentives include income tax cuts, allowance for first-time home
buyers, and other types of cash transfers. These fiscal measures contributed
18.4 to the recovery of private consumption.´168 The future growth
prospects of Asia is much brighter than any other regions; at least 2-3
percentage points better than average growth of the world, high-income
OECD, the United States, Japan, or the eurozone.
ASIAN TIGERS
$VLDQ ³GUDJRQV´ RU $VLDQ ³WLJHUV´ ZHUH XVHG WR GHVFULEH WKH SRZHU DQG
resilience of the four newly industrialized economies (NIEs); Hong Kong,
Singapore, South Korea, and Taiwan which have been able to sustain and
enjoy in excess of 7-8% annual growth year over year for the last three
decades till 1996. By the 21st century, these four nations have become high-
income nations specialized in different niche markets; for instance, Hong
Kong and Singapore have developed into world leading financial hubs
where South Korea and Taiwan have become manufacturing powerhouses
supported by innovation and information technology. ³A World Bank
report generally credited neo-liberal policies with the responsibility of the
boom, including maintenance of export-led trade regimes though it
DFNQRZOHGJHG VRPH EHQHILWV IURP SROLFLHV RI µILQDQFLDO UHSUHVVLRQ¶ VXFK
as state-imposed below-market interest rates for loans to specific exporting
LQGXVWULHV´169 Some analysts strongly refuted the view of the World Bank
and argued that some policies were introduced by governments to enable
growth did not quite fit the elements of neo-liberalism. Nevertheless, these
economies were able to sustain growth for decades since 1980s and they
will continue to do so in the future.

168
169
http://en.wikipedia.org/wiki/Four_Asian_Tigers#cite_note-Dictionary_human_geography-4
115

Macroeconomic developments (economic downturn in the US, sluggish
domestic demand in Japan, and sovereign debt crisis in the eurozone) will
FRQWLQXH WR GRPLQDWH DQG WHVW ³$VLDQ 7LJHUV´ LPPXQLW\ IURP HFRQRPLF
turmoil in the U.S., -DSDQ¶VORQJODVWLQJVOXPSWKHVRYHUHLJQGHEWFULVLVRI
the Eurozone, and global economic downturn. Some economists strongly
oppose that macroeconomic management in this volatile environment will
be easy for the NIEs :RUOG %DQN KDV WKH YLHZ WKDW ³$VLDQ 7LJHUV´ ZLOO
feel the impact of unfolding economic turmoil in the region as well as in
export partner countries due to its greater than before integration in the
ZRUOG¶VWUDGLQJDQGILQDQFLDOV\VWHPZKLFKPDNHVLWH[WUHPHO\VHQVLWLYHWR
global economic and financial conditions.170
Table 25 ȋʹͲͳͳȌͳ͹ͳ
GDP P. Capita Trade Export Import

Country
$million $ USD $million $million $million
Hong Kong Ϯϰϲ͕ϵϰϭ ϯϰ͕Ϭϰϵ ϵϰϰ͕ϴϬϬ ϰϱϭ͕ϲϬϬ ϰϵϯ͕ϮϬϬ
Singapore Ϯϲϲ͕ϰϵϴ ϰϵ͕ϮϳϬ ϴϭϴ͕ϴϬϬ ϰϯϮ͕ϭϬϬ ϯϴϲ͕ϳϬϬ
South Korea ϭ͕ϭϲϯ͕ϴϰϳ Ϯϯ͕ϳϰϵ ϭ͕Ϭϴϰ͕ϬϬϬ ϱϱϴ͕ϴϬϬ ϱϮϱ͕ϮϬϬ
Taiwan ϱϬϰ͕ϲϭϮ Ϯϭ͕ϱϵϭ ϲϮϯ͕ϳϬϬ ϯϮϱ͕ϭϬϬ Ϯϵϴ͕ϲϬϬ
Countries in East Asia & Pacific noticeably have insignificant level of

trading activity to each other in the region, but each country has substantial
exports to both Japan and the United States which were not surprisingly the
first two major countries pledging the largest financial support to the
affected countries because both the US and Japan had significant financial
investments and trade agreements in Southeast Asia. The U.S. provided

170
OECD Southeast Asian Economic Outlook 2011/12 (forthcoming); No. 90 China and India
171
See http://en.wikipedia.org/wiki/Four_Asian_Tigers, GDP (nominal) and per capita (nominal)
are used.
116

most assistance to Korea ($5 billion), about half of that to Indonesia ($3
billion), and no direct help were provided to Thailand. Japan, on the other
hand, gave huge financial support to Korea ($10 billion), exactly half of
that amount to Indonesia ($5 billion), and $4 billion to Thailand. However,
the United States also indirectly provided more financial help to these
affected countries through World Bank and IMF to which the U.S.
contributes more money than any country in the world. The total financial
rescue package was $116.2 billion of which; 49.05% went to Korea,
34.42% was received by Indonesia, and 14.8% was provided to Thailand.
Table 26 ͳͻͻ͹ȋΨȌͳ͹ʹ
Country THA MYS PHL IDN KOR USA JPN

Indonesia ϭ͘ϳ Ϯ͘ϰ ϭ͘ϰ ͲͲͲͲ ϳ͘ϭ ϭϲ͘ϯ Ϯϰ͘ϳ
Korea Ϯ͘Ϭ ϯ͘ϭ ϭ͘ϲ Ϯ͘ϵ ͲͲͲͲ ϭϲ͘ϲ ϭϬ͘ϲ
Malaysia ϯ͘ϳ ͲͲͲͲ ϭ͘ϯ ϭ͘ϱ ϯ͘Ϯ ϭϴ͘ϯ ϭϮ͘ϰ
Philippines Ϯ͘ϰ ϯ͘Ϭ ͲͲͲͲ Ϭ͘ϰ ϭ͘ϴ ϯϰ͘ϳ ϭϲ͘ϭ
Thailand ͲͲͲͲ ϰ͘ϲ ϭ͘Ϯ Ϯ͘Ϭ ϭ͘ϴ ϭϵ͘ϴ ϭϱ͘Ϭ
³*URZWK UHPDLQV VWURQJ LQ GHYHORSLQJ East Asia and Pacific, recording
8.2 percent in 2011, though it has slowed from its post-crisis peaks. With
the global slowdown expected to continue, the region needs to reduce its
reliance on exports and rebalance towards domestic demand, investing in
productivity increases. Poverty continues to fall, people living on less than
86DGD\H[SHFWHGWRGHFUHDVHLQE\PLOOLRQ´ 173
The remarkable growth in East Asia for the last three decades comes to an
end and it is expected to slow down considerably. The global financial
crisis deepened further in 2009 influenced by high and volatile

172
Direction of Trade Statistics Quarterly: IMF, June 1998 (cited in Baig and Goldfajn, 1998)
173
http://www.worldbank.org/en/news/2012/05/23/east-asia-and-pacific-economic-update-2012
117

international commodity prices along with struggling assets and firms
trying to go through the nerve racking process of deǦleveraging and
recapitalization.174 All economies in South East Asia grew on average 7%
in 2007; the growth was even more remarkable in China and India in that
year, 14.2% and 9.8% respectively. However, things changed so fast by
2008 when the global crisis gained speed and momentum, without any
exception, East and Southeast Asian nations had experienced significant
declines in GDP growth which dropped nearly 50% on average from the
SUHYLRXV\HDU¶VOHYHOEULQJLQJWKHDYHUDJHJURZWKWRRQO\LQ
Table 27

ȋΨȌͳ͹ͷ
Numbers are in % 2006 2007 2008 2009 2010 2011

Indonesia ϱ͘ϱ ϲ͘ϯ ϲ͘Ϭ ϰ͘ϲ ϲ͘Ϯ ϲ͘ϱ
Malaysia ϱ͘ϴ ϲ͘ϱ ϰ͘ϴ Ͳϭ͘ϲ ϳ͘Ϯ ϱ͘ϭ
Philippines ϱ͘Ϯ ϲ͘ϲ ϰ͘Ϯ ϭ͘ϭ ϳ͘ϲ ϯ͘ϳ
Singapore ϴ͘ϴ ϴ͘ϵ ϭ͘ϳ Ͳϭ͘Ϭ ϭϰ͘ϴ ϰ͘ϵ
Thailand ϱ͘ϭ ϱ͘Ϭ Ϯ͘ϱ ͲϮ͘ϯ ϳ͘ϴ Ϭ͘ϭ
Vietnam ϴ͘Ϯ ϴ͘ϱ ϲ͘ϯ ϱ͘ϯ ϲ͘ϴ ϱ͘ϵ
Average of the 6 ϲ͘ϰ ϳ͘Ϭ ϰ͘ϯ ϭ͘Ϭ ϴ͘ϰ ϰ͘ϰ
China ϭϮ͘ϳ ϭϰ͘Ϯ ϵ͘ϲ ϵ͘Ϯ ϭϬ͘ϰ ϵ͘ϯ
India ϵ͘ϯ ϵ͘ϴ ϯ͘ϵ ϴ͘Ϯ ϵ͘ϲ ϲ͘ϵ
Average Emer. Asia ϭϭ͘Ϭ ϭϮ͘Ϭ ϲ͘ϴ ϴ͘ϳ ϭϬ͘Ϭ ϴ͘ϭ
7KHFULVLV¶HIIHFWVZHUHPRUHVHYHUHLQ6LQJDSRUH7KDLODQGDQd Indonesia
than others; 1.7%, 2.5% and 3.9% correspondingly. 2009 was literally the
worst year for East Asian economy since the 1997-08 Asian crisis, it was
so severe that few countries even recorded negative GDP growth;
Singapore (-1.0%), Thailand (-2.6%) and Malaysia (-1.6%).

174
175
Slightly modified, World Bank East Asia Region; 2008 Consensus Forecasts for NIEs
118

Chart 5 ʹͲͳ͹͸
European Union ϭϳ͕ϲϭϭ

United States
ϭϱ͕Ϭϳϲ
China
ϭϭ͕ϯϬϬ
Japan
ϰ͕ϰϰϰ
India
ϰ͕ϰϮϭ
Germany
ϯ͕ϭϭϰ
Russia
Ϯ͕ϯϴϯ
Brazil
Ϯ͕Ϯϵϰ
United Kingdom
Ϯ͕Ϯϴϴ
France
Ϯ͕Ϯϭϰ
Italy
ϭ͕ϴϰϳ
Mexico
ϭ͕ϲϲϳ
South Korea
ϭ͕ϱϱϰ
Spain
ϭ͕ϰϬϲ
Canada
ϭ͕ϯϵϱ
Indonesia
ϭ͕ϭϮϱ
Turkey
ϭ͕Ϭϳϱ
Iran
ϵϵϭ
Australia
ϵϭϱ
Taiwan
ϴϳϲ
Poland
ϳϳϭ
Rest of World
ϭϵ͕ϲϬϱ
The global crisis had a massive tsunami effect on the Asia region in 2009
and almost brought the region to its knees; the average GDP growth for six
countries was a mere 1.0% which was an unparalleled plunge that almost
WUDQVODWHV WR D ³IUHH IDOO´ D UHGXFWLRQ LQ VL[ IROGV FRPSDUHG WR WKH *'3
growth of 6.4% in 2006 and an average growth of 7-8% during 1980s-90s.

176
List of countries (2011) by GDP (PPP), The length of the bar has no indication of the value
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)
119

US BORN CRISIS
There have been four major crises originated in the United States in less
than three decades; the savings and loan (S&L) and banking crisis in early
1980s, dot.com bust in 2000-2001, subprime crisis in 2007, and global
financial crisis 2008-2012. The S&L crisis was pretty much created by a
new legislation during Ronald Reagan (40th President of the United States,
1981-1989) administration that deregulated the banking industry and
granted more powers to S&Ls and mutual savings banks to increase profits
through engaging in new innovative ways even if it meant very risky
lending practices together with other questionable financial activities.
Ƭ ǣ Prior to the new legislation mentioned above, the profit
margins of banks in 1960s and 1970s were squeezed by the new market
entrants (i.e. money market mutual funds) which gave the commercial
banks no option but to seek out new risky businesses to generate more
profits. When banks were tightly regulated, before a legislation became law,
S&Ls were not allowed to make mortgage loans; now with the deregulation
in full effect, they were able to make up to 40% of the assets in commercial
real estate loans, another 30% of assets to be used for consumer lending,
10% of assets could be used for commercial loans, and finally another 10%
of assets to be in junk bonds or in direct investments.177
Another major event that contributed to the S&L crisis was the increase of
federal deposit insurance from $40,000 to $100,000 by the Depository
Deregulation and Monetary Control Act (DIDMCA) of 1980 and the
Depository Insurance Act of 1982. The S&L crisis recipe included several
fundamentally wrong ingredients; first, the S&L industry was growing and

177
6HH³7KH6DYLQJVDQG/RDQ&ULVLVDQG,WV$IWHUPDWK´ Appendix 1 to Chapter 11
http://wps.aw.com/wps/media/objects/7529/7710171/appendixes/ch11apx1.pdf, pp.44-46
120

expanding so rapidly that most of the hired managers did not possess
required knowledge or skills; second, lending boom created very complex
activities which were not monitored by the regulators; third, there were
insufficient number of regulators the majority of whom did not even have
the expertise; lastly, S&Ls did not take calculated risks and excessive risk
taking resulted in massive financial losses on bad loans (similar to
subprime crisis of 2007). Severe recession in 1981-82, a huge surge in
interest rates, and sudden collapse of energy prices led to significant
number of defaults on S&L loans. By the end of 1988, the financial losses
were in excess of $10 billion which doubled the following year and more
than half of the S&Ls were in the red and later became insolvent. The bail-
out operation of S&Ls eventually cost the tax payers $150 billion.178
ƬͷͽͿ
x Federal deposit insurance was single handedly responsible for the S&L
crisis. S&Ls were allowed to pay the same insurance premium rate
regardless of their risk level.
x Federal Reserve since 1933 had limited interest rate payment on deposits
(price fixing) which was changed in 1966 to allow S&Ls to pay higher
interest rates on deposits to attract more capital flows.
x Federal policy required S&Ls to use short-term funds from savings to

finance long-term fixed home mortgages (20-30 year). Although this
seemed like an excellent idea but not in the case of S&Ls because S&Ls
themselves were already funded by short-term deposits.
x Federal ban on adjustable-rate mortgages (ARMs) until 1981. With rising

interest rates, S&Ls were not able to adjust interest rates.

178
6HH³7KH6DYLQJVDQG/RDQ&ULVLVDQG,WV$IWHUPDWK´$SSHQGL[WR&KDSWHU
http://wps.aw.com/wps/media/objects/7529/7710171/appendixes/ch11apx1.pdf, pp.45-49
179
6HH%HUW(O\³6DYLQJVDQG/RDQ&ULVLV´
http://www.econlib.org/library/Enc/SavingsandLoanCrisis.html
121

x Congress in 1980 banned states from imposing interest rate ceiling.
Before low interest rates were allowed to be transferred to the new buyer
of the home with previously low interest rate.
x Federal restrictions on opening new branches and offering banking

nationwide. S&Ls were limited to their own geographies which greatly
exposed them to downturn in local or state economies.
x Creation of Fannie Mae and Freddie Mac by the federal government

which hugely affected 6 /V¶SURILWRSSRUWXQLWLHV
x )HGHUDO 5HVHUYH %RDUG¶V GHFLVLRQ WR UHVWULFW JURZWK RI PRQH\
supply; after the news, interest rates skyrocketed in the early 1980s.
x DeregulDWLRQRI6 /VLQDQGOLIWLQJRIWKHSUHYLRXVEDQRQ6 /V¶

operation areas.
x S&Ls were allowed to push their losses down the balance sheet into the
category of goodwill which enabled S&Ls to operate with less real
money and to encourage them to engage in riskier business practices.
x The Federal Home Loan Bank Board (FHLBB) in charge of regulating

S&Ls allowed mismanaged or insolvent S&Ls to continue operations.
x Delaying closure of insolvent S&Ls exponentially increased liability of

Federal Savings and Loan Insurance Corporation (FSLIC).
x Congress was hesitant to find out how much the S&L mess was actually
going to cost the taxpayers as a result it took until 1989.
It could be just a coincidence, but the U.S. economy every five or ten years
or so has gone into a boom or crash state; 1987 stock market crash, or more
FRPPRQO\ NQRZQ DV WKH ³%ODFN 0RQGD\´ UHIHUULQJ WR 2FWREHU
when Dow Jones Industrial Average (DJIA) lost more than 20% in a single
day of trading. By the end of October, stock markets in Hong Kong had
122

fallen 45.5%, Australia 41.8%, Spain 31%, the United Kingdom 26.45%,
the United States 22.68%, and Canada 22.5%. New Zealand's market was
hit especially hard, falling about 60% from its 1987 peak, and taking
several years to recover.180 Recovery was robust, markets presumed upward
trend again with anticipation that computer, software, and technology
related companies were going to substantially appreciate in share prices
due to the fact that personal computers were increasingly becoming
affordable as well as popular in 1990s. The hype created a dot.com frenzy
that started in 1997 resulting in establishment of thousands of companies
ZLWKSUHIL[HVVXFKDV³H´LQIURQWRIWKHFRPSDQ\¶VRIILFLDOQDPHLHH%D\
RU³dot.com´DSSHDULQJDWWKHHQGRI the company name (i.e. Amazon.com).
A great majority of these Internet based companies unfortunately lacked
basic business fundamentals and most of the dot.com companies had no
real future revenue prospects; therefore, Mike Masnick named the kind of
investing based on Internet fast-IO\LQJVWRFNVDV³SUHIL[-LQYHVWLQJ´7KRXJK
not all the Internet based dot.com companies were losers, some of the
dot.com companies like eBay and Amazon had solid business plans with
good future prospects of profitability.181
ǲǤǳ ǣ There were two main factors behind the
formation of the dot.com bubble; first, low interest rates in late 1990s
helped accumulation of substantial capital on the sidelines to be invested;
second, the venture capitalists saw a rare window of opportunity to bring in
extremely high returns on their investments (ROI) because the initial public
offering (IPO) of every Internet related start-up company ending with
dot.com was rewarded by the investors making the shares literally shoot up.
As a direct result of this phenomenon, stock markets in industrialized

180
See Wikipedia, Share Price Index, 1987-1998, and Commercial Framework: Stock exchange,
New Zealand Official Yearbook 2000. Statistics New Zealand, Wellington
181
See http://www.techdirt.com/articles/20031204/0824235.shtml
123

nations, especially the American Stock Market, simply known as
NASDAQ, the second largest by market capitalization in the world after
the New York Stock Exchange, became a regular household name in the
2000s thanks to nonstop TV coverage of its market activity on CNBC cable
channel, which had enticed more people to take part in the stock market.
When NASDAQ reached its pinnacle at 5,132 (doubled the level a year ago)
on March, 2000, that was the highest point ever seen which also signaled
WKH EXUVW RI WKH ,QWHUQHW EXEEOH +LJK IO\LQJ ,QWHUQHW FRPSDQLHV¶ VWRFNV
came down crashing during 2000-2002 which caused the loos of a jaw
dropping $5 trillion in the market value of the companies. Consequently, as
many as 4,000 dot.com companies disappeared from the face of earth, only
few survived with excellent business models with profits in mind. The
glory days of US stock market, from 1997 to 2001 before the dot.com burst,
unfortunately created significant number of day-traders who did not clearly
understand crucial elements of buying and selling stocks online. One may
DVNZKDWLVZURQJZLWKWKDW",QD³%XOO´PDUNHWSUREDEO\QRWKLQJEHFDXVH
everybody is busy and happy with making easy moQH\ EXW LQ D ³%HDU´
market, things could get enormously intricate and require profound
knowledge and unique skills to maneuver strategically in order to prevent
or minimize any financial loss.
The collapse of successful, well-known companies like Enron, WorldCom,

DQG WKH FUDVK RI ³GRWFRP´ EXEEOH LQ V LQ WKH 86 ZHUH WH[WERRN
examples of the real dangerous aspects of day-trading and its hugely
adverse effects in WKH ILQDQFLDO PDUNHWV¶ YRODWLOLW\ :KHQ WKH ³EXOO´ VWRFN
PDUNHW WXUQHG LQWR ³EHDU´ PDQ\ day traders lost substantial amount of
money, for some, their lifetime savings evaporated in blink of an eye.
During the dot.com crash, heavily invested public in the stock market
124

helplessly watched their hard-earned money, thousands or in some cases
millLRQV RI GROODUV OLWHUDOO\ YDQLVK 7KHUHIRUH WKH ³KHUG PHQWDOLW\´ LQ
trading stocks, especially with influx of day traders, had become so
dangerously intensified from 1997 (start of dot.com boom) to 2002 causing
a great deal of uncertainty and instability in stock markets worldwide.
ǣ
x The Internet became available to mass public in 1994 and online access
was made possible by America Online (AOL) which was followed a
VHULHV RI WRGD\¶V UHPDLQLQJ SRSXODU GRFFRP FRPSDnies such as Yahoo
(1994), Amazon (1994), and eBay (1995).
x Popularity and wider usage of fast personal computers increased

anticipation and assumptions that computer stock would trade higher.
x During 1990s greater focus was on developing web-based software

applications for computers rather than manufacturing hardware which
also gave enormous boost to software companLHV¶ stocks.
x 6RPH HFRQRPLVWV HYHQ FDOOHG WKH V DV WKH ³1HZ (FRQRP\´ ZKLFK
QDWXUDOO\ PDGH WKH SUHYLRXV RQH DV WKH ³2OG (FRQRP\´ 7KLV FUHDWHG a
huge hype and maybe unsustainable expectation which turned a great
number of investors including day traders into Internet stocks frenzy.
x NASDAQ index where all dot.com companies were listed and traded
went from 600-level in 1996 to 5,132 on March 10, 2000 which
translated to appreciation in stock values by more than 8 folds.
x By 2000 (especially when NASDAQ climaxed at its highest point ever as

mentioned above), it became apparent to investors that the great majority
of these dot.com companies were never turn to profitability. This thought
along with unreasonably high valuation in stock prices, ignited the
³GRWERPE´DQGTXLFNGHVFHQGLQJEHJDQ
125

x Herd mentality and panic trading by the day traders with no
understanding of stock market dynamics made things so much worse and
let the stock market swing sporadically from one end to the other.
ǣ Less than a decade later after the dot.com
mess, the United States has found itself in yet another crisis, but this time a
much bigger financial catastrophe called subprime mortgage crisis in 2007.
The crisis, whether it took place in Asia region or the U.S., had similar
elements; before the crises hit, there was always existence of favorable
external factors to set the stage (i.e. strong global growth, financial stability)
which led to extensive capital flows to the U.S., this in turn encouraged
financial institutions with enormous liquid assets waiting to engage in
unsafe risk management practices in order to capitalize on quick profits.
Chart 6 ǤʹͲͲͶǦʹͲͲ͸ͳͺʹ
Subprime mortgage loan owners are generally defined as those whose

FICO (Fair Isaac Corporation, credit scoring agency) scores below 620

182
Source: U.S. Census Bureau; Harvard University-6WDWHRIWKH1DWLRQ¶V+RXVLQJ5HSRUW
also see, http://en.wikipedia.org; slightly modified from the original
126

(scores range from 350 to 850). As of 2006, $1.3 trillion in subprime
mortgages were outstanding (7.5 million loans) which amounted to 21% of
all mortgages originated in 2006.183 Holders of subprime ratings are usually
categorized as financially weak; thus, they have a chronic history of late
payments or delinquencies, and high risk of defaults. The risk exposure of
financial situations became overwhelmingly intensified when over 90% of
the subprime mortgages were financed through adjustable-rate mortgage
(ARM) meaning that each ARM loan had to be re-financed at the end of
the ORDQ¶V term expiration which could lead to higher or lower monthly
mortgage payments depending on the interest rate at the time of refinance.
Chart 7 ǤǤ ͳͺͶ
The ARMs were in a way not much different than external short-term
private debt which was considered by many as the key factor behind the
escalation of the crisis in the Asian region. From World War II up to the
mid-1980s, Americans on average saved around 9% of their disposable

183
See NBCNEWS.com, http://www.msnbc.msn.com/id/17584725
184
6RXUFH86)HGHUDO5HVHUYH)5('%($++'HEWLV)5('³&0'(%7ÝDULDEOH
http://en.wikipedia.org; slightly modified from the original
127

income. Over time, the saving rate had deteriorated really fast and
approached to zero in recent years. In 2007, average American household
owed little over 25% more than the entire disposable income (127% of the
disposable income which got worse by 2008, 134%). This situation also
played a critical role in huge rise of disclosures because borrowers usually
did not have any built-up equity on their properties and they saw no reason
of continuing to make payments on their ARMs.185 The volume of
subprime mortgages had increased by 20 folds; it went up from $35 billion
in 1994 to massive $1.3 trillion in 2006; in percentage wise, the increase
meant going from 5% of all mortgage loans in 1994 to 21% in 2006
(RealtyTrac186 reported that the total value of all mortgages was $9.9
trillion as of 2006).
ǤǤ
x Average household debt to disposable income in America has been

increasing substantially since 1980s; from 70% in 1980 to over 127% in
2007 (highly leveraged, greater risk for default).
x Critical events like dot.com bust and terrorist attack of the twin towers
resulted in loss of jobs and further increase in household debts.
x Lowered lending requirements and higher-risk mortgage instruments;

moreover, record number of adjustable rate mortgages (ARMs).
x After peaking in 2006, house prices began their steep decline; thus,
mortgage-backed securities saw enormously large drops in value.
x Interest rates rose making the ARMs refinanced at higher interest rates
which also meant increased monthly mortgage payments; this caused
mortgage delinquencies to soar. Since most ARM holders had weak

185
See The Economist, http://www.economist.com/node/12637090?story_id=12637090
186
RealtyTrac is a real estate information company founded in 1993 and it publishes a monthly
U.S. Foreclosure Market Report
128

financial position, it was usually the case that they either had little or no
built-up equity on the house; so they preferred delinquencies to continue
until their banks started foreclosure procedures.
x The purchase of mortgage-backed securities by foreign investors also

weakened considerably which led to major reduction in investment of
other securities as well (foreign capital flows to the U.S. were greatly
affected). Contagion fear by other nations turned into credit tightening
worldwide which caused slowdown in the G-2.
x Massive capital inflows to the U.S. from Asia and oil-producing

countries in the Middle East together with low interest rates between
2002 and 2004 led to easing up the credit conditions and expanding credit
offerings to those with lesser quality subprime credit scores.
x ,QYHVWPHQW EDQNV DQG KHGJH IXQGV DOVR UHIHUUHG WR DV WKH ³VKDGRZ
EDQNLQJV\VWHP´ZHUHQRWUHJXODWHGVDPHDVWKHGHSRVLWRU\EDQNV
͸ͶͶ; ǣ Just in US alone, last decade has seen its
good share of corporate misconduct187; incompetent executives and
financial managers; inefficient regulatory system; and finally, but not the
least, insufficient judiciary process to punish those corporate executives
who have committed fraudulent188 and criminal acts189 (Taskinsoy, 2012).
7KHVHWWLQJRIJOREDOILQDQFLDOFULVLVZDVLQPDQ\ZD\VUHVHPEOLQJ³D
SHUIHFW VWRUP´ 0DQ\ HFRQRPLVWV KDYH FRQVLGHUHG LW WKH ZRUVW ILQDQFLDO
crisis since the 193V ,0) FDOOHG LW DV ³WKH ODUJHVW ILQDQFLDO VKRFN VLQFH
*UHDW 'HSUHVVLRQ´ 3ULRU WR FULVLV D 79 SHUVRQDOLW\ LQ 86$ FDOOHG LW DQ

187
Accounting scandals of some big name US corporations as follow: Nortel Networks, Bristol-
Myers Squibb, HealthSouth, Global Crossing, Fannie Mae, Tyco International, WorldCom,
Rite Aid, Peregrine Systems, Halliburton, AOL Time Warner, and many more
188
See bankruptcy filings of Enron (little over $63 billion dollars); WorldCom (over $100
billion dollars); and Global Crossing (nearly $50 billion dollars).
189
Enron CEO Jeff Skilling was sentenced to 24 years in prison; and WorldCom CEO Bernard
Ebbers received a sentence of 25 years of imprisonment.
129

economic ³Armageddon´ on the air before the crisis on August 1, 2007 and
accused the Fed not taking any actions.
ʹͷ

Table 28
Ƭȋ͈ȌͷͿͶ
Financial Firm Oct. 2007 Sept. 2008 Change %

ϭ͘ Citigroup ΨϮϯϲ͘ϳ Ψϵϳ͘ϴ Ͳϱϳ͘ϴ
Ϯ͘ Bank of America Ϯϯϲ͘ϱ ϭϱϮ͘Ϯ Ͳϯϲ͘ϱ
ϯ͘ American Int. Group ϭϳϵ͘ϴ ϯϯ͘Ϯ ͲϴϮ͘Ϭ
ϰ͘ JP Morgan Chase ϭϲϭ͘Ϭ ϭϰϮ͘Ϯ Ͳϭϭ͘ϳ
ϱ͘ Wells Fargo ϭϮϰ͘ϭ ϭϭϯ͘Ϯ Ͳϴ͘ϴ
ϲ͘ Wachovia ϵϴ͘ϯ ϯϬ͘ϴ Ͳϲϴ͘ϲ
ϳ͘ Goldman Sacs ϵϳ͘ϳ ϲϭ͘ϯ Ͳϯϳ͘Ϯ
ϴ͘ American Express ϳϰ͘ϴ ϰϱ͘Ϭ Ͳϯϵ͘ϴ
ϵ͘ Morgan Stanly ϳϯ͘ϭ ϰϭ͘ϭ Ͳϰϯ͘ϴ
ϭϬ͘ Fannie Mae ϲϰ͘ϴ Ϭ͘ϳ Ͳϵϴ͘ϵ
ϭϭ͘ Merrill Lynch ϲϯ͘ϵ Ϯϰ͘Ϯ ͲϲϮ͘ϭ
ϭϮ͘ Bank of New York ϱϭ͘ϴ ϰϱ͘ϱ ͲϭϮ͘ϯ
ϭϯ͘ Freddie Mac ϰϭ͘ϱ Ϭ͘ϯ Ͳϵϵ͘ϯ
ϭϰ͘ Lehman Brothers ϯϰ͘ϰ Ϯ͘ϱ ͲϵϮ͘ϲ
ϭϱ͘ Washington Mutual ϯϭ͘ϭ Ϯ͘ϵ ͲϵϬ͘ϳ
ϭϲ͘ Capital One Ϯϵ͘ϵ ϭϳ͘ϭ ͲϰϮ͘ϳ
ϭϳ͘ Suntrust Banks Ϯϳ͘Ϭ ϭϲ͘ϱ Ͳϯϴ͘ϴ
ϭϴ͘ BB&T Ϯϯ͘Ϯ ϭϴ͘ϴ Ͳϭϵ͘Ϭ
ϭϵ͘ Fifth Third Bancorp ϭϴ͘ϴ ϴ͘Ϯ Ͳϱϲ͘ϯ
ϮϬ͘ National Citi Corp ϭϲ͘ϰ ϯ͘ϳ Ͳϳϳ͘ϱ
Ϯϭ͘ Bear Sterns ϭϰ͘ϴ Ϭ͘Ϭ ͲϭϬϬ
ϮϮ͘ Keycorp ϭϯ͘Ϯ ϲ͘ϱ Ͳϱϭ͘Ϭ
Ϯϯ͘ Marshall Ilsley ϭϭ͘ϲ ϰ͘ϳ Ͳϱϵ͘ϰ
Ϯϰ͘ Leg Mason ϭϭ͘ϰ ϱ͘ϲ Ͳϱϭ͘Ϭ
Ϯϱ͘ Countrywide ϭϭ͘ϭ Ϭ͘Ϭ ͲϭϬϬ
Finally, former Fed Chairman AlaQ*UHHQVSDQZDUQHGRIµ¶ODUJHGRXEOH-

GLJLWGHFOLQHV¶¶LQKRPHYDOXHV.XKQKHQQ Many believe that Alan

190
See Wilshire Associates (reported by New York Times on September 15, 2008
http://www.nytimes.com/interactive/2008/09/15/business/20080916-treemap-graphic.html
the table and calculations done by the author
130

Greenspan was singly responsible for the real estate bubble in the U.S.;
regarding the real estate bubble; he, himself, said "I really didn't get it until
very late in 2005 and 2006."191
,Q WKH ILUVW PRQWKV RI WKH FULVLV :DOO 6WUHHW¶V PDQ\ KLJK IO\LQJ
ILQDQFLDO FRPSDQLHV¶ VWRFNV JRW SRXQGHG YHU\ KDUG E\ DOUHDG\ QHUYRXV
LQYHVWRUV UHVXOWLQJ LQ VWDJJHULQJ ORVVHV LQ VKDUHKROGHUV¶ YDOXH WKDW
aPRXQWHGWRLQVDQHWULOOLRQGROODUV7KHVWRFNPDUNHW¶VWRWDOYDOXHDWLWV
peak on October 2007 prior to the crisis was $19.1 trillion, and less than a
year later on September 12, 2008, the value quickly plummeted to $15.1
trillion. The market capitalizaWLRQRI $PHULFD¶VELJJHVWILQDQFLDOILUPV
was $1.75 trillion dollars; about 11 months later by September 12, 2008,
the market capitalization of the same 25 financial firms plunged to mind
blowing $874 billion dollars, a colossal loss of 50.03% ($872.9 billion) in
shareholder value.192 Several banks largely exposed to sub-prime lending
(i.e. Countrywide) unfortunately could not continue operations and
eventually they went bankrupt.
The current account deficit of the United States was about $140 billion in
1996 which amounted to around 1.5% of GDP (about $9.5 trillion). In
exactly two decades later in 2006, current account deficit has massively
increased to nearly $800 billion which meant 5.8% of GDP ($13 trillion).
Everything was a massive chain of reaction; significant rise in popularity of
fast personal computers in businesses and personal use (of course invention
of the Internet along with introduction of Windows95 had a lot to do with
the whole transformation) in later part of the 1990s led to the beginning of
technology transformation in the U.S. then in the rest of the world. The

ϭϵϭ
See Wikipedia, Guha, Krishna (September 17, 2007). "Greenspan alert on US house prices"
Financial Times, September 17, 2007, http://www.ft.com/cms/s/0/31207860-647f-11dc-
90ea-0000779fd2ac.html.
192
6HH1HZ<RUN7LPHV³$<HDURI+HDY\/RVVHV´6HSWHPEHU
131

development of various web-based technologies through which new more
complex business opportunities were created for the financial institutions
(i.e. derivatives, options, hedge funds). The beginning of online trading of
stocks, bonds, currencies, options, and other various financial instruments
suddenly changed the traditional definition of trading in the stock market.
7KLVVLWXDWLRQDOVRFUHDWHGDQHZSKHQRPHQRQFDOOHG³GD\WUDGLQJ´ZKHUH
people with minimum knowledge or lack of understanding sat in front of
FRPSXWHUVDQGH[HFXWHG³EX\´DQG³VHOO´RUGHUVDOOGD\
Chart 8 ǤǤ
Ψͳͻ͵
With the inclusion of thousands and maybe millions of day traders, the
stock market trading volumes had increased day after day making
NASDAQ break records after records of new highs. Therefore, venture
capitalists saw a rare window of opportunity to push more of the Internet
related dot.com companies down the pipe, but in the process they totally
ignored basic requirements of sound business fundamentals as they were

193
Source: US Bureau of Economics Analysis (BEA), http://en.wikipedia.org; slightly modified
from the original.
132

busy cashing in stock valuations from their investments. These positive
developments or at least they seemed that way at the time led to enormous
increases in average family home prices which got further intensified when
more people started buying second homes as an investment which was
made possible due to considerably relaxed lending and borrowing
conditions (i.e. zero down mortgage loans, easy AMR financing).
Chart 9 ǤǤͳΨ ͳͻͶ
The rise of the Internet boom lasted only three years from 1997 to 2000 and
by March 2000, close to two thirds (70%) of Americans owned stocks,
bonds, or some type of mutual funds (this was at least 25% above the
normal average in the 1980s and 1990s). The increase in stock market
participation was largely achieved by the inclusion of day traders through
whose involvement the stock market trading business changed completely
and became more volatile than ever before. Day traders were causing

194
Source: Chart was made by Roy Boy, using data initially published as Thomas Piketty and
Emmanuel Saez (2003), Quarterly Journal of Economics, 118(1), 2003, 1-39., slightly
modified from the original.
133

sudden and more sporadic fluctuations in the stock markets (at one time
25% of trading volume). Everyone involved so far was happy because it
ZDV D ³EXOO PDUNHW´ DQG SHRSOH HQMR\HG investing in the stock market;
however, the hidden but exponentially growing problem was that most of
these day traders funded their stock-trading activities through taking an
equity-line-of credit on their mortgages which increased their total debt
exposure and reduced their built-up equities in some cases to zero and in
some other cases day traders took out more money than the market value of
their homes falling in negative equity (increased risk of default).
Americans saved more money in the past than definitely today, especially
after the Great Depression era between post World War II and all the way
up to the 1980s, during which time there was a such thing as true middle-
class Americans who owned a family house with built-up equity and couple
of cars in the drive way. The baby-boomers have also saved up and wisely
invested their earnings which explain the major decline between the wealth
of the top 1% Americans and rest of the population. The gap had been the
smallest in 1980 (10%), but by 2008, it was almost back to the level in
1928 just before the 1929 crash. Americans have been suffocating under
the pressure of enormous debt and no means to reduce it, on the contrary,
the debt burden has been steadily climbing up.
͸ͶͶ;ͷͿͻ
x ³,QWKH86Securities and Exchange Commission relaxed the net

capital rule, which enabled investment banks to substantially increase the
level of debt they were taking on, fueling the growth in mortgage-backed
VHFXULWLHVVXSSRUWLQJVXESULPHPRUWJDJHV´ 196

195
See http://en.wikipedia.org/wiki/2008_financial_crisis
196
Labaton, Stephen (Sept. 27, 2008). "SEC Concedes Oversight Flaws" The New York Times
134

x Massive capital inflows to the U.S. mainly from Europe and oil
producing countries in the Middle East and low interest rates during
2004-2006 made money available cheaper, easier, and more flexible than
ever before which gave a huge boost to home sales and extended credit
offerings to those borrowers with less than prime credit ratings.
x Government sponsored Fannie Mae and Freddie Mac held 13 million

subprime loans totaling over $2 trillion.197
x Through previous crises (S&L crisis, Asian crisis, dot.com bust, and
subprime crisis), the wealth of Americans have declined by trillions of
US dollars and average household have incurred more debt.
x The share of subprime mortgages in all mortgages has been around 10%
historically but the ratio reached little over 20% in 2006.198
x ³7KHFROODSVHRIPRUWJDJHXQGHUZULWLQJVWDQGDUGVZDVHQGHPLF´GXULQJ
2006-2007. Over 80% of mortgages that Citigroup purchased from 1,600
different mortgage companies did not meet underwriting standards
meaning they were fraudulent.199
x Mortgage-backed securities (MBS) and collateralized debt obligations

(CDO) have enjoyed healthy profits when home prices skyrocketed up to
2006, but the profit story turned upside down when the crisis hit.
x The U.S. household debt to disposable income ratio has increased

tremendously from 70% in 1980 to 127% in 2006 just before the crisis
and further gone up to 134% in 2008. Very stressful and highly risky
situation to be in because the entire disposable incomes were used just to
pay off debt which increased default risk substantially.

197
See http://www.aei.org/article/why-the-left-is-losing-the-argument-over-the-financial-crisis/
198
See Harvard Report-State of the Nation's Housing 2008 Report
199
Hearing on Subprime Lending and Securitization and Government Sponsored Enterprises,
April 7, 2010". 2010.
135

x Real estate bubble started forming in 2004 and peaked in 2006 which
consisted of dangerous level of subprime mortgages, 21% of all
mortgages originated by 2007 (7.5 million first lien mortgage loans
valued at $1.3 trillion). It was even more concerning that over 90% of the
subprime mortgages were financed an ARMs.
x Fixed income investments worldwide doubled between 2000 (over $30

WULOOLRQDQGWULOOLRQDFRUUHVSRQGHQWFDOOHGWKLV ³*LDQW3RRO
RI0RQH\´0%6DQG&'2DWWUDFWHGWKLVPDVVLYe pool of money with the
help of credit rating agencies assigning safe ratings on them.200
x Banks started foreclosure procedures on 1.3 million properties in 2007

and the number of foreclosures increased to 2.3 million by 2008. 201
x Some lenders (i.e. Countrywide) using unimaginable methods to entice

ERUURZHUVWRHQJDJHLQ³XQVDIH´RU³XQVRXQGÓRDQV&DOLIRUQLD$WWRUQH\
General Jerry Brown sued Countrywide for "unfair business practices"
and "false advertising."202
ǯ ǣ The 2008 global financial crisis started
showing some serious side effects for the few troubled countries in the
Eurozone and the situation quickly turned into a sovereign-debt crisis for
these nations where public debt well exceeded their GDPs. For instance,
Greece carries the highest risk of potential insolvency with 161.7% public
debt ($482 billion) to GDP ($298.1 billion) ratio. Portugal ($284.5 billion
public debt/$252.2 billion GDP) and Ireland ($193.8 billion public
debt/$183.9 billion GDP) are the next two high-risk countries with debt to

200
See http://www.pri.org/stories/business/giant-pool-of-money.html
201
http://www.realtytrac.com/content/press-releases/foreclosure-activity-increases-81-percent-
in-2008-4551?accnt=64847
202
BofA Modifies 64,000 Home Loans as Part of Predatory Lending Settlement | Debt Relief
Blog". Thinkdebtrelief.com. May 25, 2009.
136

GDP ratios of 112.8% and 105.4% respectively.203 As of July 2012, Spain
joined these three financially high-risk countries with its own recently
appeared risk of sovereign debt crisis due to rising long-term interest rates
in the country; and according to Wearden (2011), any country with a yield
of 6% or more (see figure 1.1) indicates that financial markets have serious
doubts about credit-worthiness; as a result, Spain is having tougher time
lately to raise new capital to re-finance or re-structure its sovereign debt.
Chart 10 ǦǡʹͲͳʹȋΨȌʹͲͶ
BASEL ACCORDS I, II, AND III
The first installment of the Basel Accords, known as Basel I, was

introduced in 1988 and intended to ensure harmonization among the 11
member nations and to address mainly the credit risk. Series of macro and
microeconomic events throughout the world such as Mexican peso crisis in
1994; Turkish economic crisis in 1994 and 1999; Asian currency crisis in
late 1997 and early 1998; Russian financial crisis in 1998; the dot-com

ϮϬϯ
Source of GDP and public debt figures: CIA-The World Factbook, https://www.cia.gov/
ϮϬϰ
Source: European Central Bank, http://www.ecb.int/stats/money/long/html/index.en.html
(percentages per annum; period averages; secondary market yields of government bonds
with maturities of close to ten years)
137

bubble crash of the United States in 2000±2001, and another Turkish
economic crisis in 2001 paved the way for the Committee to introduce the
second installment, Basel II in 2004. Basel II, differently than Basel I,
included operational risk, supervisory review process and disclosure
requirements. Furthermore, Basel II allowed banks to develop their own
internal rating mechanism to assess the risk of credit, operation, and
management of capital. What we have now as of 2010 is, a brand new
installment of the Basel Accords, called Basel III; with the help and support
of its current 27 member nations, Basel III promises introducing major
banking reforms to create a strong and resilient banking system that will be
capable of absorbing financial and economic shocks during crises or at
times of global acute financial stress. The Committee also promises to
build standards harmonization, transparency, and strong governance.

x The Committee, in its September 26, 1975 report to the Governors on

WKHVXSHUYLVLRQRIEDQNV¶IRUHLJQHVWDEOLVKPHQWVVXJJHVWHGWKUHH ZD\V
WR LPSURYH WKH HIILFDF\ RI EDQNV¶ IRUHLJQ HVWDEOLVKPHQWV EUDQFKHV
(integral part of the parent bank), subsidiaries (set up as independent
institutions in the host country, but controlled by one foreign parent
bank), and joint ventures (independent operations in the host country but
controlled by two or more foreign parent financial institutions.
x The report highlighted three key focus areas; liquidity, solvency and
foreign exchange operations and positions. The committee agreed that
no foreign banking institutions should be able to escape supervision;
however, the Committee did not draw clear-cut rules and responsibilities
on how supervision was going to be handled.205

205
See Bank for International Settlements ± BIS, http://www.bis.org/publ/bcbs00a.pdf
138

x The Committee, in its October 1978 report, addressed the issue of
FRQVROLGDWLRQRIEDQNV¶EDODQFHVKHHWVFRQFHQWUDWLQJRQDJJUHJDWLRQRI
risk-bearing assets as a method of supervising solvency. The banking
authorLWLHVWKURXJKRXWWKHZRUOGIHOWWKDWDVVHVVPHQWRIEDQNV¶ILQDQFLDO
health (transparency) and their capital adequacy ratios were critically
important. Although consolidation should be useful for supervision
purposes; however, it should not be recognized as a substitute for other
supervisory techniques. Thus, consolidation may give a misleading
SHUFHSWLRQDERXWWKHSDUHQWFRPSDQ\¶VFDSLWDODGHTXDF\WKHUHIRUHWKH
supervision of the parent institution must continue separately.206
x The Committee, in its March 1979 report, due to further internalization

RIPDQ\EDQNV¶RSHUDWLRQVLQGHYHORSHGRUGHYHORSLQJFRXQWULHVVDZLW
QHFHVVDU\WKDWWKHWRWDOLW\RIHDFKEDQN¶VEXVLQHVVZRUOGZLGHKDGWREH
carefully examined. Few concerns were highlighted; the risk assets of
overseas branches should be aggregated for supervisory purposes;
consolidation of banking figures concern foreign subsidiaries,
participations and joint ventures due to the fact that they are subject to
jurisdiction of countries in which they operate.
x The Committee recognized that the member countries were not

harmonized in respect to consolidation practices which vary
considerably from country to country; in addition, at this time it cannot
be expected to achieve uniformity.207
x leakage issue was addressed; first, consolidation of minority interests is

appropriate if a financial interest exists; second, it is disadvantage to a
bank to consolidate very small interests (because reporting burden and
cost will outweigh the benefits); third, consolidation should be the true

206
See Bank for International Settlements ± BIS, http://www.bis.org/publ/bcbs00b.pdf
207
See Bank for International Settlements ± BIS, http://www.bis.org/publ/bcbsc112.pdf
139

reflection of the responsibility of parties involved; finally, the capital of
a bank with an investment in a financial company either should be
adjusted for the associated risk or in the case where the interests were
not consolidated, then the book value of such investment should be
GHGXFWHGIURPWKHEDQN¶VFDSLWDO208
x 7KH &RPPLWWHH LQ LWV 1RYHPEHU UHSRUW DQQRXQFHG WKDW EDQNV¶
unconsolidated or unsupervised minority interests constitute a
significant leakage in the supervisory system because such minority
interests can be considerably important for some individual banks.
x The Committee, in its August 1980 report, addressed the issue of

VXSHUYLVLRQ RI EDQNV¶ IRUHLJQ H[FKDQJH SRVLWLRQV ,Q WKH UHSRUW LW ZDV
pointed out that banks might be exposed to risks of large losses in
foreign exchange business, especially, running open exchange positions
due to increased instability of exchange rates. Although the Committee
was increasingly concerned, it was necessary to weigh prudential
considerations against the need to enable banks to continue their role in
the stable and efficient currency exchange markets.
x Exchange rate risk seems to be the only risk for banks in foreign
currency business. Another potential risk is interest rate risk where
banks may suffer losses as a result of changes in the interest rates of the
two currencies involved. Banks have to consider and manage credit risk
(counterparty risk), i.e. an owner of a foreign exchange contract or loan
leaving a positive unpaid balance at the time of default; in a foreign
exchange contract, the bank may suffer a loss of the cost covering the
open position; however, in the case of a loan contract, then the bank
may lose the entire amount of the contract.

208
See Bank for International Settlements ± BIS, http://www.bis.org/publ/bcbs00d.pdf
140

x The Committee also addressed time-zone risk where banks may be
exposed to full amount of the contract resulting in due to 24-hour nature
of foreign exchange business and time legs between different time zones
in North America, Asia Pacific and Europe.209
x The Committee, in its December 1987 report, provided proposals for

international convergence of capital measurement and standards to
strengthen the international banking system. Standardized measurement
of capital adequacy was important as well as establishment of minimum
standards for banks with significant cross-border business.
x The Committee said that it was examining possible approaches to

manage risks related to; credit risk, interest rate risk, currency exchange
risk, and investment risk. It was also suggested that the capital should
only comprise equity (common stock shares excluding preferred shares)
and disclosed reserves (retained earnings), which are common elements
in all banking systems worldwide. One of the member countries had the
view that an international definition of capital should effectively be
confined to the core capital elements.
x The Committee concluded that the capital should be defined in two tiers;
Tier 1 and Tier 2. It was mentioned that supplementary capital elements
may or may not be included based on national accounting, banking and
supervisory regulations. Areas of supplementary capital: undisclosed
reserves, revaluation reserves, general provisions/general loan loss
reserves, hybrid debt capital instruments, and subordinated debt term.
As far as deductions from capital were concerned for the purpose of
calculating risk-weighted capital ratio; goodwill should only be
deducted from Tier 1 capital elements; if investments in subsidiaries
were not consolidated in national systems, then the deductions would be

209
See Bank for International Settlements ± BIS, http://www.bis.org/publ/bcbs00e.pdf
141

made against the total capital base. Even though some G-10 supervisory
DXWKRULWLHV UHTXLUH GHGXFWLRQ RI EDQNV¶ KROGLQJV RI FDSLWDO LVVXHG E\
other banks or deposit taking institutions in order to discourage banking
system as a whole from creating cross-holdings of capital; however, at
the time the Committee said that it was not in favor of a general policy
GHGXFWLQJDOOKROGLQJVRIRWKHUEDQNV¶FDSLWDO7KH&RPPLWWHHEHOLHYHG
that the weighted risk ratio was the preferred method for assessing the
capital adequacy of banks. The Committee acknowledged existence of
other useful methods but considered them as supplementary to the risk
weight approach.
BASEL - I CAPITAL ACCORD
%DVHO , ³7KH ,QWHUQDWLRQDO &RQYHUJHQFH RI &DSLWDO 0HDVXUHPHQWV DQG

&DSLWDO 6WDQGDUGV´ PDLQO\ IRFXVHG on achieving regulatory standards
harmonization and capital adequacy within the member nations; France,
Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United
Kingdom, the United States, and Luxembourg. The Committee had
received too many complaints and criticism regarding Basel I Accords and
what the Committee intended to do with them. The exclusiveness of Basel I
only to the original 11 member nations and the decision of leaving the
HPHUJLQJHFRQRPLHVRXWVLGHRI%DVHO,¶VVFRSHZHUH not received well.
Ǧͺ͸ͷͶ
1) 3LOODU RI ³7KH &RQVWLWXHQWV RI &DSLWDO´ GHILQLWLRQ RI FDSLWDO ZKLFK
consisted of Tier 1 and Tier 2 where Tier 1 capital included reserves
(retained earnings) and proceeds from sale of stocks and preferred
shares. However, Tier 2 capital was not defined clearly and it was left a

210
142

bit vague as to what it was supposed to include (i.e. capital buffers to
cover losses, hybrid debt, capital gains from sale of bank stocks).
Basel - ͹Ǥʹͳͳ
x 1970s and 1980s saw some international banks taking advantage of

geographical limitations of domestic banking legislation.
x Internationally active banks opened off-shore branches in countries where
weak regulations existed.
x Basel I intended to harmonize regulatory and capital adequacy standards
among its members, which was not intended for emerging economies.
x Basel I considers domestic currency and debt as the most reliable and
favorable financial instruments.
x Basel I was introduced only to provide adequate capital to guard against
ULVNLQWKHFUHGLWZRUWKLQHVVRIDEDQN¶VORDQERRN
x Basel I stated that its proposals were only minimum capital requirements
for internationally active banks.
x The Basel I Accord was divided into four main pillars: first, The
Constituents of Capital; second, Risk Weighting; third, A Target Standard
Ratio; and fourth, Transitional and Implementing Agreements.
x Because Basel I only targeted G-10 countries, it was hugely criticized for
its narrow scope and its irrationality to create stability in international
banking system without considering international implementation.
x $QRWKHUFULWLFLVPIRU%DVHO,ZDVWKDWLWJDYHEDQNVPRUHZD\VWR³ZLJJOH´
DURXQGWKH6WDQGDUGVWKURXJKD PHWKRGFDOOHG³FKHUU\ SLFNLQJ´ZKHUHRQ
paper banks looked as though they shielded themselves against risks but in
reality they took far more risks.

211
See Bank for International Settlements ± %,6 %U\DQ - %DOLQ ³%DVHO , %DVHO ,, DQG
Emerging Markets: A Nontechnical Analysis, The Johns Hopkins University School of
Advanced International Studies (SAIS), Washington DC 20036, USA, 2008.
143

2) 3LOODURI³5LVN:HLJKWLQJ´ZHLJKWLQJULVNVRIDOOEDQN¶VDVVHWV5LVN
free asset had 0% weight (cash, sovereign debt in domestic currency,
OECD central government debt); low risk assets were assigned 20%
weight (OECD or non-OECD bank debt, short term debt less than 12
months); moderate risk was assigned 50% which included home
mortgages; high risk had 100% which included private debt and debt
with more than 12 months of maturity).
3) 3LOODURI³$7DUJHW6WDQGDUG5DWLR´ZKLFKVHWWKDWRIEDQN¶VULVN-
weighted assets must be covered by Tier 1(4%) and Tier 2 capitals.
4) 3LOODU RI ³7UDQVLWLRQDO DQG ,PSOHPHQWLQJ $JUHHPHQWV´ LQWHQGHG WR

ensure that Basel I Accords were implemented in a timely manner by the
member nations; in addition, the central bank of each country had to
enforce and monitoring implementation process to ensure the standards
were adopted by 1992 (Balin, 2008, pp.1-6).
BASEL - II CAPITAL ACCORD
Banks were naturally at the epicenter of the crisis. The Committee felt that
RQHRI%DVHO,,¶VIODZVKDGWREHFRUUHFWHGULJKWDZD\7KHVROXWLRQZDVWR
raise the quality and quantity of capital and to make sure that all banking
systems in member countries and worldwide are consistent and transparent.
Next, the BCBS promised to strengthen the area of risk coverage and its
management, one of the underlining Basel II deficiencies.
Banks in many countries throughout the world were able to build up

excessive on-and-off-balance sheet leverage under Basel II, which in turn
led to erosion of capital quality. More importantly, banks were not ready to
absorb substantial amounts of systemic trading and credit related losses
because as mentioned earlier banks were not in a position to handle large
144

off-balance sheet exposure. When all this was going on, what made things
uncontrollable was that investors (market) lost confidence in the whole
banking system as well as its questionable ability to take the crisis under
control. This alone, created a panic situation resulting further deterioration
in the global financial system. Chain reactions of investors worldwide got
intensified and caused illiquidity in the marketplace. This is when
governments felt the need to step in by injecting additional liquidity and
giving promises of further capital support for failed financial institutions.212
According to the BCBS, the current definition of capital under Basel II

suffers three fundamental flaws: (1) regulatory adjustments currently
applied to either Tier 1 or both Tier 1 and Tier 2 when they are supposed to
be applied to the common equity component of Tier 1 because common
equity not only can best absorb the losses but it can also work as the best
barometer to show financial stress related concerns; (2) lack of a
harmonized list showing all regulatory adjustments, which noticeably differ
from country to country resulting major inconsistency; (3) capital
disclosures of banks seriously lack necessary detailed information about
their regulatory capital bases, which in turn makes it very difficult for the
banking industry participants and regulatory bodies to come up with an
DFFXUDWHDVVHVVPHQWRIWKHEDQNLQJV\VWHP¶VDFWXDOVWDWXV213
Because banks are critical intermediaries of financial transactions, it would

be literally almost impossible to handle complex economic activities of
modern living without financial instruments; thus, as the Committee
GHILQHG ³D VWURQJ DQG UHVLOLHQW EDQNLQJ V\VWHP LV WKH IRXQGDWLRQ IRU
sustainable economic growth, as banks are at the center of the credit
intermediation process between savers and investors. Moreover, banks

212
213
145

provide critical services to consumers, small and medium-sized enterprises,
large corporate firms and governments who rely on them to conduct their
GDLO\EXVLQHVVERWKDWDGRPHVWLFDQGLQWHUQDWLRQDOOHYHO´7KH&RPPLWWHH
is set out to create a resilient banking system, but first, it is fully committed
to correct Basel II flaws through introduction of new measures:214
Basel - ͺǤʹͳͷ
x Minimum Capital Requirements were introduced to eliminate the overly

criticized loopholes under Basel I. +ROGLQJFRPSDQLHV¶LQWHUQDWLRQDOO\
active banks were included to avoid hiding risk exposure of bad assets.
x The Standardized Approach and the Internal Ratings Based (IRB)
Approaches were introduced to calculate credit risk.
x Foundation IRB and Advanced IRB were proposed to develop in-house
ULVNZHLJKWLQJPHDVXUHVRUWRFUHDWHEDQN¶VRZQFUHGLWGHIDXOWPRGHOV
x Operational risk is addressed through three methods; Basic Indicator
Approach, Standardized Approach, and Advance Measurement Approach.
x 0DUNHWULVNVHSDUDWHGIL[HGLQFRPHIURPDOORWKHUSURGXFWW\SHVDQG³YDOXH
DWULVN´9$5DSSURDFKZDVXVHGWRFDOFXODWHULVN
x Risk for market based instruments such as stocks, bonds, currencies, and
commodities were calculated using The Simplified Approach, Scenario
Analysis, and Internal Model Approach.
x Pillar 2 made the regulatory framework more powerful. Regulators were
given additional power to decide as they saw it fit regarding risk
mechanisms used by banks.
x Regulators were also given power to hold bank executives accountable if
they saw any evidence of misuse of power in hiding of riskier assets.

214
215
See Bank for International Settlements ± %,6 %U\DQ - %DOLQ ³%DVHO , %DVHO ,, DQG
Emerging Markets: A Nontechnical Analysis, The Johns Hopkins University School of
Advanced International Studies (SAIS), Washington DC 20036, USA, 2008.
146

A leverage ratio is introduced to help contain the excessive leverage in the
banking system. Because lack of appropriate liquidity was a fundamental
problem before and during the crisis; to take care of this issue, the
&RPPLWWHHLVLQWURGXFLQJDFDSLWDOEXIIHUFDOOHGµFRQVHUYDWLRQEXIIHU¶WRlet
banks buildup of capital buffers to be available for use during a financial or
economic stress. Moreover, another buffer called countercyclical will be
introduced under Basel III to ensure a more stable banking system. The
BCBS wanted to take care of another flaw in Basel II by introducing a 30-
day liquidity coverage ratio for all internationally active banks.216
BASEL - III CAPITAL ACCORD
7KH &RPPLWWHH¶V QXPEHU RQH IRFXV ZLWK %DVHO ,,, LV WR VWUHQJWKHQ WKH
quality and quantity of capital, which the BCBS strongly believes that was
the underlining reason behind the 2008 global financial crisis. Although
there were a number of fundamental flaws with Basel II; however, one of
%DVHO ,,¶V FULWLFDO GHILFLHQFLHV ZDV WKH XQFOHDU GHILQLWLRQ RI FDSLWDO
presenting a higher risk exposure for banks throughout the world.
There were too many confusing tiers and sublevels in each tier with own
limits and requirements enabling banks to become sophisticated to
manipulate financial results to their advantage. The worst of all was that
under Basel II, it was nearly impossible for the market participants or
regulators to assess the strengths or weaknesses of the banking system
worldwide due to some banks reporting stronger Tier 1 on paper than the
actual figures in reality; in addition, there was no international
harmonization along with weak transparency, inefficient regulatory process,
and lack of governance which finally made things get terribly out of control
resulting a global scale financial crisis. The Basel Committee announced in

216
147

December 2009 a set of consultative proposals targeted to strengthen the
resilience of the banking sector worldwide. Through these proposals, the
&RPPLWWHH¶V JRDO ZDV WR SURPRWH ILQDQFLDO LQQRYDWLRQ DQG VXVWDLQDELOLW\
which are strongly believed to be the key factors for creating a strong
banking system capable of absorbing financial and economic shocks.
The consultative documents covered five fundamental areas: 1) capital

should be quality, transparent, and consistent. This will enable banks to
cover potential losses on both a going concern and a gone concern basis; in
addition, the quality of Tier 1 capital had to be improved and harmonized
internationally across different financial institutions. 2) Risk coverage and
the capital requirements for counterparty credit risk exposures arising from
derivatives should be strengthened. 3) A leverage ratio is introduced to
contain the build-up of excessive leverage in the banking system; leverage
build-up was a major issue in previous crises as well as the most recent
crisis. 4) Capital buffers are introduced to encourage banks to build-up
capitals to be used at times of financial stress. Also forward-looking
SKLORVRSK\LVEHLQJLPSOHPHQWHGWKLQNLQJPRUHRI³H[SHFWHGORVV´LQVWHDG
RI³LQFXUUHGORVV´5) A liquidity coverage ratio is introduced (LCR) which
require banks to have enough liquidity (cash, or short-term securities) to
cover operation for at least a 30-day period.217
a. Raising the quality, consistency and transparency of the capital base.

The capital quality and quantity under Basel II were not sufficient which
resulted in a higher risk exposure for banks. Also, there was a question
of inconsistency in the definition of capital across banks. Under Basel
III, Tier 1 capital will predominantly consist of common shares and
retained earnings from which credit losses and write-downs cannot be

217
148

deducted as observed during the 2008 crisis. Under Basel III, innovative
hybrid capital instruments (15% of Tier 1 capital) will be phased out;
and sublevels (Tier 3) will be eliminated. Finally, minimum Tier 1
capital will be increased from 2% to 4.5%.218
Basel - ͻǤʹͳͻ
x Basel III Accord intended to raise the quality, quantity, consistency and
transparency of the capital base. Tier 1 capital will predominantly consist
of common shares and retained earnings.
x Tier 2 will be simplified by removing any sub categories and Tier 3 will be
abolished totally because of redundancy.
x By 2015, the minimum level for common equity Tier 1 (CET1) will
increase to 4.5% of RWA and Tier 1 to 6% of RWA.
x A capital conservation buffer, of 2.5% of CET1, will be added to the
minimum CET1 level of 4.5%, bringing total CET1 to 7%.
x The country-specific countercyclical buffer will be applied to overheating
markets. This buffer will vary between 0% and 2.5% of CET1.
x A leverage ratio will be introduced as a supplementary measure to the
Basel II risk-based framework. The ratio will require a minimum
percentage of Tier 1 to gross on- and off-balance-sheet assets.
x LCR: Liquidity coverage ratio and NSFR: Net stable funding ratio will be
introduced. LCR will ensure that each institution will carry sufficient
liquidity for 30 days under a specific financial stress.
x With NSFR, 100% of illiquid assets will need to be backed by stable
funding; however, this requirement is 65% for residential mortgages.
x Minimum capital requirement as of January 1, 2013 is 7% (4.5% Tier 1
and 2.5% capital buffers.

218
219
See Bank for International Settlements ± BIS; Basel III: Ernst & Young Approach
149

b. Enhancing risk coverage. Limited risk coverage under Basel II was
apparent and this needed to be enhanced. Off-balance sheet risks and
derivative related exposure are seen as the key destabilizing factors.
Value-at-risk (VaR), is introduced as part of Basel III to strengthen
supervisory review process and disclosures. The BCBS said that the
Pillar 2 risk management standards became effective immediately.
Interconnectedness between different financial institutions and
marketplaces still remains to be a major problem. The Committee is
supporting establishing of a Payment and Settlement System.220
c. Supplementing the risk-based capital requirement with a leverage ratio.

Leverage build-ups were a major problem during the 2008 crisis and
have also been problematic in previous crises as well (i.e. 1998 Asian
crisis). Leverage build-up, as the crisis intensifies, becomes a downward
force on banks to reduce prices of assets. The Committee eliminates the
EDQNLQJVHFWRU¶VGHVWDELOL]LQJDQGGHOHYHUDJLQJHIIHFWVE\VHWWLQJDOLPLW
for how much leverage banks can build up.221
d. Reducing procyclicality and promoting countercyclical buffers. The

Committee claims that market participants have the tendency to behave
in a procyclical manner which may have been the most destabilizing
element of the crisis. Therefore, the BCBS is introducing a number of
critical measures to transform the banking system from being a shock
transmitter to a major shock absorber. Some of the key objectives
include: reducing excess cyclicality, building capital buffers at
individual banks, and preventing excess credit growth by adopting the
broader macroprudential goal of protecting the banking system.222

220
See Basel III: Strengthening the resilience of the banking sector, pp.13-14
221
222
150

e. Addressing systemic risk and interconnectedness. The Committee saw a
flaw under Basel II that prior to the crisis, the policy options were not
developed in such a way to ensure systematically important banks being
subject to same regulatory requirements.223
Table 29 ʹʹͶ
2012 2013 2014 2015 2016 2017 2018 2019

Countercyclical buffer Ϭ͘ϲϮϱй ϭ͘Ϯϱй ϭ͘ϴϮϱй Ϯ͘ϱй
Capital conservation buffer Ϭ͘ϲϮϱй ϭ͘Ϯϱй ϭ͘ϴϳϱй Ϯ͘ϱй
Future Possibility ϵ͘Ϯϱй ϭϬ͘ϱϬй ϭϭ͘ϳϱй ϭϯ͘Ϭй
ϴ͘ϲϮϱй ϵ͘Ϯϱй ϵ͘ϴϳϱй ϭϬ͘ϱϬй
ϴй ϴй ϴй ϴй ϴй
Total ϴй ϴй
ϴй ϲй ϲй ϲй ϲй ϲй
Capital
ϱ͘ϱй
ϰ͘ϱй
Tier 1 ϰ͘ϱй ϰ͘ϱй ϰ͘ϱй ϰ͘ϱй ϰ͘ϱй
ϰй
Capital ϰй
CET 1 ϯ͘ϱй
Ϯй
Capital
x The risk ratio provides the following advantages:225
1) Unbiased base for comparing different international banking systems;

2) Inclusion of off-balance-sheet exposures easily into measurement;
3) Banks are not deterred from holding liquid or other low-risk assets.
x The Committee believed that it was significantly important to catch all

off-balance-VKHHW HQJDJHPHQWV 7R GR WKDW WKH &RPPLWWHH¶V UHSRUW RQ
the supervisory treatment of off-balance-sheet exposures issued to banks
in March 1986 remained same, which provided five broad categories:226

223
224
Slightly modified from Ernst & Young approach on Basel III, table prepared by the author
225
226
151

a. Those which substitute for loans (e.g. guarantees and letters of credit)
will carry a 100% credit risk conversion factor:
b. Certain transaction related contingencies (e.g. bid bonds and

warranties) will carry a 50% credit risk conversion risk;
c. Short-term trade related contingent liabilities arising from movement

of goods will carry a 50% credit risk conversion risk;
d. Longer maturity commitment will carry a 50% credit conversion risk;
e. Interest and exchange rate related items are calculated in different

ways because banks are not exposed to credit risk for the full amount.

x Banks that are set up as joint stock companies, Tier 1 capital must only
consist of common shares and retained earnings of the firm; in addition,
regulatory adjustments must be applied to this component. It is also
absolutely necessary to harmonize regulatory adjustments and their
application internationally.
x 7LHU FDSLWDO¶V RWKHU LQVWUXPHQWV EHVLGH FRPPRQ HTXLW\ ZLOO EH

strengthened. QualLW\HURGLQJµVWHS-ups¶ feature of Tier 1 will be phased
out. The idea is that all Tier 1 instruments must be loss absorbent on a
going-concern basis. Payments on Tier 1 instruments will be considered
a distribution of earnings under the capital conservation buffer proposal.
x Tier 2 will be simplified by removing any sub categories. Under Tier 2

capital, instruments subordinated to depositors and creditors must have
an original maturity of 5 years which will be amortized using the
straight line approach. The Tier 3 was redundant, so it was abolished.
The capital used to meet market risk requirements will be of the same
152

quality of composition as capital used to meet credit and operational risk
requirements.
x To improve transparency and address disclosure issues, the Committee

will make sure that banks will be required to disclose the following
items in their reporting: the balance sheet will contain a full
reconciliation of regulatory capital elements; separate disclosure of all
regulatory adjustments; a description of all positive and negative limits
that the capital has been subject to; when banks disclose any ratios used,
they also need to provide explanation how these ratios have been
calculated. Finally, the Committee requires that all banks on their
websites have to provide full terms and conditions of all instruments
used as part of the regulatory capital.227
The 2008 crisis certainly qualify as the costliest wake-up call for
governments of the developed nations and for the BCBS to seriously
consider developing a new regulatory framework under Basel III, which is
highly promoted having the capability of strengthening the resilience of the
current global banking system to absorb financial and economic shocks
during times of financial stress.228
The invaluable lessons learned from the 2008 crisis (certain Tier 1 capital
instruments under Basel II were unable to absorb losses) prompted the
Committee to tighten up its definition of regulatory capital, lack of which
was believed to be one of the main contributors to the crisis. The BCBS
firmly believes that full, timely and consistent implementation of Basel III
by its members is more essential for restoring confidence in the regulatory
framework for banks and to help ensure a safe and stable global banking

227
228
See Basel III: Seoul G20 Summit document
153

system.229 Under Basel III, the minimum capital requirement will be
increased to 7% (4.5% Tier 1 plus 2.5% conservation buffer).
Table 30 ȋΨȌʹ͵Ͳ
Basel II Basel III
Minimum common equity capital ratio Ϯ͘Ϭй ϰ͘ϱй
Capital conservation buffer Ϭ͘Ϭй Ϯ͘ϱй

Common equity + capital conservation Ϯ͘Ϭй ϳ͘Ϭй
Minimum Tier 1 capital ratio ϰ͘Ϭй ϲ͘Ϭй
Minimum total capital ratio ϴ͘Ϭй ϴ͘Ϭй
Total capital + capital conservation ϴ͘Ϭй ϭϬ͘ϱй
Leverage ratio (non-risk-based) Ϭ͘Ϭй ϯ͘Ϭй
Countercyclical capital buffer (nat. discretion) Ϭ͘Ϭй Ϭ͘ϬͲϮ͘ϱй
SIFI capital buffer Ϭ͘Ϭй Ϭ͘Ϭй
Some banks are already having difficult time meeting Basel II capital
requirements and banks through the world will probably have tougher time
when Tier 1 is raised from 4% to 6% on January 1, 2015, and then the new
minimum capital requirement will be 8.5% including the 2.5%
conservation buffer. However, the total capital ratio will still remain as 8%
of the weighted assets under Basel III. The main difference will be that the
8% of weighted assets will have to consist of 6% Tier 1 and 2% Tier 2. In
addition, Basel III simplifies Tier 2 and eliminates Tier 3 category. By
2019, the minimum capital requirement will be 10.5% (8% + 2.5%).231

229
See Basel III: Report to G20 Leaders on Basel III implementation
230
http://www.cmegroup.com/education/files/ed144-mayra-YDOODGUHVSGI6RXUFH³%DVHO,,,$
*OREDO5HJXODWRU\)UDPHZRUNIRU0RUH5HVLOLHQW%DQNVDQG%DQNLQJ6\VWHPV´5HYLVHG
June 2011, Bank for International Settlements.
231
See Basel III: Strengthening the resilience of the banking sector
154

Chart 11

Source: MRV Associates; 0RRG\¶V$QDO\WLFVVOLJKWO\PRGLILHGE\WKHDXWKRU

155

IMPACTS OF BASEL III
%DVHO ,,,¶V QHZ FDSLWDO UHTXLUHPHQWV ZLOO PHDQ PRUH UHVHUYHV DQG
additional capital buffers that banks of all sizes will have to put aside. This
also means that banks will be required to meet higher capital adequacy
ratios. In turn, new capital rules may force banks to engage in saver lending
and borrowing practices to save more and to reduce the percentage of
nonperforming loans. Indirectly, the new Basel III rules may lead banks to
develop internal mechanisms to manage risks better and to implement
DGGLWLRQDOPHDVXUHVWRJRYHUQEDQN¶VRSHUDWLRQVPRUHHIIHFWLYHO\
Before the 2008 global financial crisis, the banks along with other types of
financial institutions carried significant amount of risks which reduced their
return on equity (ROE). Some bank attorneys believe that Basel III will
result in reduction of lending activities; for instance, Davis Polk, partner at
/XLJL / 'H *KHQJKL VDLG WKDW ³,QFUHDsed capital requirements will drive
EDQNVDVVHOOHUVEXWZLOOWHPSHUEDQNVDVEX\HUV´%DQNVQRZZLOOKDYHWR
take extra precautions and think twice before investing due to risk concerns,
which will majorly affect their ability as buyers but not as sellers. Another
DWWRUQH\ 0DUN 1XFFLR DW 5RSHV *UD\ EHOLHYHV WKDW ³7KH QHZ FDSLWDO
regime will be a drag on economic recovery, but it ought to produce greater
long-WHUPILQDQFLDOVWDELOLW\´232
6RPHEDQNDWWRUQH\VDUJXHWKDW%DVHO,,,¶VFRQWDJLRQHIIHFWVPDy spillover
to the broader market where developers and home buyers may be adversely
affected. It is argued that banks will have no chance but increase prices of
assets in order to achieve the same level of ROE, and this price hike will in
turn drive the costs and fees higher for consumers. Rob Fleetwood, attorney
at Barack Ferrazzano, feels that banks are punished for risk taking, he says,

232
http://www.bankdirector.com/board-issues/legal/how-will-basel-iii-impact-banks/
156

³%HFDXVH VXFK SHQDOWLHV KDYH D SRWHQWLDOO\ VHYHUH LPSDFW RQ FDSLWDO
prudent bankers will reduce their risk of a capital shortfall either by
UHMHFWLQJORDQVDWWKHPDUJLQRUPDLQWDLQLQJKLJKHUFDSLWDOFXVKLRQV´233
.30* LQ LWV ³%DVHO ,,, ,VVXHV DQG ,PSOLFDWLRQV´234 report has divided
quantitative impacts of Basel III proposals into two sections; impact on
individual banks and impact on the financial system. According to the
UHSRUW³:HDNHUEDQNVFURZGHGRXW´'DUZLQ¶VSURPLQHQW³VXUYLYDORIWKH
ILWWHVW´DQG³QDWXUDOVHOHFWLRQ´WKHRULHVZLOOSOD\DNH\UROHLQZHHGLQJRXW
the weaker banks in the industry, in other words a major consolidation in
WKH ILQDQFLDO V\VWHP PD\ RFFXU 7KH UHSRUW DOVR PHQWLRQHG ³6LJQLILFDQW
SUHVVXUHRQSURILWDELOLW\DQG52(´,WZLOOEHH[WUHPHO\WRXJKfor banks to
find investments with low risks but high returns; such thing would be even
against the nature of linear relationship between risk and return. Investors
perfectly understand that low risk investments produce low returns and vice
versa. The last impact on individual banks in the report is said to be
³&KDQJH LQ GHPDQG IURP VKRUW-term to long-tHUP IXQGLQJ´ %DQNV DUH
generally better off to distribute the risk over a longer period. Short-term
funding may produce excellent returns during upturn of economies, but the
opposite is also true meaning that the losses of short-term funding may be
so significantly great in downturn of economies due to huge default risks.
.30*UHSRUWOLVWHGWKHLPSDFWRQWKHILQDQFLDOV\VWHPDV³5HGXFHGULVNRI
V\VWHPLFEDQNLQJFULVLV´LI%DVHO,,,UXOHVDUHSHUIHFWO\IROORZHGE\EDQNV
and all other industry participants, meaning banks manage risks, build-up
quality capital, and improve governance, transparency and disclosures, then
the chances of systemic banking crisis will be much reduced); ³5HGXFHG
OHQGLQJ FDSDFLW\´ OHQGLQJ YROXPH PD\ EH UHGXFHG LQ WZR ZD\V ILUVW

233
http://www.bankdirector.com/board-issues/legal/how-will-basel-iii-impact-banks/
234
6HH.30*UHSRUW³%DVHO-III-issues-implicaWLRQV´KWWSZZZNSPJFRP0.HQ,VVXHV
157

banks will have less capital to lend due to higher conserving requirements
and additional building of capital buffers; second, in order to meet same
ROE, banks may increase or pass some of the cost to consumers in fees
which may reduce borrowing interest); ³5HGXFHGLQYHVWRUDSSHWLWHIRUEDQN
GHEWDQGHTXLW\´VLQFHEDQNVZLOOQRWEHDJJUHVVLYHWRZDUGVULVN\DQGKLJK
return investment instruments, their ROE and profitability will be
significantly reduced which will in turn draw less number of investors).
The world is divided into two sides in terms of their massive size of
financial activity (Asia could be the possible third); therefore, international
harmonization between the G-2 is extremely crucial. It would be sort of
irrational to think that the United States and Europe as the G-2 have
different standards not complementing each other. As a result, the U.S.
Federal Reserve voted unanimously on June 7, 2012 to adopt several Basel
III rules. Federal Reserve Chairman Ben Bernanke has said:
³&DSLWDO LV LPSRUtant to banking organizations and the financial system

EHFDXVHLWDFWVDVDILQDQFLDOFXVKLRQWRDEVRUEDILUP¶VORVVHV:LWKWKHVH
SURSRVHG UHYLVLRQV EDQNLQJ RUJDQL]DWLRQV¶ FDSLWDO UHTXLUHPHQWV VKRXOG
better reflect their risk profiles, improving the resilience of the U.S.
banking system in times of stress, thus contributing to the overall health of
WKH86HFRQRP\´235
$ UHFHQW .30* 0D\ VWXG\ ³/LTXLGLW\ $ %LJJHU &KDOOHQJH WKDQ

&DSLWDO´ LOOXVWUDWH QXPHURXV VLJQLILFDQW OLTXLGLW\ FKDOOHQJHV WKDW Pay be
faced by banks: 1) some banks may have to face higher costs meeting Basel
,,,¶VQHZFDSLWDOUHTXLUHPHQWVHVSHFLDOO\WKRVHEDQNVwith insufficient high
quality liquid assets and too much reliance on short-WHUPIXQGLQJEDQNV¶
safer and less risk taking practices may lead to lower ROE hence suffer low

235
http://www.cmegroup.com/education/files/ed144-mayra-valladres.pdf
158

profitability due to in low-yielding, low-return investments; 3) severe
FRPSHWLWLRQZLOOPRVWOLNHO\UHGXFHEDQNV¶FKDQFHVRIORFDWLQJKLJKTXDOLW\
liquid assets because increased demand for scarce resources.
Chart 12 ǡʹͲͳͻ ȋ̀Ȍʹ͵͸
$FFRUGLQJ WR 0F.LQVH\ ZRUNLQJ SDSHUV QR ³%DVHO ,,, DQG (XURSHDQ
banking: Its impact, how banks might respond, and the challenges of
LPSOHPHQWDWLRQ´based on Q2 2010 balance sheets, the European sector by
ZLOOQHHGDERXW¼WULOOLRQRIDGGLWLRQDO7LHUFDSLWDO¼WULOOLRQ
of short-WHUPOLTXLGLW\DQGDERXW¼WULOOLRQRIORQJ-term funding, absent
any mitigating actions. The paper indicated that the situation will be similar
for smaller banks in the United States; Tier 1 capital shortfall at $870
ELOOLRQ¼ELOOLRQWKHJDSLQVKRUW-WHUPOLTXLGLW\DWELOOLRQ¼
billion), and the gap in long-WHUP IXQGLQJ DW WULOOLRQ ¼ WULOOLRQ
There is a common conclusion by economists and banking industry
professionals that Basel III will have declining effect on ROE and

236
Source: Annual reports; bank filings; Global Insight; McKinsey Global Banking Pools;
McKinsey analysis2,200570600 (Note: Bank data are from Q2 2010 where available;
otherwise they are extrapolated from Q4 2009). Slightly modified by the author
159

McKinsey paper indicates that ROE for the average bank will drop by
about 4% in Europe and about 3% in the United States.
Table 31 ʹͷǡʹͲͳʹ ʹ͵͹
Institution Name City Total $VVHWV¶V

JPMorgan & Chase Co New York Ϯ͕ϯϮϬ͕ϯϯϬ͕ϬϬϬ
Bank of America Corporation Charlotte Ϯ͕ϭϴϬ͕Ϭϱϱ͕ϲϴϮ
Citigroup Inc. New York ϭ͕ϵϰϰ͕ϰϮϯ͕ϬϬϬ
Wells Fargo & Company San Francisco ϭ͕ϯϯϯ͕ϳϵϵ͕ϬϬϬ
Goldman Sachs Group, Inc. New York ϵϱϭ͕Ϯϭϳ͕ϬϬϬ
Metlife, Inc. New York ϴϭϵ͕ϲϬϰ͕ϰϬϵ
Morgan Stanley New York ϳϴϭ͕ϬϯϬ͕ϬϬϬ
U.S. Bancorp Minneapolis ϯϰϬ͕ϳϲϮ͕ϬϬϬ
HSBC North America Holdings Inc. New York ϯϰϬ͕ϯϰϮ͕ϰϵϲ
Bank of New York Mellon Corp. New York ϯϬϬ͕ϭϵϳ͕ϬϬϬ
PNC Financial Services Group, Inc. Pittsburgh Ϯϵϲ͕ϭϭϵ͕ϬϳϬ
Capital One Financial Corporation Mclean Ϯϵϰ͕ϱϳϯ͕ϳϯϭ
TD Bank US Holding Company Portland ϮϬϰ͕ϯϭϬ͕ϯϵϳ
State Street Corporation Boston ϭϴϳ͕ϲϬϵ͕ϲϱϭ
Ally Financial Inc. Detroit ϭϴϲ͕ϯϱϬ͕ϬϬϬ
Suntrust Bank, Inc. Atlanta ϭϳϴ͕Ϯϱϲ͕ϭϳϭ
BB&T Corporation Winston-Salem ϭϳϰ͕ϳϱϭ͕ϴϵϰ
American Express Company New York ϭϱϬ͕ϱϴϯ͕ϬϬϬ
RBS Citizens Financial Group Providence ϭϮϵ͕ϵϲϯ͕ϲϰϬ
Regions Financial Corporations Birmingham ϭϮϴ͕Ϯϴϭ͕ϳϴϳ
BMO Financial Corporation Wilmington ϭϭϳ͕ϰϱϬ͕ϵϯϴ
Fifth Third Bancorp Cincinnati ϭϭϲ͕ϳϰϳ͕Ϭϵϴ
Unionbancal Corporation San Francisco ϵϮ͕ϯϮϱ͕ϲϳϱ
Northern Trust Corporation Chicago ϵϭ͕ϲϬϰ͕ϯϮϰ
Keycorp Cleveland ϴϳ͕ϱϲϵ͕ϴϱϲ
All banks in the United States one way or other will be affected by the new
capital rules under Basel III. Table 31 lists 25 U.S. top banks with total

237
Source: MRV Associates, http://www.cmegroup.com/education/files/ed144-mayra-
valladres.pdf (slightly modified by the author)
160

assets of nearly $14 trillion dollars. Tougher global banking capital rules
will barely hinder economic growth, said a study on Wednesday, casting
doubt on claims from the banking sector that the new capital requirements
under Basel III would result in a significant credit squeeze that would
derail economic recovery (Huw, 2010).
The Committee of European Banking Supervisors (CEBS) study of the 33

major European banks had a slightly lower common equity Tier 1 ratio
under Basel III definitions (4.9%) and a common equity ratio of 10.7%
under Basel II. Echoing the BIS impact study, 157 mid-sized banks suffer a
less pronounced decline in their ratio under the new rules, from 11.1% to
$WWKHHQGRI DFFRUGLQJWR WKH %DVHO &RPPLWWHH¶V VWXG\ WKH
additional capital needed to be raised by banks with a common equity ratio
of below 7% in order to reach that level (7%) amounteGWR¼ELOOLRQRI
ZKLFK¼ELOOLRQIRUJURXSEDQNVDQG¼ELOOLRQIRUJURXSEDQNV,Q
WKH&(%6VWXG\WKHFDSLWDOQHHGHGWREHUDLVHGZDV¼ELOOLRQRIZKLFK
¼ELOOLRQE\JURXSEDQNVDQG¼ELOOLRQE\JURXSEDQNV4XLJQRQ
2011). When the two studies are compared, the additional capital that group
2 banks need to raise in both studies come relatively close to each other;
however, the results for group 1 banks are significantly different where the
%DVHO&RPPLWWHH¶VVWXG\reports twice more than what CEBS study shows.
Two major studies have been conducted in 2009 in order to assess the
liquidity levels of banks (financial institutions) in relation to capital
requirements under both Basel II and Basel III. Quignon (2011) asserts that
the study done by the Bank for International Settlements (BIS) has found
that the 74 group 1 banks238 would have had an average common equity
Tier 1 ratio of 5.7% under Basel III on December 31, 2009, assuming full

238
The 94 group 1 banks, of which 91 supplied information, have excess Tier 1 capital of over
¼ELOOLRQDUHGLYHUVLILHGDQGDFWLYHLQWHUQDWLRQDOO\$OORWKHUEDQNVDUHLQJURXS
161

application of the new rules. Their common equity ratio was 11.1% under
Basel II at the same date. 133 mid-sized banks would have seen these same
ratios ease from 10.7% to 7.8%, suggesting a much greater impact for
larger financial institutions.
ͳͲͲ
Table 32
ʹ͵ͻ
Country GDP level (%) Growth (%)

(region) Year 1 Year 2 Year 3 Year 4 Year 5 Annual
United States ͲϬ͘Ϭϴ ͲϬ͘ϯϭ ͲϬ͘ϱϰ ͲϬ͘ϳϳ ͲϬ͘ϵϯ ͲϬ͘ϭϴ
Euro area Ϭ͘ϬϬ ͲϬ͘Ϯϯ ͲϬ͘ϵϯ Ͳϭ͘ϰϬ ͲϮ͘ϭϬ ͲϬ͘ϰϮ
Japan Ϭ͘ϬϬ ͲϬ͘ϯϯ ͲϬ͘ϱϬ Ͳϭ͘ϭϳ Ͳϭ͘ϯϯ ͲϬ͘Ϯϳ
240
Turkey Ϭ͘ϬϬ ͲϬ͘Ϯϵ Ͳϭ͘ϭϲ Ͳϭ͘ϳϱ ͲϮ͘ϲϮ ͲϬ͘ϲϱ
Average (simple) ͲϬ͘Ϭϯ ͲϬ͘Ϯϵ ͲϬ͘ϲϲ Ͳϭ͘ϭϭ Ͳϭ͘ϰϱ ͲϬ͘Ϯϵ
Average ͲϬ͘Ϭϯ ͲϬ͘Ϯϴ ͲϬ͘ϲϵ Ͳϭ͘Ϭϴ Ͳϭ͘ϰϱ ͲϬ͘Ϯϵ
(GDP weighted)
The OECD working paper241 RQ ³0DFURHFRQRPLF ,PSDFW RI %DVHO ,,,´
estimated the medium-term impact of Basel III implementation on GDP
growth is in the range of negative í WR í SHUFHQWDJH SRLQW SHU
annum. Economic output is mainly affected by an increase in bank lending
spreads as banks pass a rise in bank funding costs, due to higher capital
requirements, to their customers. To meet the capital requirements effective
in 2015 (4.5% for the common equity ratio, 6% for the Tier 1 capital ratio),
banks are estimated to increase their lending spreads on average by about
15 basis points. The capital requirements effective as of 2019 (7% for the

239
6RXUFH2(&'(FRQRPLFV'HSDUWPHQW:RUNLQJ3DSHUV1R³0DFURHFRQRPLF,PSDFWRI
%DVHO,,,´WDEOHFRQVWUXFWHGE\WKHDXWKRr.
240
The figures for Turkey are estimated by the author. Euro figures are multiplied by a factor of
1.25 and this factor is merely an assumption that Turkey would be affected at least 25%
more than Europe because of contagion effects due to close business ties to eurozone.
241
6HH³0DFURHFRQRPLF,PSDFWRI%DVHO,,,´2(&'(FRQRPLFV'HSDUWPHQW:RUNLQJ3DSHUV
No. 844, p. 3, OECD Publishing
162

common equity ratio, 8.5% for the Tier 1 capital ratio) could increase bank
lending spreads by about 50 basis points (Slovik & Cournède, 2011, p.3).
The OECD study also points out that banks will need to increase their
common equity ratio on average 1.2% and Tier 1 capital ratio by 0.5% in
order to meet total capital requirement by 2015. However, with the capital
conservation buffer of 2.5% in full effect by January 1, 2019 by which,
minimum total capital requirement becomes 10.5%, and this will mean that
banks will have to increase common equity ratio on average by about 3.7%
and Tier 1 capital ratio by 3.0% (Slovik & Cournède, 2011, p.7).
The 2008 global financial crisis did not disappoint expectations in the sense
that rigorous new capital requirements were going to force banks
worldwide to become more conservative to achieve increased levels of
quality and quantity of liquid capital to enable them to absorb shocks
arising from financial and economic stress. Between the years of 2006-
2009, the United States has improved both its Tier 1 and common equity
capitals; 9.8% to 11.4% (+1.6%) and 8.6% to 10.5% (+1.9%) respectively.
During the same period, the Euro area has achieved 1.4% increase in its
Tier 1 ratio (from 8.0% to 9.4%) and 1.2% increase in its common equity
ratio (from 6.8% to 8.0%). Tier 1 and common equity capital levels were
much lower in Japan prior to the crisis (2006) and after the crisis (2009);
Tier 1 increased from 5.4% to 6.9% (+1.5%) and common equity improved
to 4.1% from 3.3% (+0.8%).242
In the three main OECD economies (the US, the EU, and Japan), a one
percentage point (100 basis points) increase in the ratio of bank capital to
risk weighted assets would result in an average negative impact on GDP

242
Source: IIF - ,QVWLWXWH RI ,QWHUQDWLRQDO )LQDQFH ³,QWHULP 5HSRUW RQ WKH &XPXODWLYH
Impact on the Global Economy of Proposed Changes in the Banking Regulatory
)UDPHZRUN´&DOFXODWLRQVGRQHE\6ORYLN &RXUQqGH
163

OHYHORIíILYH\HDUVDIWHUWKHLPSOHPHQWDWLRQZKLFKWUDQVODWHVLQWRD
negative í0.04 percentage point impact on annual GDP growth.243
Quignon (2011) argues that alterations have been made (i.e. Basel 2.5) to
the original Basel III; therefore, it does not represent all the changes in
EDQNV¶ SUXGHQWLDO UXOHV VLQFH WKH ILUVW YHUVLRQ RI %DVHO II. Quantitative
impact studies suggest that the new standards will make such a big
difference to bank balance sheets that they will significantly affect the
structure and volumes of financial savings and funding.
Findings of a study by Otcker-Robe and PazarbaúÕR÷OX LQGLFDWHG

that most banks worldwide would have no problem meeting the new
minimum capital requirements under Basel III in 2013 (7%) and 2014 (8%),
but more banks close to 2019 would start failing one after another as the
Tier 1 capital will be increased bringing the minimum requirement to
10.5%. Slovik and Cournède (2011) argue that the estimated medium-term
LPSDFWRI%DVHO,,,LPSOHPHQWDWLRQRQ*'3JURZWKLVLQWKHUDQJHRIí
WR í SHUFHQWDJH SRLQW SHU DQQXP According to the World Pensions
Council (WPC), European legislators have pushed dogmatically and
naively for the adoption of the Basel II recommendations forcing private
banks, central banks, and bank regulators to rely more on assessments of
credit risk by private rating agencies (Nicolas & Firzli, 2011). The findings
of a comprehensive study by Angelini et al. (2011) suggests that each
percentage point increase in the capital ratio causes a median 0.09 percent
decline in the level of steady state output, relative to the baseline. The
impact of the new liquidity regulation is of a similar order of magnitude, at
0.08 percent. The U.S. Federal Deposit Insurance Corporation Chair Sheila
%DLU H[SODLQHG LQ -XQH WKDW ³«ZLWKRXW SURSHU FDSLWDO UHJXODWLRQ

243
Macroeconomic Impact of Basel III, OECD Economics Department Working Papers, No.
844, p. 10
164

banks can operate in the marketplace with little or no capital. And
governments and deposit insurers end up holding the bag, bearing much of
WKHULVNDQGFRVWRIIDLOXUH´%ODLU
The data presented in the paper of Cosimano and Hakura (2011) suggests
that large banks would on average need to increase their equity-to-asset
ratio by 1.3 percentage points under the Basel III framework. GMM
(generalized method of moments) estimations indicate that this would lead
large banks to increase their lending rates by 16 basis points, causing loan
growth to decline by 1.3 percent in the long run.
Elliott (2010) asserts that the banking industry argues that Basel III will
seriously harm the economy. For example, the Institute of International
Finance (IIF) calculated that the economies of the US and Europe would be
3% smaller after five years than if Basel III were not adopted. For example,
the French banking association offered calculations that suggested a 6% hit
to the French economy which is double the size of impact suggested by the
IIF. 7KHUHIRUH*RUG\VD\V³$VLQJOHIDFWRU PRGHOFDQQRWFDSWXUH
any clustering of firm defaults due to common sensitivity to these smaller
VFDOHFRPSRQHQWVRIWKHJOREDOEXVLQHVVF\FOH´*RUG\DOVRSRLQWV
out that calibrating a single factor model to a broadly diversified
international credit index may significantly understate the capital needed to
support a regional or specialized lender. Jackson (1999) argues that the
Committee released Basel II despite many issues with Basel I, most notably
of all that regulatory arbitrage was rampant.
On the contrary to what many in the banking industry fear, Allen et al.
(2012) feel that the long-term effect of Basel III will be much less; however,
they agree with critics of Basel III that risk management and governance
will be the key to avoiding severe shortages of liquidity. Caruana (2010),
165

unlike everybody else, does not point to Basel II as the architect behind the
2008 crisis for two reasons: first, he argues that the crisis manifested itself
in 2007 on the basis of imbalances that had built up prior to the
implementation of Basel II; second, he says that majority of Basel II
adopting countries did so in 2008 or later. So, this means that Basel II was
aftermath of the crisis which hit the surface in late 2007 and early 2008 and
it would be sort of irrational to hold something or somebody responsible
for the part that was not taken.
A comprehensive research by McKinsey & Company claims that Basel

,,,¶V QHZ FDSLWDO UHTXLUHPHQWV LQFUHDVHG TXDOLW\ DQG TXDQtity of capital,
will create a severe shortage of funds in the European banking sector that
by 2019 the industry will need DERXW ¼ WULOOLRQ RI DGGLWLRQDO 7LHU
FDSLWDO¼WULOOLRQRIVKRUW-WHUPOLTXLGLW\DQGDERXW¼WULOOLRQRIORQJ-
term funding, absent any mitigating actions. Although the story for the U.S.
banking sector is not much different, the impact seems to be slightly
smaller according to the McKinsey & Company estimates that Tier 1
FDSLWDO VKRUWIDOO DW ELOOLRQ ¼ ELOOLRQ WKH JDS LQ VKRUW-term
OLTXLGLW\DWELOOLRQ¼ELOOLRQDQGWKHJDSLQORQJ-term funding at
WULOOLRQ¼WULOOLRQ). After full implementation by 2019, 0F.LQVH\¶V
UHVHDUFK DOVR KLJKOLJKWHG WKDW (XURSHDQ EDQNV¶ SUHWD[ UHWXUQ RQ HTXLW\
(ROE) would decrease by between 3.7 and 4.3 percentage points from the
pre-crisis level of 15 percent (between 11.3% and 10.7%).244 It is
understood from the McKinsey report that all segments of banking
operations to a varying degree will be affected by higher capital and
liquidity requirements. For instance, retail banking business will be
probably more affected than that of wholesale banking. Retail banks have

244
See McKinsey & Company, Basel III and European banking: Its impact, how banks might
respond, and the challenges of implementation,
http://riepis.org/European%20banking_McKinseyCo.pdf, p.3
166

been already operating under lower capital ratios for some time compared
to wholesale banks. Increased capital requirement at the retail banking end
will push some of the cost to consumers in the way of either higher fees or
higher interests on loans (70 basis points).245 Corporate banking may see its
fair share of adverse impact as in rising cost for the following product and
services; uncommitted credit lines, long-term corporate loans, and long-
term asset based finance businesses. Of the three different segments,
investment banking will probably face more changes in product and service
offerings because they are more complex in nature than those offered by
retail or corporate banking.246
A recent OECD study shows minor macroeconomic impact of a one

percentage point increase in bank capital ratios. Based on this study, one
percentage point increase in the ratio of bank capital to risk weighted assets
(i.e. increase from 7% to 8%) in the three main OECD economies, would
result in an DYHUDJH LPSDFW RQ *'3 OHYHO RI í ILYH \HDUV DIWHU WKH
LPSOHPHQWDWLRQZKLFKWUDQVODWHVLQWRDíSHUFHQWDJHSRLQW LPSDFWRQ
annual GDP growth. As a result, the annual GDP growth in the United
States would be negative -0.04% per annum.
The largest impact on GDP growth is in the Euro area with -0.06%, and
Japan seems to be the least affected (-0.02%). The same study shows that
%DVHO,,,¶VFDSLWDOUHTXLUHPHQWVIRUWKHFRPPRQHTXLW\UDWLRIRU
the Tier 1 capital ratio) fully effective as of 2015 further reduces GDP
growth on average by -0.23% five years after implementation. Although
%DVHO,,,¶VLQFUHDVHGOHYHORIFDSLWDOUHTXLUHPHQWVE\SURGXFHVELJJHU
impact on annual GDP growth for the Euro area (-0.08%) and Japan (-0.04),
however in the case of U.S., the impact on GDP growth slows down

245
See McKinsey & Company, http://riepis.org/European%20banking_McKinseyCo.pdf, p.10
246
McKinsey & Company, http://riepis.org/European%20banking_McKinseyCo.pdf, pp.11-12
167

considerably (half of what it was before prior to 2015). The highest level of
Basel III capital requirements (10.5% - 8% plus 2.5% conservation buffer)
will be in full effect as of January 1, 2019, and by this time, the negative
impact of Basel III on annual GDP growth will be at its peak; -0.12% in
U.S., -0.23 in the Euro area, and -0.09% in Japan.247
Slovik and Cournède (2011) argue that the estimated medium-term impact
of Basel III implementation on G'3 JURZWK LV LQ WKH UDQJH RI í WR
íSHUFHQWDJHSRLQWSHUDQQXP7KH\DOVRFODLPWKDWWKHLPSDFWRQ*'3
is further scaled by the share of banks in total credit intermediation because
the Basel III capital requirements affect the banking sector. The analysis of
Slovik and Cournède (2011) shows that the banks in the United States
account for 23.6% of the total credit intermediation compared to 73.8% in
the Euro area and 52.6% in Japan.248 Shearman & Sterling said in a report
that the U.S. has pledged to implement Basel III into U.S. law through
agency rulemakings. Nonetheless, the U.S. may determine not to apply the
standards to all U.S. banks or may otherwise determine to apply the
standards selectively.249 The estimated medium-term impact of Basel III
implementation on GDP growth in Turkey could be more than a half of a
percentage point (-0.65%)250 RU KLJKHU SHU DQQXP GXH WR 7XUNH\¶V
developing-country status and close business ties to the Euro area. In
addition to that, Turkey will have the domino effect of negative impact
once the banks in Europe go under major banking structural changes to
PHHWWKHQHZ%DVHO,,,¶VPLQLPXPFDSLWDOUHTXLUHPHQWV - 4.5% Tier 1

Ϯϰϳ
6HH2(&':RUNLQJ3DSHUV1R³0DFURHFRQRPLF,PSDFWRI%DVHO,,,´
Ϯϰϴ
6HH,QVWLWXWHRI,QWHUQDWLRQDO)LQDQFH³,QWHULP5HSRUWRQWKH&XPXODWLYH,PSDFWRQ
the Global Economy of Proposed &KDQJHV LQ WKH %DQNLQJ 5HJXODWRU\ )UDPHZRUN´
Washington, DC
Ϯϰϵ
6KHDUPDQ 6WHUOLQJUHSRUW³7KH1HZ%DVHO,,,)UDPHZRUN,PSOLFDWLRQVIRU%DQNLQJ
2UJDQL]DWLRQV´
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The impact of Basel III on GDP growth in Turkey is assumed to be at least 50% greater than
the Euro area (-0.42x1.5)
168

plus 2.5% conservation buffer) in full effect by January 1, 2013. Banks in
Turkey probably account for a larger percentage (close to 60-70%) of the
total credit intermediation than the Euro area because banks there are pretty
much the only sources for obtaining credit unlike the situation in U.S.
where consumers, businesses, or investors have more financial
intermediaries to choose from for their credit needs.

The priority aside from increasing the quality and quantity of capital, the
&RPPLWWHH¶VRWKHUWRSIRFXVDUHDLVWRVWUHQJWKHQWKHULVNFRYHUDJHRI%asel
II and just to that the BCBS is already taking a number of steps just to do
that. Under Basel II, the counterparty credit risk251 (CCR) was not properly
FRYHUHGDQGDFFRUGLQJWRWKH&RPPLWWHH¶VDVVHVVPHQWWKHFDSLWDOUHODWHGWR
CCR was inadequate in several areas. 7KH&RPPLWWHH¶VILQGLQJVVKRZWKDW
roughly two-thirds of CCR losses were due to CVA losses and only about
one-third were due to actual defaults.252
The BCBS also introduced internationally harmonized leverage ratios;

Leverage coverage ratio (LCR-short-term liquidity) = Stock of high-quality
OLTXLGDVVHWV7RWDOQHWFDVKRXWIORZVRYHUWKHQH[WGD\V DQG
Net stable funding ratio (NSFR-long-term liquidity) = Available amount of
stable funding/Required amount of stable funding = >100).253 Ernst &
Young approach on Basel III claims that banks are required to back 100%
of the illiquid assets by stable funding; however, qualifying residential
mortgages are only backed up by 65% NSFR.254

251
Counterparty credit risk means, risk associated with credit that goes into default leaving
behind a positive balance; thus, a positive balance is remaining on the loan (credit) that still
needs to be paid.
252
253
See Basel III: Report to G20 Leaders on Basel III implementation, p.9
254
Ernst & Young approach on Basel III
169

Prior to the 1998 Asian crisis, Asian-5 countries (Thailand, Indonesia,

Malaysia, Philippines, and South Korea) attracted nearly half of the foreign
capital inflows (FDIs and FPIs) to developing countries ± almost $100
billion in 1996 (Fisher, 1998). Consequently, during the 1998 Asian crisis,
investors had lost close to a trillion dollars which prompted the BCBS to
work on new banking reforms under Basel II. Baig and Goldfajn (1998)
FDOOHGWKHFULVLVDV³$VLDQ)OX´DQGFODLPHGWKDWWKHFULVLVZDVDFDVH
of contagioQ ZKHUH RQH FRXQWU\¶V LOO IDWH TXLFNO\ WUDQVPLWV WR RWKHU
neighboring countries. Bill Clinton, the 42nd President of the United States,
FDOOHG WKH $VLDQ FULVLV DV D ³JOLWFK´ $V 1DQWR SRLQWHG RXW LQ
January 1998, the U. S. Federal Reserve Chairman Alan Greenspan
170

indicated that because of the financial crisis, foreign investors in Asian
equities (excluding those in Japan) had lost an estimated $700 billion-
including $30 billion by the Americans. Nanto (1998) also claims that the
crisis caused liquidation of nearly half of the banks in Thailand (56 of 91),
South Korea (16 of 30), and permanent closure of 16 banks in Indonesia.
Calvo and Mendoza (1997) argue that investors in financial markets of
developing countries and/or emerging markets make buy/sell decisions
concerning financial securities based on what everybody else is doing (herd
mentality), which can be considered as an irrational approach where rumors
or incidents are not checked or confirmed. Masson (1998) also asserts that
already once jittery investors will have a minimum threshold for the next
bit of bad news which may be just enough to trigger a collective sell-off
and ultimately lead to loss of investor confidence.
Chart 13 ʹͷͷ
Fitch, one of the "big three credit rating agencies" (Standard & Poor's,
Moody's Investor Service and Fitch Ratings), does not foresee any major
obstacles for banks in Malaysia to meet new Basel III capital requirements.

255
Source: Citigroup Global Markets 22 January 2010 (as cited in KPMG UHSRUW³%DQN7HFK
$VLD´
171

Although, a recent report by Fitch showed that Tier1 (CET1) ratio of a
small group of banks in Malaysia ranged from 8% to 11%; however, the
banking sector average in the country was around 8.7% under Basel III,
which was slightly lower than 9.3% under Basel II. Fitch also mentioned in
its report that several banks with CET1 less than 8% in Malaysia may come
short of meeting CET1 capital requirement under Basel III.256 Citi Research
indicated in a report that banking sectors in Taiwan and Malaysia have
relatively low equity Tier1 capital and relatively high leverage ratios
(LCR).257 Anita Menon, executive director for financial risk management
services at KPMG in Malaysia, said that she sees capital requirement for
most Asian countries as non-problematic, but implementation of Basel III
poses challenges in the area of liquidity in many Asian countries including
Malaysia due to a shortage of high-quality liquid assets for banks to hold as
liquidity.258 Anandakumar Jegarasasingam, Malaysian Rating Corp Bhd
vice-president and head of financial institution ratings, sees the biggest
challenge in Malaysian banking sector as the investor expectation of high
dividends because almost all banks in Malaysia are traded on Bursa
Malaysia (stock exchange).259
7LHUFDSLWDOXQGHU%DVHO,,,PXVWHQVXUHDEDQN¶VVROYHQF\; in other words,

Tier 1 capital must help banks continue their operation during periods of
financial or economic stress. Therefore, common equity (common stock)
under Basel III is recognized as the highest quality component of capital
which is the primary form of funding to help banks remain solvent. It is

256
6HHQHZV³)LWFK0DOD\VLDQEDQNVDEOHWRPHHW%DVHO,,,FDSLWDOUXOHV´
http://biz.thestar.com.my/news/story.asp?file=/2012/8/10/business/20120810112749&sec
257
6HHQHZV³%DVHOSRVHUIRUEDQNV´
http://biz.thestar.com.my/news/story.asp?file=/2010/3/1/business/5708878&sec=business
258
6HHQHZV³0DOD\VLDQEDQNVQHHGWRDGMXVWWRFRPSO\ZLWK%DVHO,,,´
259
6HHQHZV³%DVHOSRVHUIRUEDQNV´
172

important that Tier 1 should consist of non-common equity elements but
banks nevertheless must not overly rely on these elements. The Committee
also says that in the past some non-common equity elements have been
included in Tier 1 to reduce cost; however, these elements negatively
affecting the quality of capital will have to be phased out.
Regulatory adjustments must be applied at the level of common equity

along with retained earnings. The logic behind this is that banks will not be
able to show strong Tier 1 ratios while having low levels of tangible
common equity. The BCBS argues that there should not be too many tiers
and sub-tiers of capital which makes it very difficult to form an
internationally harmonizeG GHILQLWLRQ RI FDSLWDO 7KDW¶V ZK\ %DVHO ,,,
introduces only Tier 1 and simplifies Tier 2 (no sub-tiers as before) and
eliminates Tier 3 category. Basel III will ensure a full disclosure of various
components of the regulatory capital so that appropriate analyses or
comparisons can be made.260
In its report to G20 Leaders on Basel III implementation, the Committee

said that as of end of May 2012, 21 of the 27 Basel member countries have
implemented Basel II and Indonesia and Russia have implemented only
%DVHO,,¶V3LOODUPLQLPXPFDSLWDOUHTXLUHPHQWV,QDGGLWLRQ$UJHQWLQD
China, Turkey and the United States are still in the process of
implementing Basel II. Furthermore, Argentina, Hong Kong SAR,
Indonesia, Korea, Russia, Turkey and the United States have not yet issued
draft Basel III regulations. Although these seven countries above believe
that they could meet the January 1, 2013 deadline, nevertheless time
consuming bureaucratic domestic rule-making processes will make it
considerably challenging.

260
See Basel III: Strengthening the resilience of the banking sector, pp.22-23
173

TURKISH ECONOMY
The 2008 financial crisis and its huge impact on nations worldwide earned
WKHFULVLVWKHWLWOHRIµglobal financial crisis,¶ some economists even called
LWµILQDQFLDOPHOWGRZQ;¶KRZHYHU, Turkey has escaped severe effects of the
crisis with slight interruptions in its economy, HYHQWKRXJKWKHFULVLV¶KLJK
magnitude impact, according to Haidar (2012), contributed to the European
sovereign-debt crisis. Turkey would have been thought as the last country
that was prone to crises before 2001 during which time political instability,
chronic high inflation and frequent economic crises were just usual scenes
in daily life; but today, thanks to brilliant work of the Banking Regulation
and Supervision Agency (BRSA or BDDK in Turkish), Turkey now has
much envied banking system that is both resilient and capable of absorbing
financial and economic shocks during a global scale acute stress.
,Q RUGHU WR XQGHUVWDQG WKH QDWXUH RI 7XUNH\¶V EDQNLQJ V\VWHP today, one
really needs to look at its unique evolution throughout four specific periods
in its history: (1) rise & fall of the Ottoman Empire; (2) the new Republic
under $WDWUN¶VUHIRUPV; (3) political instability amid privatization; and (4)
economic progress through political stability.
Ƭ
Unlike its counterparts in the Western world (monetary policy was mainly
used), the Ottoman Empire, for its fiscal policy (fiscalism), predominantly
relied on military expansionism and aggressive collection of numerous
taxes from the agrarian society primarily found in Anatolia (middle part of
Turkey), plus various fees were collected from merchants in Istanbul who
had trade related business dealings with administrative branches of the
Empire. 6RFDOOHGWKH³EQODUJHPHQW´ RUµ5LVHRIWKH(PSLUH¶period began
174

with Mehmet II (1451 to 1481) RUSRSXODUO\NQRZQDVµ6XOWDQ0HKPHWWKH
&RQTXHURU¶ who, at the age of 21, conquered Constantinople and brought
an abrupt end to the Byzantine Empire (Greek). However, the Ottoman
Empire experienced its apex years of power by every imaginable measure
under the reign of Kanuni Sultan Süleyman (1520 to 1566) or as the West
liked to FDOOKLPµ6XOHLPDQWKH0DJQLILFHQW¶
About a century later, the Empire soon went into stagnation period (1680 to
1825) which gave the West a rare opportunity to gain strength and later to
reclaim back its previously lost territories knowing that the ailing Ottoman
Empire was not as powerful as before plus it was not in any position to
fight back especially with its diminishing military power and slumping
treasury. The decline (1825 to just before WWI) and soon after the fall of
the Ottoman Empire happened rather quickly with weak and incompetent
Sultans who were more interested in entertaining themselves through a
lavish palace lifestyle than safeguarding the interests of the Empire.
Despite all the efforts by France and Russia to keep the Ottoman Empire
out of World War I; nonetheless, Enver Pasha, as being the Major General
of the Ottoman army then, was the main actor who secretively orchestrated
an Ottoman-German alliance to enter the WWI because he thought that this
would greatly benefit him personally as well as the Empire. On the contrary
to his thoughts, already financially drained and militarily weakened
Ottoman Empire ended up losing more of its critical territories in the
Balkans and Mediterranean. However, the worst was yet to come; although
the Ottoman army was victorious in some hard-fought battles; but
QHYHUWKHOHVV WKH (PSLUH¶V EOHDN future after the WWI was unfortunately
decided not in the battle fields but on the negotiation table where the
Ottoman Empire ZDVIRUFHGWRVLJQWKHµ7UHDW\RI6qYUHVLQ¶ which
175

contained most harsh terms imaginable and gave the Western powers
(Great Britain, Italy and France) the absolute right to territorially carve up
the Ottoman land.
òǯ
The Ottoman Empire had been debt free for 500, but the financial burden
of the Crimean war of 1853-1856 forced the Ottoman Empire for the first
time to borrow money from countries in Europe. Although there were some
small banking operations in Istanbul (i.e. Galata bankers and Bank of
Constantinople), according to Raccagni (1980), they were not even close to
any means of financial capacity to undertake such borrowing. However, the
2WWRPDQ¶V increasing foreign debt had to be administered somehow in the
absence of its own financial system. With the involvement of France and
England, the Imperial Ottoman Bank was founded in 1856 as a joint
venture (actually it would be hardly called joint); England owning 59%,
France 37% and the Ottoman Empire having a mere 4% of ownership.
7XUNH\¶V PRGHUQ history started in 1922 with one brilliant man, soldier,
politician, strategist, genius; Mustafa Kemal (Atatürk), who abolished the
Ottoman Empire in 1922 by overthrowing Sultan Mehmet VI Vahdettin
and a year later forming the Turkish Republic in 1923. To make things
right, Atatürk first UHMHFWHG WKH µ7UHDW\ RI 6qYUHV¶ DQG DOO LWV erroneous
harsh terms, and then he rightly claimed that Turkish people were not going
to be KHOGUHVSRQVLEOHIRUWKH2WWRPDQ(PSLUH¶VLOO-fated actions and their
consequences :LWK WKH µ7UHDW\ RI /DXVDQQH¶ LQ 7XUNH\ VWDUWHG
negotiations afresh to correct some of 6qYUHV¶FULSSOLQJoutcomes. Atatürk,
as the first elected president (one-party system, 1923-1946), immediately
went to work and introduced many critical reforms in every facet of life
with a promise of modernization. Atatürk realized that any type of factory
176

to produce goods had to be built first by the government due to lack of
skilled labor, resources, and potential investors. This was the start of an era
in which any sort of production was done by state-owned enterprises.
Next, Atatürk IRFXVHGRQHVWDEOLVKLQJ7XUNH\¶VEDnking system because he

knew it perfectly even WKHQWKDW7XUNH\¶VIRUZDUGSURJUHVVZDVonly going
to be possible with creation of a strong national banking system that would
be FDSDEOH RI VHUYLQJ WKH \RXQJ FRXQWU\¶V H[WHQVLYH DQG FKDOOHQJLQJ
financial needs as well as enabling and fostering other industries through
financial assistant. Therefore, Atatürk wanted to create a truly national
EDQNWKDWZDVJRLQJWRGRDOOWKDWøú%DQN UDQNHGRIµ7RS:RUOG
%DQN¶261) was founded in 1924 assuming this enormous responsibility.
Ziraat Bank (Agricultural Bank) was primarily focused on meeting the

financial needs of farmers who were a significant part of the Turkish
economy at the time. Later $WDWUN RUGHUHG WKH QDPH RI µWKH ,PSHULDO
2WWRPDQ%DQN¶to be changed EDFNWRµWKH2WWRPDQ%DQN¶DQGKHDOORZHG
it to remain as a state-owned bank with limited central bank functions until
ZKHQWKH7XUNLVK5HSXEOLF¶VRZQFHQWUDOEDQNZDVILQDOO\HVWDEOLVKHG
in the same year. Furthermore, Atatürk initiated introduction of a couple
PRUHQHZEDQNVLQWRWKHFRXQWU\¶VJURZLQJILQDQFLDOV\VWHP6PHUEDQNLQ
1932 and Etibank in 1935.262
%HIRUHWKHVWDUWRI:RUOG:DU,,$WDWUN¶VUHIRUPVKHOSHG7XUNH\FUHDWHD
financial sector of its own which in turn provided necessary financial
means to develop other vital industries. By 1950s, Turkey had a remarkable
progress independent of the West; this time, not only Turkey had a well-
functioning financial system, but it also had several working industries.

261
See Financial Times Survey: http://en.wikipedia.org/wiki/Financial_Times
262
See Wikipedia: Economic History of the Ottoman Empire
http://en.wikipedia.org/wiki/Economic_history_of_the_Ottoman_Empire
177

Although state-owned enterprises were first initiated by Atatürk as a way of

rebuilding the young Republic aftermath abolishment of the Ottoman
Empire and the Turkish war of independence; however, by 1980s, still
nearly half of all production in Turkey was done by the inefficient state
companies with excessive staffs on payroll. These state enterprises were
incurring huge financial losses and becoming a real burden on the
government budget leading to further borrowing from foreign sources.
Rawdanowicz (2010) claims that financial crises in 1994 and 2001 in
Turkey (biggest economic shock in Turkish history) were direct results of
7XUNH\¶Vlong standing record of high current account imbalances.
Mody and Schindler (2005) feel that growth during Özal administration
responded strongly to the liberalization and opening up of the economy, but
the impact of the reforms was ultimately undermined by poor financial
discipline. Turgut Özal, as the Prime Minister in 1983 after the military
coup ended263 in 1982, was the main architect behind the challenging
transformation work of the Turkish economy from import-focused to
export-focused through privatization of major state-owned companies,
which meant a much reduced government role in the general economy.
g]DO¶V URDGPDS RI UH-structuring the economy included other key factors
such as developing sound monetary policies, encouraging foreign direct
investments (FDIs), reducing subsidies, and putting a stop on price controls.
The VXFFHVV RI g]DO¶V HFRQRPLF programs nevertheless was later
overshadowed by the rising current account deficit bubble due to massive

263
In less than a century old modern history, Turkey has witnessed 4 military interventions; the
military coups of 1960, 1971, and 1980; and the 1997 military memorandum (also known as
the "coup by memorandum").
178

foreign debt amounting to more than $65 billion at the end of 1993.
According to Rijckeghem and Ucer (2005), high level of political
instability, growing concerns about bank soundness, and political
uncertainties, created a ³perfect storm´ that subverted market confidence.
Furthermore, adverse effects of the first Persian Gulf War (1990-1991) and
its embargo outcome on Iraq by the United States (major blow to Turkish
trade) along with chronic inflation (constant fluctuation in consumer prices)
caused current account deficit to swell.264
Until 1991, all of the banks in Turkey were government banks and
establishing a private bank was almost impossible due to stringent
government control and excessive bureaucratic steps. The situation
suddenly changed by the end of 1991 just before the general election that
year; Mesut YÕlmaz, who was the Prime Minister at the time, made a
politically motivated move and granted a special permission to five
businessmen with strong ties to the government to open private banks.
In just five years from 1994 to 1999, 14 new banks started operations
bringing the number of banks to 81 before 2001 crisis. Some of these banks
were used by owner companies as a channel to siphon money.265 Things got
so out of control by 1999 that a second financial crisis in less than a decade
(the first was in 1994) was about to surface the markets. A major
earthquake (more than 20,000 people died) hitting a city nearby Istanbul in
later part of 1999 was the last excuse outside of economy before everything
came crashing down. Crisis was inevitable and Turkey experienced the
biggest financial shock in its history in 2001 which ended up costing the
government over $50 billion to clean up the mess. The financial meltdown
slashed the number of banks in half and caused loss of 15,000 bank jobs.

264
See http://www.mongabay.com/reference/country_studies/turkey/ECONOMY.html
265
See Wikipedia: Economy of Turkey, http://en.wikipedia.org/wiki/Turkish_economy
179

͸ͶͶͷ

A series of events, both macro and microeconomic, had major adverse
LPSDFWV RQ 7XUNH\¶V ILQDQFLDO VHFWRU SULRU WR WKH HFRQRPLF FULVLV
which was the biggest financial shock in Turkish history since 1923 when
it was first established as the young Republic. Turkey experienced two
major financial crises in less than a decade (1994 & 2001). The key reasons
behind the crisis can be listed as; inadequate capital base; significant risk
exposure to FX positions; lack of internal control, poor risk management
and corporate governance at each bank; and a weak regulatory system. The
Turkish lira lost 50% of its value overnight during 1994 economic crisis.
Table 33 ǡʹͲͲͲ ʹ͸͸
Total Assets Total Loans Total Deposits

Bank Type
$ billion % $ billion % $ billion %
State Banks ϱϯ͘ϭϱ ϯϰ͘Ϯ ϭϯ͘ϳϯ Ϯϳ͘Ϭ ϰϭ͘Ϭϵ ϰϬ͘ϯ
Private Banks ϳϯ͘ϱϵ ϰϳ͘ϰ Ϯϳ͘ϳϱ ϱϰ͘ϱ ϰϰ͘ϯϱ ϰϯ͘ϱ
Top 5 Private Banks ϱϬ͘ϱϯ ϯϮ͘ϲ ϮϬ͘ϰϵ ϰϬ͘Ϯ ϯϬ͘ϭϬ Ϯϵ͘ϱ
Other Private Banks Ϯϯ͘Ϭϲ ϭϰ͘ϴ ϳ͘Ϯϲ ϭϰ͘ϯ ϭϰ͘Ϯϱ ϭϰ͘Ϭ
Foreign Banks ϴ͘ϰϬ ϱ͘ϰ ϭ͘ϰϰ Ϯ͘ϴ ϯ͘ϯϬ ϯ͘ϯ
TMSF Banks ϭϯ͘ϭϵ ϴ͘ϴ ϯ͘ϯϭ ϲ͘ϱ ϭϯ͘ϭϰ ϭϮ͘ϵ
Total ϭϰϴ͘ϯϰ ϵϱ͘ϲ ϰϲ͘Ϯϯ ϵϬ͘ϴ ϭϬϭ͘ϴϴ ϭϬϬ͘Ϭ
*
D & I Banks ϲ͘ϵϬ ϰ͘ϰ ϰ͘ϳϬ ϵ͘Ϯ Ϭ Ϭ
Sector Total ϭϱϱ͘Ϯϰ ϭϬϬ͘Ϭ ϱϬ͘ϵϯ ϭϬϬ͘Ϭ ϭϬϭ͘ϴϴ ϭϬϬ͘Ϭ
* D & I means development and investment banks
0RUHRYHU SROLWLFDO LQVWDELOLW\ DOVR FRQWULEXWHG WR WKH ILQDQFLDO V\VWHP¶V

further deterioration (parliamentary elections of 1990s produced two-party

266
Source: BDDK and The Banks Association of Turkey
180

or three-party coalition governments; and finally the military coup of 1980
when coalition parties created an unstable situation negatively affecting life
in general, and then the arm forces intervened). Turkey was not alone in the
crisis situation because there were so many hot spots elsewhere; Mexican
peso crisis in 1994; the late 1997 and early 1998 Asian currency crisis,
ZKLFK%DLJDQG*ROGIDMQFDOOHGLWDV³$VLDQ)OX´DQGFODLPHGWKDW
WKH FULVLV ZDV D FDVH RI FRQWDJLRQ ZKHUH RQH FRXQWU\¶V LOO IDWH TXLFNO\
transmits to other neighboring countries; the 1998 Russian currency crisis
DQG 5XVVLD¶V GHIault on its debt. As predicted and anticipated by many,
Turkey experienced the inevitable; the biggest economic crisis in 2001.
Bredenkamp et al. (2009) argue that the Turkish economy, like many of its
peers in the developing world, was characterized by heavy regulation,
protection from foreign competition, and extensive state involvement in
commercial activity. Following the series of boom and busts between the
late 1980s and the early 2000s, Turkey enjoyed strong and uninterrupted
expansion until 2007 (Rawdanowicz, 2010). Turkey witnessed a high
degree of political instability during 1980s and 90s (15 governments, 10 of
which were coalitions or minority governments), which was also
accompanied by skyrocketing inflation (over 70% by 1990s) and chronic
budget deficit fueled by regular money printing. When the massive
earthquake (7.6 of magnitude) on August 17, 1999 (epicenter Kocaeli) was
added into the equation, things became uncontrollable.
By December of 1999, the government, headed by the Prime Minister

%OHQW(FHYLW'63'HPRFUDWLF/HIW3DUW\ZDVIRUFHGWRVLJQDµ6WDQGE\
$UUDQJHPHQW¶ ZLWK ,0) for in excess of $10 billion (original agreement
was about $4 billion) 7KH ILQDO ELOO RI 7XUNH\¶V ZRUVW ILQDQFLDO GLVDVWHU
ever was nearly $50 billion. Bredenkamp et al. (2009) point out that by the
181

HQG RI WKHVWDWH EDQNV¶ GXW\ ORVVHVKDG JURZQ WR VRPH ELOOLRQ
their short-term liabilities to some $22 billion and their foreign exchange
exposure to $18 billion. When the crisis hit in February 2001, the value of
Turkish lira depreciated almost half of its value overnight.
Banks in Turkey during the 1990s enjoyed a very loosely monitored

financial sector; plus, the banking rules were so easily manipulated in order
to show better financial results than actual numbers. In addition, all the
PDMRUEDQNVZHUHIDPLO\RZQHGLH$NEDQNE\6DEDQFÕIDPLO\DQG<DSÕ
Kredi by Koç family both of which are the two richest families in Turkey)
which allowed them to be used as a way of funneling money to other
family-owned businesses for either paying less or no tax to the government.
The Savings Deposit Insurance Fund-SDIF (TMSF in Turkish) managed
banks (2 in 1998) increased to 8 by 2000 and 13 by 2001.
After so many crises in the 1990s; the 1994 economic crisis in Turkey and
the negative effects of the late 1997 and early 1998 Asian crisis and 1998
Russian devaluation of its ruble along with its debt default; establishment
of the Banking Regulation and Supervision Agency of Turkey (BRSA or
BDDK in Turkish) became absolutely necessary in 1999. By 2003, a total
of 11 banks with combined assets of $11.4 billion failed and they were
transferred to the TMSF.267 Before the 2001 crisis, the Turkish banking
sector had $117.7 billion in total assets; all together 61 banks had 6,885
branches with 138,962 employees. Private bDQNV¶ risk exposure to FX
(foreign exchange) positions on balance sheets was at an alarming level by
November, 2000 ($10.67 billion); however, the FX risk improved a bit
(16.03%) by February, 2001 ($8.96 billion), then diminished and became
no issue in the following few years later.

267
See BDDK, http://www.bddk.org.tr/WebSitesi/English.aspx
182

Amid macroeconomic uncertainties, Turkey still witnessed rather a quick
expansion of its banking sector during most part of the 1990s; the number
of banks increased from 43 in 1980 to 66 in 1990 and to 79 by the end of
2000. However, 5 banks (Egebank, Bank Kapital, Yurtbank, YaúDUEDQN
and Ulusal Bank) were merged under Sümerbank when they were
transferred to the Savings Deposit Insurance Fund (TMSF), reducing the
number of banks to 74 by mid-2001. Of these 74 banks, 56 banks were
deposit money banks and 18 were investment & development banks. Of the
56 deposit money banks, 4 were state banks, 26 were private domestic
banks, l8 were private foreign banks and 8 were still under TMSF.
Table 34 ǣ ʹ͸ͺ
Billion $USD* 1990 1994 1999 2000 2001 2002 2003
Total Assets ϱϴ͘Ϯ ϱϮ͘ϲ ϭϯϯ͘ϱ ϭϱϱ͘Ϯ ϭϭϳ͘ϳ ϭϯϬ͘ϭ ϭϱϭ͘ϰ

Total Loans Ϯϳ͘ϯ ϮϬ͘ϲ ϰϬ͘Ϯ ϱϬ͘ϵ Ϯϯ͘ϰ ϯϬ͘ϭ ϯϳ͘Ϭ
Securities ϲ͘Ϭ ϱ͘ϵ ϮϮ͘ϵ ϭϳ͘ϴ ϰϭ͘Ϯ ϱϮ͘ϳ ϲϵ͘Ϯ
Total Deposits ϯϮ͘ϲ ϯϯ͘Ϯ ϴϵ͘ϰ ϭϬϭ͘ϵ ϳϲ͘ϲ ϴϰ͘ϰ ϵϱ͘ϰ
Banks ϲϲ ϲϳ ϴϭ ϳϵ ϲϭ ϱϰ ϱϭ
Branches ϲ͕ϱϲϬ ϲ͕Ϭϴϳ ϳ͕ϲϵϭ ϳ͕ϴϯϳ ϲ͕ϴϴϱ ϲ͕Ϯϭϲ ϲ͕ϭϲϵ
3HUVRQQHO¶ ϭϱϰ ϭϯϵ ϭϳϰ ϭϳϬ ϭϯϵ ϭϮϰ ϭϮϰ
* Billion $USD except number of banks, branches, and personnel numbers
Turkish Banking Sector after the 2001 Crisis
gQLúRIIHUVIRXUNH\LQWHU-related elements for the expansion of the

Turkish economy fueled by a resilient banking system post 2001 financial
crisis; 1) the crucial role of the IMF and the World Bank; 2) transformation
RIWKHUHODWLRQVKLSEHWZHHQWKHVWDWHDQG7XUNH\¶VILQDQFLDOVHFWRUWKURXJK

268
Source: The Banks Association of Turkey, BRSA & Ercan Türkan BRSA London
presentation, October 20, 2003
183

regulatory reforms; 3) significant inflow of foreign direct investment; and
lastly 4) LQWURGXFWLRQRIQXPHURXVUHIRUPVDLGLQJ7XUNH\¶VELGWRMRLQLQWR
the European Union (EU). Bredenkamp, Josefsson, and Lindgren (2009)
DUJXHG WKDW 7XUNH\¶V LPPHGLDWH FKDOOHQJH in the aftermath of 2001 crisis
ZDVWRGHFLGHZKDWVWHSVWRWDNHWRUHVWRUHLQYHVWRUV¶FRQILGHQFHTherefore,
it became absolutely apparent that tKHJRYHUQPHQW¶VILUVW critical step was
to form a new, strong economic team that would be capable of taking
extreme measures with great deal of confidence WR WDFNOH JRYHUQPHQW¶V
urgent financing issues. .HPDO 'HUYLú D VHQLRU :RUOG %DQN executive
(vice president), was overwhelmingly considered for the job to head this
new economic team whose challenging task was to design a new economic
program first to repair the wreckage in the banking system, and then
stabilize the swelling budget due to huge repair costs (over $50 billion), as
well as keep the inflation under control.
The Banking Regulation and Supervision Agency (BRSA), as the

independent authority by law to regulate and supervise the banking sector,
identified four fundamental areas to work on to strengthen the banking
system; (1) improve the position of the devalued Turkish lira-TL against
other currencies (macroeconomic instability and ongoing chronic inflation
volatility along with unstable political environment reduced the LQYHVWRUV¶
confidence in TL and forced them to take significant positions in foreign
currencies); (2) resolve inadequate capital base in public sector (insufficient
liquidity enabled private banks to borrow from overseas banks at low
interest rates and supply the funds to the public sector with very high
interest rates, this in turn led to a substantial risk increase of SULYDWHEDQNV¶
in FX position); (3) develop a state bank reform (inefficient, illiquid, and
ineffectively operated state banks caused further deterioration in the whole
financial system due to their frequent borrowing activity at high interest
184

rates and short maturities to cover their losses); (4) create a sound, well
working regulatory and supervisory framework (Existence of deposit
insurance along with ineffective supervision and an absence of a strong
regulatory process made banks pay less or no attention to both risk
assessment and risk management). All of these deficiencies or banking
flaws have been sufficiently addressed by the BRSA in a decade-long
process; these issues are also covered under Basel III.269
7KH SROLWLFDO LQVDWLDELOLW\ DQG LWV QHJDWLYH HIIHFWV LQ 7XUNH\¶V HFRQRPLF
growth could be understood better when the next lines are analyzed. There
had been six parliamentary election periods between 1983 and 2002 (1983,
1987, 1991, 1995, 1999, and 2002) and 9 different parties took part in the
government. The election years of 1991, 1995, and 1999 saw two-party or
three-party coalition governments. Moreover, Turkey¶V SROLWLFDO SURFHVV
has been intervened by tKH FRXQWU\¶V military at four different times
causing further instability (the coups of 1960, 1971, and 1980; and the
1997 military memorandum (also known as the "coup by memorandum").
The study by Feridun (2004) points out that the political considerations
were an important factor behind the 2001 financial crisis. In particular, his
study suggests that political insatiability in the 1990s in Turkey was
primarily the direct result of divided coalitions which were mainly
interested in political gain of power than the good of the country.
Furthermore, frequent elections seriously affected the Turkish
JRYHUQPHQW¶V MXGJPHQW WR FRUUHFW VRPH RI WKH PDFURHFRQRPLF
misalignments and fiscal severity, which resulted in frequent devaluation of
Turkish lira. :KHQ7XUNH\¶VUHFHQWHFRQRPLFKLVWRU\LVYLHZHGLWLVIXOORI
shockingly surprising events of forward progress, which is not really

269
6RXUFH6XQGD\¶V=DPDQ %''.KWWSZZZEGGNRUJ.tr/WebSitesi/English.aspx
185

DFFXVWRPHG RU OLNHOLKRRG YLHZ RI 7XUNH\¶V SDVW KLVWRU\ )RU LQVWDQFH WR
outsiders, Turkey is more known for its frequent economic crises where
chronic case of inflation is a usual scene; unstable political atmosphere is
always present (parliamentary elections leading to two-party or three-party
coalition governments); poor financial regulation, constant corruption,
worrisome budget and trade deficits, and weak governance.
Table 35 ʹͲͲͳ ʹ͹Ͳ
$ billion USD 2001 2010 $ billion USD 2000 2001 2010

Loans ($) Ϯϭ͘ϳ ϯϬϬ͘ϲ GDP ($) ϭϳϯ͘ϲ ϭϲϲ͘ϴ ϳϱϯ͘Ϯ
Deposits ($) ϱϳ͘ϰ ϯϱϮ͘ϲ Growth (%) ϲ͘ϴ Ͳϱ͘ϳ ϴ͘ϵ
Employees ϭϰϭ ϭϵϭ PPI (%) ϯϮ͘ϳ ϴϴ͘ϲ ϴ͘ϴ
Branches ϲ͕ϵϴϯ ϭϬ͕Ϭϲϲ CPI (%) ϯϵ ϲϴ͘ϱ ϲ͘ϰ
Total Assets ($) ϭϭϳ͘ϳ ϱϳϲ͘Ϭ Export ($) ϰϭ͘ϯ Ϯϭ͘ϴ ϭϭϰ͘Ϭ
Profit/Loss ($) Ͳϲ͘Ϭ ϭϮ͘ϱ Budget Deficit ($) ϭϵ͘ϱ ϭϵ͘ϴ ϯϬ͘ϰ
Banks ϲϳ ϰϵ Unemployment (%) ϲ͘ϱ ϴ͘ϰ ϭϭ͘Ϭ
But not anymore, the financial and social achievements of Turkey in less
than a decade are envied by many people; moreover, even some countries
have been considering adopting what Turkey has done with its banking
system through the resilient work of the TMSF. When the recent economic
numbers are analyzed (see table 6), it is better understood what enormous
success Turkey was able to accomplish especially aftermath of the biggest
financial and economic shock in its modern history since 1923. Turkey is a
natural energy resources poor country; thus, it heavily depends on foreign

270
6RXUFH %''. ³6WUXFWXUDO &KDQJHVLQ %DQNLQJ´9ROXPH 'HFHPEHU ,661-1307-
5691, prepared by the author (11 failed banks were trasfered to the TMSF; Demirbank
(2000), Ulusal Bank (2001), Iktisat Bank (2001), Kentbank (2001), Ege Bank (2001),
%D\ÕQGÕU %DQN 6LWHEDQN 0LOOL $\GÕQ %DQN 7RSUDN %DQN
Pamukbank (2002), and Imar Bank (2003). Exchange rate $1 = 1.75 TL is used.
186

resources in order to grow. 7KH,($GDWDVKRZVWKDW7XUNH\¶VORZHUHQHUJ\
import dependence and higher energy efficiency would help redress current
account imbalances. Energy self±sufficiency in Turkey was around 30% in
2008, implying a heavy reliance on energy imports. Consequently, trade
deficits in energy were high (Rawdanowicz, 2010).
Turkey is always in desperate need of healthy foreign direct and portfolio

investment inflows (FDIs & FPIs) to make up for the usual gaps in its fiscal
and current account imbalances. Rawdanowicz (2010) believes that a
successful energy strategy would also support stronger economic growth.
Although Turkey has done a spectacularly fine job in most parts of the
economy, but it has not been able to successfully tackle urban
unemployment, budget, current account, and trade deficits. Reuters
reported on October 6, 2012 that Turkey's budget deficit was set to widen
sharply to 33.5 billion lira ($18.5 billion) this year, and Finance Minister
Mehmet Simsek said on Tuesday that this was exceeding the official
forecast by more than half.271 Last October (2011), the current account
deficit ballooned to a record $78.3 billion, or 10% of GDP, spooking
investors and prompting a lira selloff that by December led to double-digit
inflation for the first time in three years. However, government officials say
that the current account deficit is expected to narrow until October 2012
and the year-end target remains to be $59.1 billion. The unemployment rate
in urban cities is still above 11% (rural, around 7%).272
Globalization of finance made Foreign Direct Investments (FDIs) and

Foreign Portfolio Investments (FPIs) become crucial components of further
development for emerging and developing countries; however, excessive
FPI inflows can have potentially adverse effects because as easily they

271
http://www.reuters.com/article/2012/10/16/turkey-budget- idUSL5E8LG63L20121016
272
http://online.wsj.com/article/SB10000872396390444017504577645031874268416.html
187

inflow, they can also outflow the same way. This characteristic alone
makes FPI one of the hottest and most volatile types of foreign investments.
$V 5D]LQ SXW LW )',V¶ ORQJ-term contributions to the general
economy can be more lasting and therefore less volatile than those of FPIs.
It is true that any investment, whether physical (FDI) or non-physical (FPI),
can be irreversible once made, however in the case of an FDI, funds
associated with that particular investment may not be irreversible (Sarno
and Taylor, 1999). There are two camps of thoughts; on one hand, Broner
and Rigobon (2004) argue the case of more volatility of FPI inflows to
emerging markets than those to mature markets; Bekaert and Harvey
(2003), on the other hand, believe the reverse being true meaning FPI
inflows to emerging markets are less volatile than developed countries.
Chart 14 ȋ̈́Ȍ ʹ͹͵
7XUNH\¶V XQSUHFHGHQWHG HFRQRPLF SURJUHVV in recent years has been

contributed in part due to foreign capital inflows as in FDIs or FPIs.
However, Turkey still has a long way to catch up with the FDI levels of
countries such as the United States which is still by far the number one FDI

273
6RXUFH7KH:RUOG%DQN³)RUHLJQGLUHFWLQYHVWPHQWQHWLQIORZVFXUUHQW86´FKDUWLV
prepared by the author
188

recipient (nearly $200 billion in 2010); China comes as second with little
less than half of the US (almost $90 billion). As of 2010, Turkey received
$61.5 billion worth of FPI inflows invested in the equity market and
received another $32.7 billion of FPI inflows invested in the bond market.
Chart 15 ǡ ȋ̈́Ȍʹ͹Ͷ
The top five European countries with high FDI inflows ($46.2 billion
which was 53.2% of all FDI inflows in 2006) to Turkey in 2006 were;
Netherlands ($18.5 billion), United Kingdom ($7.3 billion), France ($7.3
billion), Germany ($7.2 billion), and Belgium ($5.8 billion). Out of the
three main FDI receiving sectors, services sector ($58.8 billion) was the top
recipient, industrial sector came as second with $27.9 billion, and as
expected agriculture came last ($141 million). As far as FPI inflows were
concerned, Turkey received a total of $117.3 billion foreign portfolio
investments in equities ($59 billion), $33.2 billion in government domestic
debt securities (GDDS), and $25 billion for bonds issued abroad.275
A nonperforming loan (credit) is either delinquent (past due) for 90 days or

more, or it is a loan that is close to being in default. One of the most

274
6RXUFH7KH:RUOG%DQN³)RUHLJQGLUHFWLQYHVWPHQWQHWLQIORZV´SUHSDUHGE\WKHDXWKRU
275
6HH7KH&HQWUDO%DQNRI7XUNH\³,QWHUQDWLRQDO,QYHVWPHQW3RVLWLRQ5HSRUW´
189

obvious outcomes of a crisis is a natural tendency for payment
delinquencies and loan defaults to increase. Thus, Turkey is no different,
which saw the largest non-performing loans during the first couple of years
after the 2001 crisis (12.7% in 2002 and 11.5% in 2003). However by 2004,
non-performing loan figures sharply declined to a more manageable level,
and then continued descending all the way to 3.1% in 2011 except a little
spike in 2009 (jumped from 3.8% in 2008 to 5.6%) which may be
contributed to the global effects of the 2008 crisis.
Chart 16 ʹ͹͸
The rate of non-performing commercial and consumer loans and credit

cards, which totaled 4.7 billion lira ($2.69 billion) in September 2011, rose
by 65 percent to 7.9 billion lira ($4.51 billion) in April 2012. In 2011,
447,000 people were not able to pay their consumer loans to the banks (an
increase of 183%); furthermore, in the first two months of 2012, 154,000
people could not pay their card debts. As of January 2012, there was a
significant rise in all nonperforming loans; 13.96% increase in consumer
loans, 13.51% in commercial loans, and 10.43% in credit cards.277 Ergün
Özen, the CEO of Garanti Bank, said that rising non-performing loans in

276
6RXUFH7KH:RUOG%DQN³)RUHLJQGLUHFWLQYHVWPHQWQHWLQIORZV´SUHSDUHGE\WKHDXWKRU
277
See Hürriyet Daily News, http://www.hurriyet.com.tr/english/finance/11507810.asp?gid=236
190

2012 will hit profits. He also mentioned that although nonperforming loans
are increasing both for Garanti and other Turkish banks in general,
*DUDQWL¶V QRQSHUIRUPLQJ ORDQ UDWLR however was 1.9 percent in the first
quarter and the LQGXVWU\¶VZDV278
Chart 17 ʹ͹ͻ
Even WKRXJK7XUNH\¶VEDQNLQJVHFWRULVVKRZLQJincreasing nonperforming

loan numbers in recent months, nonetheless the nonperforming percentage
to the total gross loans (ratio) still remains fairly small when it is compared
to countries in Europe or North America, which were 3.1% in 2011 and
2.7% in 2012. The World Bank nonperforming loans data of 2012 shows
that the Turkish banking industry figure (2.7%) is closely compatible with
the figures of other banking industries in developed nations. For instance,
7XUNH\¶V QRQSHUIRUPDQFH ILJXUH LV EHWWHU WKDQ WKose of Italy (7.8%), the
United States (4.9%), Spain (4.6%), France (4.2), the United Kingdom
(4.0%), Malaysia (3.4%), and Germany (3.3%). However, Canada (1.2%)
and China (1.1%) had better nonperforming figures than Turkey.280

278
See http://www.bloomberg.com/news/2012-04-25/rising-non-performing-loans-will-hit-
profit-garanti-says-1-.html
279
6RXUFH7KH:RUOG%DQN³)RUHLJQGLUHFWLQYHVWPHQWQHWLQIORZV´SUHSDUHGE\WKHDXWKor
280
6RXUFH7KH:RUOG%DQN³%DQNQRQSHUIRUPLQJORDQVWRWRWDOJURVVORDQV´
191

A considerable consolidation and structural changes took place in Turkish

banking sector for a decade after the biggest financial shock in TurkH\¶V
modern history arising from the 2001 crisis. The number of banks in
operation came down from 81 in 1999 to 48 as of 2012. The Banking
Regulation and Supervision Agency (BRSA and BDDK in Turkish) is now
well established with a strong commanding regulatory authority over all
banking operations in Turkey.
Chart 18 ȋΨ
Ȍʹͺͳ
By December 2012, the Turkish banking sector consisted of three main

segments by asset size; money deposit banks (92%), profit/loss sharing
(interest free) banks (4.6%), and development & investment banks (3.4%).
)RUHLJQEDQNV¶SUHVHQFHLQWKHEDQNLQJVHFWRUKDVDOVRJURZQYHU\VWURQJ
LQUHFHQW\HDUVPRUHRYHUWKHIRUHLJQFRPSDQLHV¶VKDUHLQWKHVHFWRU¶VWRWDO
profit from 2010 to 2011 has more than tripled, 2.1% and 7.5% respectively.
Bank loans continue to dominate all banking activities, consumer loans and
mortgage loans are two major growth areas in all banks.

281
6RXUFH7KH:RUOG%DQN³Domestic Credit Provided by Banking Sector (% of GDP´
192

$VRI'HFHPEHUEDQNV¶DFWLYLWLHVE\DVVHWVL]HDUHFRPSULVHG 84.9%
domestic and 15.1% international. Especially due to the 2008 crisis,
7XUNLVK EDQNV¶ LQWHUQDWLRQDO SRVLWLRQV KDYH EHHQ GHVFHQGLQJ VLQFH WKHQ
EDQNV¶ RYHUVHDV DVVHWV GURSSHG IURP LQ WR DV RI
December 2011. In 2011, banks in the sector through their bank branches
provided $393.27 billion worth of loans; of these loans, $361.7 billion was
provided by the domestic branches and $28.6 billion was given by the
branches in overseas markets.
Table 36 ǡ ʹͺʹ
all numbers in % 2005 2006 2007 2008 2009 2010 2011

Large Banks (4) ϳϰ͘Ϭ ϳϱ͘Ϯ ϳϰ͘Ϭ ϳϰ͘ϯ ϳϱ͘ϱ ϳϰ͘ϴ ϳϯ͘Ϯ

Medium Banks (9) ϭϲ͘Ϭ ϭϰ͘ϵ ϭϲ͘ϱ ϭϲ͘ϰ ϭϲ͘ϯ ϭϲ͘ϴ ϭϴ͘ϱ
Small Banks (14) ϭϬ͘ϭ ϵ͘ϴ ϵ͘ϱ ϵ͘ϯ ϴ͘Ϯ ϴ͘ϱ ϴ͘Ϯ
Money Deposit ϵϬ͘ϰ ϵϮ͘ϱ ϵϭ͘ϵ ϵϮ͘Ϭ ϵϬ͘ϱ ϵϭ͘ϭ ϵϭ͘Ϭ

Dev. & Investment ϯ͘ϳ ϯ͘ϯ ϯ͘ϭ ϯ͘Ϯ ϯ͘ϱ ϯ͘Ϭ ϯ͘ϰ
P/L Sharing Banks ϱ͘ϵ ϰ͘ϯ ϰ͘ϵ ϰ͘ϴ ϲ͘Ϭ ϱ͘ϵ ϱ͘ϲ

First 5 Banks ϲϯ͘ϵ ϲϯ͘Ϯ ϲϮ͘Ϯ ϲϮ͘ϯ ϲϮ͘ϲ ϲϯ͘ϭ ϱϵ͘ϴ

First 10 Banks ϴϲ͘ϵ ϴϳ͘ϯ ϴϲ͘ϯ ϴϲ͘ϭ ϴϲ͘ϭ ϴϲ͘ϵ ϴϲ͘ϱ
Part of the $361.7 domestically generated loans, 23.6% of the loans were in
foreign currencies ($85.36 billion); and out of the $28.6 billion of the
internationally generated loans, and 2.3% was in Turkish lira ($657.8
PLOOLRQ$OWKRXJKGHSRVLWJHQHUDWLRQE\WKHEDQNV¶RYHUVHDVEUDQFKes has
been declining for the past few years, however the share of deposits by
foreign residents in Turkish banks has increased to 4% as of 2012.283

282
6RXUFH%''.³6WUXFWXUDO&KDQJHVLQ%DQNLQJ´9ROXPH'HFHPEHU,661-1307-
5691, prepared by the author
283
%''.³6WUXFWXUDO&KDQJHVLQ%DQNLQJ´9ROXPH'HFHPEHU,661-1307-5691, p.30
193

As of December 2011, the top five banks (1. øú %DQN =LUDDW %DQN
(public), 3. Garanti Bank, and 4. Akbank) in Turkey enjoyed 63.47%
ELOOLRQ RI WKH VHFWRU¶V EDQNV WRWDO PRQH\ GHSRVLW DFFRXQWV
amounting to $1.12 trillion lira ($639.95 billion). Same way, three of the 13
development & LQYHVWPHQW EDQNV DOVR FRQWUROOHG RI WKH VHJPHQW¶V
(13 banks) $41.64 billion of assets.
Table 37 ǡʹͲͳͳ ʹͺͶ
Business loans % Consumer loans % SME loans %

Garanti Bank ϭϯ͘Ϯ Ziraat Bank ϭϳ͘Ϯ <DSÕ.UHGL ϭϮ͘ϰ
,úBank ϭϮ͘Ϭ 9DNÕIODU%DQN ϭϭ͘ϰ Halk Bank ϭϮ͘ϯ
Ziraat Bank ϭϬ͘Ϯ ,ú%DQN ϭϭ͘Ϯ ,ú%DQN ϭϭ͘ϵ
Akbank ϭϬ͘Ϯ Garanti Bank ϭϬ͘ϳ Garanti Bank ϭϬ͘ϰ
<DSÕ.UHGL ϵ͘ϱ Akbank ϵ͘Ϯ Akbank ϵ͘ϭ
9DNÕIODU%DQN ϴ͘ϯ Halk Bank ϴ͘ϯ Ekonomi Bank ϱ͘ϰ
Halk Bank ϴ͘ϭ <DSÕ.UHGL ϳ͘ϵ VDNÕIODU%DQN ϱ͘ϯ
Finans Bank ϰ͘ϯ Finans Bank ϲ͘ϭ Ziraat Bank ϰ͘ϵ
Ekonomi Bank ϯ͘ϲ Deniz Bank ϰ͘ϭ Finans Bank ϯ͘ϳ
Deniz Bank ϯ͘Ϯ Ekonomi Bank ϯ͘ϳ ING Bank ϯ͘ϯ
Total ϴϮ͘ϲй Total ϴϵ͘ϴй Total ϳϴ͘ϳй
Significant portion (88.2%) of commercial (business) loans were generated

by money deposit banks by the end of 2011; the remaining was shared by
development & investment banks (4.8%) and profit/loss sharing banks
(7%). Small business loans are 35% of all business loans generated by all
banks in the sector. Nevertheless, the credit market for SMEs has been
shrinking since 2006, but the declining period ended in 2011. Just like in all
banking segments, the SME credit market is also fundamentally dominated

284
6RXUFH%''.³6WUXFWXUDO&KDQJHVLQ%DQNLQJ´9ROXPH'HFHPEHU,661-1307-
194

by the large money deposit banks having 66.4% (7 of the 31 banks);
medium-size banks had a respectable 24.6% share; and 7.2% was handled
by the small banks. All 31 money deposit banks enjoyed 88.8% of loans
given to small-medium size businesses. The profit/loss sharing banks has
increased their market share to 9.5%.285
A great deal of competition between banks exists; for instance, 4 of the 18

micro-size banks in 2010 (2 money deposit banks and 2 development &
investment banks) moved into small-size bank segment in 2011; and one of
the small development & investment bank was promoted to the medium-
size bank segment. The ownership of the Turkish banking sector consists of
26.5% (public), 35.4% (global investors), 27.3% is publicly traded in the
Istanbul stock exchange. Out of the 48 banks in Turkey, 35 banks currently
have foreign investment in their ownership composition. Also, 22 of 48
banks have operations outside of Turkey. Furthermore, the Turkish banking
sector could be seen by potential foreign investors as less risky due to the
fact that 71% of all the banks in Turkey is structured as main partnership
by several owners.286
High concentration of assets by few banks in both money deposit bank and
development & investment bank segments may be viewed as posing
possible risks because limited diversification. There was no major
dominance by any banks in four of the profit/loss sharing banks, interest
free banking ($56.15 billion), as observed in other two segments. The
banking sector is divided into four areas by bank asset size:287 7 large
money deposit banks comfortably enjoy 73.2% of the industry; 9 medium-
VL]HPRQH\GHSRVLWEDQNV¶VKDUHLVVPDOO-size banks have 6.8%;

285
6HH%''.³6WUXFWXUDO&KDQJHVLQ%DQNLQJ´9ROXPH,661-1307-5691, pp.45-46
286
6HH%''.³6WUXFWXUDO&KDQJHVLQ%DQNLQJ´9ROXPH,661-1307-5691, p.22
287
Large banks (5% or higher), medium (between 1% and 5%), small (between 0.20% and 1%),
micro (below 0.20%)
195

and 18 micro-size banks have an insignificant 1.4% share of the banking
sector. Out of the 18 micro-size banks, the share of the 13 banks is below
0.1% (less than $12 billion).288
As of December 2011, 96.3% of consumer loans were provided by the

money deposit banks, and 3.3% was handled by the profit/loss sharing
banks. Public banks have the highest market share (26.8%) in this segment.
Except one bank (ING Bank), the top 10 list has not changed from 2010 to
2011. The largest public bank, the Ziraat Bank, kept its number one place
LQ9DNÕI%DQNQXPEHUWZRODUJHVWSXEOLFEDQNLPSURYHGLWVUDQNLQJ
from number 4 in 2010 to number 2 in 2011. The position of the third
largest public bank, Halk Bank, remained same as the number 6 place. The
(8 FRXQWULHV RQ DYHUDJH JDYH ¼ ELOOLRQ DV FRQVXPHU ORDQV DQG WKLV
QXPEHUIRU7XUNH\ZDVDURXQG¼ELOOLRQ289
0RUHWKDQKDOIRIWKHEDQNV¶ branches are located in five big cities

(30% in Istanbul, Ankara (capital city), Izmir, Antalya, and Bursa). Banks
in the Turkish banking sector have operations in 34 different countries.
Most of overseas operations are located in Northern Cypress Turkish
Republic (KKTC) and other Turkish speaking countries. Although branch
operation in the European zone is more evenly distributed, the Nederland
has a considerably larger share among the other EU countries. Banks
continued opening new branches in 2011 as they did in past years; banks
increased domestic branches by 4% (402 more branches) bringing the total
to 10,468. Out of those 88 overseas branches, 76 are off-shore and 12 of
them are on-shore branches. For further growth, banks opened 10 branches
in Bahrain, 4 in Iraq, and one in Saudi Arabia.290

288
SeH%''.³6WUXFWXUDO&KDQJHVLQ%DQNLQJ´9ROXPH,661-1307-5691, p.19
289
6HH%''.³6WUXFWXUDO&KDQJHVLQ%DQNLQJ´9ROXPH,661-1307-5691, pp.47-48
290
196

Even though profits of the foreign owners in the banking sector have
increased from 2.1% in end of 2010 to 7.5% in December 2011; however,
this huge rise in profits is overshadowed when the market size (15.1% of
all banks in Turkey) of the foreign banks is taken into consideration. 2011
saw a limited activity in mergers and acquisitions (M&A); a domestic bank
and an international bank merged bringing the bank total to 48.
Table 38 ȋȌʹͻͳ
Rank Name of Bank Deposits $ % of Sector % of Group
Money Deposit Banks 31 banks total = $639.95 billion USD

1 Türkiye øú%DQN ϵϮ͕ϰϰϯ ϭϯ͘Ϯϵ ϭϴ͘ϭϰ
2 T.C. Ziraat Bank ϵϭ͕ϴϭϴ ϭϯ͘ϮϬ ϭϴ͘ϬϮ
3 Türkiye Garanti Bank ϴϯ͕ϳϵϱ ϭϮ͘Ϭϰ ϭϲ͘ϰϱ
4 Akbank ϳϲ͕ϯϭϱ ϭϬ͘ϵϳ ϭϰ͘ϵϴ
Total ϯϰϰ͕ϯϳϭ ϰϵ͘ϱй ϲϳ͘ϱϵй
Profit & Loss Sharing Banks 4 banks total = 32.07 billion USD
1 $V\D.DWÕOÕP%DQN ϵ͕ϴϮϮ ϭ͘ϰϭ ϯϬ͘ϲϮ
2 Kuveyt Türk Bank ϴ͕ϱϰϰ ϭ͘Ϯϯ Ϯϲ͘ϲϲ
3 Albaraka Türk Bank ϱ͕ϵϳϴ Ϭ͘ϴϵ ϭϴ͘ϲϯ
Total Ϯϰ͕ϯϰϰ ϰ͘ϲϰй ϭϬϬй
Development & Investment Bank 13 banks total = $23.79 billion USD

1 øOOHUFLWLHV%DQN ϲ͕ϱϭϬ Ϭ͘ϵϰ Ϯϳ͘ϯϲ
2 7UNøKUDFDW.UHGL%DQN ϱ͕ϱϮϬ Ϭ͘ϳϵ Ϯϯ͘ϮϬ
3 Türk 6ÕQDL.DONÕQPD ϱ͕ϰϬϯ Ϭ͘ϳϴ ϮϮ͘ϳϭ
4 7UN.DONÕQPD%DQN ϭ͕ϲϬϬ Ϭ͘Ϯϯ ϲ͘ϳϮ
Total ϭϵ͕Ϭϯϯ Ϯ͘ϳϰй ϳϵ͘ϵϵй
Grand Total ϯϵϱ͕ϰϳϴ ϱϲ͘ϴϴй ϲϭ͘ϴϬй

291
SourcH%''.³6WUXFWXUDO&KDQJHVLQ%DQNLQJ´9ROXPH'HFHPEHU,661-1307-
197

The BRSA awarded a banking license to a foreign investment group in
2011. As of last year, nearly 2/3 of all 48 banks are money deposit banks
(31) and about 50% of these banks contain foreign investment. Within the
last decade, there has been no change in the public bank number and there
has been a decline in privately funded banks.292
After 19 IMF Standby arrangements and a total borrowing of over $50

billion (remaining $1.7 billion IMF debt will be paid in April 2013),
Turkey finally decided to end its long-running relationship with IMF since
1960s and said that it would not sign another standby arrangement after the
conclusion of the 19th arrangement which ended in May 2008. The last
three standby arrangements were particularly important for Turkey to
manage the 2001 crisis adequately; Turkey received $34.5 billion from
IMF, $15.0 billion at the 17th (1999-2002), $12.8 billion at the 18th (2002-
2005), and $6.7 billion at the 19th arrangements (2005- 7XUNH\¶V
recent pledge of $5 billion to help boost IMF account, which is first ever in
7XUNH\¶V-year history, shows clearly how far the Turkish economy has
developed in just a decade time since the 2001 crisis.293
7XUNH\¶V UHPDUNDEOH HFRQRPLF GHYHORSPHQW DQG ILQDQFLDO JURZWK DORQJ

with a major decline in interest rates created a perfect opportunity for
establishment of the real estate mortgage industry which has been the
fastest growing segment in Turkish banking industry. As of December
2011, mortgage loans make up 11% of all loans and 33% of personal loans
(individual loans). A decline of mortgage loans in small-size banks has
been observed; thus, 97.7% of all mortgage loans are provided by the large
and medium-size banks. The money deposit banks, as usual, hold 93.3% of
the mortgage loan market; the remaining 6.7% is provided by the

292
293
6HH7KH&HQWUDO%DQNRI7XUNH\³,QWHUQDWLRQDO,QYHVWPHQW3RVLWLRQ5HSRUW´
198

profit/loss sharing banks whose market share improved from 5.5% in 2010
to 6.7% in 2011. Even though the banking industry experienced a strong
growth in real estate mortgage sector, the volume of mortgage loans was
aroXQG¼ELOOLRQDVRIWKLVZDVWULOOLRQIRUWKH86ELOOLRQ
for the UK, $962 billion for Germany, $716 for France, $657 for Spain,
$378 for Holland, $68 for Greece, and $27 for Russia.294
The credit card segment (8% of all loan types and 25% of consumer loans)
continues to be one of the most important business areas in Turkish
banking sector. The market share of large and medium size banks has not
changed from 2010 to 2011, which is 98.1% as of December 2011. The top
banks by volume in the credit card segment included two public banks and
eight private banks. Yapi Kredi Bank was number one in both 2010 and
2011; the two public banks were 9DNÕI%DQNUDQNHGQXPEHUDQG=LUDDW
Bank (number 8). In 2010, The U.S. was on top of the list with 39% of all
transactions done by credit card; the U.S. fell to the second place for
payments by check (30.9%), China with 44.9% took the first place.295

Simon Clark, Bloomberg Businessweek ± Global Economics, reported that
7XUNLVK)LQDQFH0LQLVWHU0HKPHW6LPVHNVDLG³7XUNH\¶VEDQNLQJLQGXVWU\
would have a capital adequacy ratio of about 17% if the country
implemeQWHGWKH%DVHO,,,¶VQHZUXOHVWRGD\´296 Regardless of new capital
requirements under Basel II or III, Turkish banking system has already
been under a great deal of scrutiny for some time and the banks have been

294
295
296
See Bloomberg Businessweek, http://www.businessweek.com/stories/2010-11-24/turkish-
banks-would-have-17-percent-basel-iii-capital-simsek-saysbusinessweek-business-news-
stock-market-and-financial-advice
199

operating under heavy regulation of the BRSA since 2002. Furthermore,
banks operating in Turkey must keep a capital adequacy ratio (CAR) of
12% in order to open bank retail branches. Although some minor issues are
expected to come, in general majority of banks in Turkey feel that Basel
,,,¶Vnew stringent capital requirements will not pose significant challenges
because banks in Turkey are already above 12% CAR.
Chart 19 ʹͻ͹
Wolfgang Schilk, executive vice-SUHVLGHQW IRU ULVN PDQDJHPHQW DW <DSÕ

.UHGL%DQNIRXUWKODUJHVWEDQNLQ7XUNH\IHHOVWKDW³ORFDOUHJXODWLRQLV
very strict and very clear, so either it will go on like this or we will need to
see some harmonization with EXURSHDQ 8QLRQ FRXQWULHV´298 Ali Ulvi
6DUJRQ +DONEDQN¶V ULVN PDQDJHPHQW SUHVLGHQW FODLPV WKDW ³DOWKRXJK WKH
return on equities might be adversely affected because of the additional
capital requirements under Basel III, it is highly expected that these
measures will make positive contributions to the growth rates in the middle
term. Besides, it is quite obvious that a banking system with stronger

297
See BDDK, http://www.bddk.org.tr
298
6HH 5LVN 0DJD]LQH QHZV ³7XUNLVK EDQNV VHHN IUHHGRP DV %DVHO ,, KLWV FDSLWDO UDWLRV´
http://www.risk.net/risk-magazine/feature/2183190/turkish-banks-seek-freedom-basel-ii-
hits-capital-ratios
200

capital structure will have a more effective role in the creation of
PDFURHFRQRPLFEDODQFHV´298
According to a press release on August 6, 2012, the BRSA reported that the
asset size of the Turkish banking sector has reached $727.87 billion ($1 =
7/ XVHG DV RI -XQH 7KH VHFWRU¶V WRWDO DVVHW KDV LQFUHDVHG E\
$32.04 billion (4.6%) comparing to the end of last year ($30.63 billion). As
of June 2012, loans were 57.9% of total assets amounting to $421.44
ELOOLRQ,QWKHVDPHSHULRGWKHVHFWRU¶VSURILWLVELOOLRQZKLFKLVDQ
increase of $674.85 million (11.4%) compared to the same period of
previous yeDUPLOOLRQ7KH VHFWRU¶VUHWXUQRQDVVHWV52$DQG
return on equity (ROE) are 1.9% and 16.3% respectively, which are
considerably high compared to the results of banks in the eurozone. The
7XUNLVK EDQNLQJ VHFWRU¶V FDSLWDO DGHTXDF\ VWDQGDUG UDWLR has been higher
than Basel II or Basel III CAR requirement since 2002. As the BRSA
UHSRUWHG UHFHQWO\ WKH EDQNLQJ VHFWRU¶V &$5 LV DV RI -XQH
which is even much higher than the 10.5% CAR requirement under Basel
III which will be in full effect E\ -DQXDU\ 7KH VHFWRU¶V WRWDO QRQ-
performing loans (gross) have increased slightly from the end-2011 levels;
however, when this slight increase is evaluated, it is contributed to the
growth experienced in credit portfolio in recent years, and not from the
increase due to the number of loans that have gone into default.299
Turkey has been postponing its adoption of Basel II for a long time (Turkey
was one of the 6 out of 27 countries that has not implemented Basel II, the
U.S. is also among the six), but the day finally came in July 2012 and

298
6HH7RGD\¶V=DPDQDUWLFOH³7XUNLVKEDQNVLQGLIIHUHQWDERXW%DVHO,,,FULWHULD´
http://www.todayszaman.com/news-222747-turkish-banks-indifferent-about-basel-iii-
criteria.html
299
BDDK (BRSA) Press Release (NO: 2012/21) on 6/8/ 2012: General Outlook of the Turkish
Banking Sector, June 2012
201

Turkey pushed aside its fears and entered a new chapter in its banking
sector by finalizing Basel II inauguration. Before induction into Basel II,
7XUNH\¶VEDQNLQJVHFWRUKDGDYHUDJHd 16.5% CAR which was well above
%DVHO,,¶VRU%DVHO,,,¶VHIIHFWLYHE\-DQXDU\
The BDDK has initially estimated that immediate impact of switching to

Basel II on CARS would be about 140bp; surprisingly, Fitch, one of the
three major rating agencies, was more optimistic than the BDDK and
forecasted that the impact of Basel II would likely reduce average CAR by
about 100bp. 6RPHEDQNVZHUHHYHQPRUHXSEHDWLQUHJDUGVWR%DVHO,,¶V
downward pressure on CARS, and they projected that the average CAR
would not drop more than 40bp-50bp. 6WDQGDUG 3RRU¶V UHSRUWHG WKDW
7XUNH\¶V%DVHO,,DGRSWLRQZRXOGKDYHQRLPSDFWRQWKHFXUUHQWUDWLQJRI
its banking sector, but the S&P had mentioned that Turkey would not run
into any major difficulty in its forthcoming transition to Basel III mainly
GXHWRLWVEDQNLQJVHFWRU¶VFXUUHQWstrong capital levels and composition.
The BDDK has been busy introducing necessary measures to ensure a

smooth transition from Basel I to Basel II which required some tweaking
here and there. Like every other country, Turkey has made some slight
modifications in implementing Basel II which has helped the country to
keep adverse effects to minimum. Regulatory capital adequacy ratios are
calculated as a percentage E\ULVNZHLJKWLQJEDQNV¶FDSLWDO against credit,
market, and operational risks. Therefore, in 2006 Turkish regulators
adopted Basel II¶V risk-weighted market provisions. As of July 2007, the
BDDK implemented risk-weighted operational exposure as part of
regulatory calculation of CAR. There are two key reasons why Turkey has
been affected only little during its migration from Basel I to Basel II; first,
earlier we said that Turkey made some minor changes to Basel I rules to
202

create its own modified version, and one of those changes made to the
original Basel I framework was to include operational risks in calculating
of regulatory CAR (if this was not done already as part of Basel I, then at
the time of Basel II DGRSWLRQWKHEDQNLQJVHFWRU¶VDYHUDJH&$5FRXOGKDYH
dropped one or two percentage points, from 16.5% to 14.5% - 15.5%);
second, the BDDK chose zero risk-weighting for foreign currency reserves
held by the Central Bank of Turkey, originally it would have been 100%
risk-ZHLJKWLQJ WKDW LQ WXUQ ZRXOG KDYH DIIHFWHG EDQNV¶ &$5V QHJDWLYHO\
and possibly reduced them for another point or two. However, even if we
assumed that Turkey had not done any previously mentioned alterations to
%DVHO , DQG DV D UHVXOW WKH EDQNLQJ VHFWRU¶V DYHUDJH &$5 DW WKH WLPH RI
migration had suffered as many as three or four percentage points, even
with that, the average CAR would have been around 12-13% which would
have been still DERYH%DVHO,,,¶VUHTXLUHPHQWDVRI-DQXDU\300
The BDDK reported in March 2010 that consolidated capital adequacy

ratio of banks decreased from %18.35 to %16.95 with implementation of
new Basel-II capital requirements. The average CAR of Turkish banking
sector is well above those countries in Europe or even that of the United
States. For instance, before the crisis between 2006 and 2008, the U.S.
banks on average had 9.6% Tier 1and 8.4% common equity both of which
increased to 11.4% and 10.5% respective in 2009. Europe on the other hand
had lower Tier 1 and common equity during the same period; 8.1% Tier 1
DQG FRPPRQ HTXLW\ (XURSH¶V QXPEHrs improved in 2009 as well;
9.4% and 8.0% respectively. Japan had the lowest Tier 1 and common
equity ratios; 5.5% Tier 1 and 3.3% common equity; although both figures
improved in 2009 but still below Basel III requirements, 6.9% and 4.1%.

300
6HH6WDQGDUG 3RRU¶V³How Basel II May Affect Turkey's Banking System´WKH%''.
http://www.bddk.org.tr; BDDK (BRSA) Press Release (NO: 2012/21) on 6/8/ 2012: General
Outlook of the Turkish Banking Sector, June 2012
203

³To meet the capital requirements effective by 2019, which include the
conservation buffer, banks will need to increase their common equity ratio
on average by about 3.7 percentage points and the Tier 1 capital ratio by
DERXWSHUFHQWDJHSRLQWV´Slovik and Cournède, 2011, p.6)
Chart 20 Ǧ͵Ͳͳ
5DWLQJ DJHQFLHV OLNH 0RRG\¶V )LWFK RU 6WDQGDUG 3RRU¶V EHOLHYH WKDW
some issues related to CAR reporting still exist in Turkish banking system
because of some irregularities between how banks in Turkey calculate
CARs and those international peers in the eurozone. Over a decade, the
BDDK has built a bulletproof banking regulation in the context of national
rules and regulations built into the system which in many instances differ
from those introduced under Basel II or III. Regardless, some discrepancies
will continue to exist in Turkish banking system, but Basel II and later
Basel III implementations will nevertheless improve prolonged issues like
governance, transparency and disclosures; more importantly, Basel II and

301
Source: Annual reports; bank filings; Global Insight; McKinsey Global Banking Pools;
McKinsey analysis2,200570600 (Note: Bank data are from Q2 2010 where available;
otherwise they are extrapolated from Q4 2009). Slightly modified by the author
204

Basel III will help regulators develop programs that will eventually lead to
FUHDWLQJ WKH RI EDQNLQJ FXOWXUH ZKLFK ZLOO FRQVLVW ³improved supervisory
review process´ ³HQKDQFHG GLVFORVXUH´ DQG ³EHWWHU ULVN JRYHUQDQFH´
Although it is uncertain when The BDDK will enforce the proposed new
capital standards on its banks, a closer attention needs to be paid to the
enhanced risk coverage measures. Disclosures are expected to improve
since banks will start publishing disclosures as part of Pillar III

The Basel Committee on Banking Supervision (BCBS) clear observed

during the recent crisis that risk coverage of the capital framework under
Basel II was insufficient and needed to be strengthened; in addition, banks
worldwide were ineffective capturing on- and off-balance sheet risks, as
well as derivative related exposures. These fundamental deficiencies in the
banking system were key destabilizing factors before, during, and
aftermath the 2008 financial crisis. As an enhanced treatment of risk
coverage, the BCBS introduced a stressed value-at-risk (VaR) capital
requirement based on a 12-month period of significant financial stress.302
7KH &RPPLWWHH DOVR LQWURGXFHG VRPHWKLQJ FDOOHG ³UH-securitizDWLRQV´ RI

both banking and trading books where banks are required to carry higher
capital. The adverse effects of counterparty credit exposures arising from
EDQNV¶ GHULYDWLYHV UHSR DQG VHFXULWLHV ILQDQFLQJ DFWLYLWLHV EHIRUH DQG
during the crisis not only affected the banking system but the broader
economy was significantly affected as well. With these new additional
enhanced risk coverage, Basel III standard will attempt to reduce
procyclicality which in turn will help further reduce systemic risk across
the financial system.

302
205

Banks will have to determine how much capital to put aside for
counterparty credit risk because there were concerns before regarding
capital charges being too low to address procyclicality. Going forward,
banks will be subject to a capital charge for mark-to-market losses. During
WKHFULVLVWKH&RPPLWWHHVDZDPDMRUIODZLQ%DVHO,,¶VULVNFRYHUDJH
of counterparty defaults, which did not even address the associated risk
UHVXOWLQJ IURP ³FUHGLW YDOXDWLRQ DGMXVWPHQW &9$´ 7KH SRWHntial losses
from this particular source were much greater than those losses related to
counterpart defaults. Moreover, better collateral risk management practices
are also introduced under Basel III.303
To address the issue of the buildup of excessive on- and off-balance sheet
leverage in the banking system, the Committee is introducing the leverage
ratio which is intended to improve the risk-based capital requirement. The
mentioned issue above has been a familiar feature in previous financial
crisis such as the late 1997 and early 1998 Asian crisis, 1999 and 2001
Turkish crisis. With the leverage ratio, banks will not be allowed to buildup
on- and off-balance sheet leverage because Basel III will enforce a limit
(floor) to what extend banks can buildup leverage. This way, it is
envisioned to protect the banking system and the broader economy from
any risk of destabilizing deleveraging processes. The important thing is that
the leverage ratio will be calculated the same way (equivalent) across
countries worldwide.304
The Committee felt that Basel II completely failed to cover any of the
potential risks related to complex trading activities, re-securitizations and
exposures to off-balance sheet vehicles, in fact, according to the Committee,
Basel II was in a way responsible for the risk sensitivity and coverage of

303
304
206

the regulatory capital requirement to increase. To better handle this matter,
the BCBS is introducing downturn loss-given-GHIDXOW³/*'´%DQNVDUH
also required to conduct stress tests during an economic recession or
financial stress to determine the direction (downward) of their credit
portfolios. The Committee said that it received a number of proposals on
two of which an impact study is being conducted. These two proposals
under review are; use RIWKHKLJKHVWDYHUDJHSUREDELOLW\RIGHIDXOW³3'´
estimate; and use of historic PD estimates for each exposure class.305
The Committee introduced two liquidity ratios; (1) short-term liquidity ±

/LTXLGLW\&RYHUDJH5DWLR³/&5´ZKLFKZLOOEHLQIXOOHIfect as of 2015.
This basically means that banks must have high quality liquid assets at any
given time as produced by the LCR. In spite of that, banks will be required
to maintain enough liquid assets for a month-long (30 days) under a
specified acute liquidity stress; (2) long-term liquidity ± Net Stable
)XQGLQJ 5DWLR ³16)5´ RI ZKLFK WKH LPSOHPHQWDWLRQ LV VFKHGXOHG IRU
2018. With NSFR, banks will be required to have stable funding in place to
address funding needs over a stressed one year period. The idea through
NSFR to ensure that banks do not carry longer-term structural liquidity
mismatches in their balance sheets.
It became explicitly obvious as the 2008 crisis intensified that a good

number of financial institutions possessed instable forms of funding which
made them extremely vulnerable to the financial and economic shocks
during stress. What this means is that illiquid assets must be backed with
100% NSFR. In the case of residential real estate mortgages, NFSR can be
as low as 65%.306

305
306
6KHDUPDQ 6WHUOLQJUHSRUW³7KH1HZ%DVHO,,,)UDPHZRUN,PSOLFDWLRQVIRU%DQNLQJ
2UJDQL]DWLRQV´
207

Usual factoUV OLNH FRXQWULHV¶ JURZWK H[SHFWDWLRQV HFRQRPLF DQG SROLWLFDO
stability, corporate governance, tax laws, well-developed financial system
DQG PRGHUQ DFFRXQWLQJ VWDQGDUGV FDQ FHUWDLQO\ LQIOXHQFH LQYHVWRUV¶
decisions. As an emerging market, according to IMF International
Financial Statistics, Turkey still receives a tiny fraction of gross foreign
portfolio inflows compared to countries such as Brazil and South Africa
(twice more), Korea (three times more), and Spain (thirteen times more).
Foreign portfolio LQIORZFDQEHLQFUHDVHGVLJQLILFDQWO\LI7XUNH\¶VUDWLQJLV

UDLVHG WR µLQYHVWPHQW FRXQWU\¶ RU 7XUNH\ LV LQFOXGHG LQ LQWHUQDWLRQDOO\
UHFRJQL]HGµ0RUJDQ6WDQOH\&DSLWDO,QWHUQDWLRQDO¶06&,HTXLW\LQGLFHV
according to which, Turkey represented 0.05% of the MSCI compared to
the US (53.99%), Spain (1.32%), Korea (0.86%), India (0.20%), Mexico
(0.31%), Brazil (0.21%), and Poland (0.05%). If Turkey really wants to get
more FDI, then as a top priority, it must develop non-bank financial
institutions (NBFIs) such as insurance companies, mutual funds, leasing
and venture capitalist firms, all of which together only account less than
20% and the banking sector still continues to dominate with over 85%. 307
Turkey finally succeeded in fixing traditional sources of fragility that was

affecting forward economic progress (irresponsible monetary policies,
unsustainable fiscal expenditures, poor financial regulation, or inconsistent
exchange-rate policies). Monetary policy is now governed by an inflation
targeting framework and an independent central bank focused on
developing sound monetary policies. Fiscal policy has been generally
restrained and the public debt-to-GDP ratio stable or declining. Turkish
Banks in general have strong balance sheets, and regulation and
supervision are much tighter than before. The currency is afloat. When it

307
Source: MSCI - Morgan Stanley Capital International equity indices, A World Bank country
VWXG\UHSRUW³1RQ-%DQN)LQDQFLDO,QVWLWXWLRQVDQG&DSLWDO0DUNHWVLQ7XUNH\´
208

comes to macroeconomic management, Turkey has adopted all the best
practices (Rodrik, 2009).
CONCLUSION
The past three decades have seen its share of good days and bad days; there
have been three major wars led by the United States and its allies with
estimated total cost of $4 trillion and the financial community worldwide
has witnessed numerous financial and economic crises during the 1990s
and 2000s which have resulted in massive monetary losses of trillions of
dollars, according to some estimates the financial damage could be as much
as $20 trillion which is about 25% more than the entire US economy and it
is little over one fourth of the world GDP ($79 trillion in 2011). The
financial crises have shaken investor confidence in the financial systems all
together, caused loss of jobs in great numbers, and left behind dislocated
societies in many regions.
Some economies in Asia region, particularly newly industrialized

economies (Hong Kong, Korea, Singapore, and Taiwan) and ASEAN-4
(Indonesia, Malaysia, Philippines, and Thailand) have been growing
remarkably in the range of 8-9% of GDP growth for the last three decades
RU VR+RZHYHUWKLQJVDEUXSWO\FDPHWRKDOWDQGWKHUHVLOLHQFHRI ³$Vian
7LJHUV´ RU ³$VLDQ 'UDJRQV´ DORQJ ZLWK $6($1-5 nations were being
tested in summer of 1997 and early 1998 when Baig and Goldfajn (1998)
called WKH³$VLDQ)OX´VWUXFNThe Asian crisis was like a massive tsunami,
hit without a warning and retrieved so fast that only a year later Asia was
already on its way for a quicker and stronger recovery. Foreign investors in
Asian equities (excluding those in Japan) lost an estimated $700 billion,
$30 billion by the American investors. Although recovery varied across the
209

region, the crisis seemed to have EDUHO\ PDGH D GHQW RQ $VLD¶V VWURQJ
sustained economic growth.
Krugman (1994) said that the rapid growth in the NIEs has been achieved
through an astonishing mobilization of resources. ³Economic growth seems
to be driven by extraordinary acceleration of performance in inputs like
labor and capital rather than by gains in efficiency.´ The high-magnitude
Asian crisis had prompted uncontrollable fast deterioration in living
standards in the region accompanied by record unemployment and jolted
society from its roots. 'HYDOXDWLRQ RI 7KDLODQG¶V EDKW FUHDWHG VHYHUH
contagion effects in other neighboring nations and currencies in the region
one after another came under massive attacks. Indonesia, Thailand, and
Korea were hit the hardest, Malaysia was considerably affected but
Singapore was well contained despite the severity of the crisis.
There were legitimate fears that spillover effects of the Asian crisis might
transfer to external environment causing disruption in other parts of the
world. Things became totally out of control in Indonesia due to sudden
FROODSVHRIWKHFRXQWU\¶VILQDQFLDOV\VWHPFRXSOHGZLWKSROLWLFDOXQUHVWDQG
it was time to call in IMF for financial assistance, although Indonesia called
LW ³WHFKQLFDO DVVLVWDQFH´ IMF had agreed to provide monetary assistance
for the region totaling well over $100 billion: $17.2 billion to Thailand, $40
billion to Indonesia, and $57 billion to Korea. However, IMF was overly
criticized for its choice of approach to handle the crisis which was thought
to be largely inappropriate and only little attention was paid to country
specific details. For instance, many found IMF insincere in its level of
involvement and accused the International Monetary Fund in its application
RI ³XQivariate solutions to multivariate problems.´ Martin Feldstein felt
that IMF followed an inappropriate course of actions dealing with 1997
210

Korean crisis. He strongly argued that IMF should have stayed away from
WKHXVXDO³SUHVFULSWLRQRIEXGJHWGHILFLWUHGXFWLRQ´ instead it should have
introduced measures to prevent massive capital outflows.
The view of IMF deteriorates real fast from being positive to negative
when people in developed, emerging, newly industrialized, developing, or
underdeveloped nations are asked to provide their opinion regarding the
role of the International Monetary Fund in crises. Furthermore, people
along with some governments in poor nations see IMF as more politically
oriented in its approaches than just providing monetary assistance;
therefore, people in some parts of the world hold demonstrations against
IMF and its policies, and they see the organization as an extension of
capitalism without any sincerity to their unique circumstances.
All of the recent financial crises have either originated in G-2 (The U.S.
and Europe) or initiated elsewhere by the actions of investors from
developed nations. Poor countries absent from any means of resources
(human, capital, and other high-value assets) would not have the ability or
the capacity to create massive crises to affect rest of the world because;
first, limited or no infrastructure of any kind would be present and weak
financial systems with no SIBs would exist; second, the size of financial
transactions would be in such small amounts and volumes compared to
those in industrialized countries. The situation being like this, the leading
world organizations such as World Bank, IMF, and the Basel Committee
on Banking Supervision still constantly point out that these poor nations
must introduce fiscal and structural reforms, improve current account
imbalances, increase foreign currency reserves, avoid imposing control or
taxes on currencies, and open up their financial systems to foreign investors
to avoid financial or economic crises. Nothing has worked so far;
211

regulation, deregulation, self-regulation, and now more regulation again.
Every decade since 1980s has witnessed at least one major crisis in spite of
all the prudential policies, reforms, fiscal and structural changes. Now,
Basel III has assumed the responsibility of massive task to achieve
harmonization of standards internationally, increase quality and quantity of
capital, and improve transparency, governance, and disclosures in order to
create banking resilience.
While the speed of the recovery in industrialized nations has been

extremely slow due to persisting high unemployment, weak domestic
household consumption, and lackluster bank credit situation; Asia is
leading the global recovery. Although the swift recovery has been slightly
different from country to country in Asia, nonetheless the growth pace has
exceeded that of the industrialized nations (more than 2%). Moreover, Asia
region for the first time contributed to the recent global recovery more than
any other regions (sluggish US economy, persisting recession in Japan,
slow recovery in the eurozone arising from sovereign debt crisis). IMF
expects Asia to lead the global recovery in the coming years for two main
reasons; first, as the global recovery will be more robust in near future,
domestic household consumption along with increased exports to advanced
QDWLRQV ZLOO VXSSRUW $VLD¶V LQGXVWULDO SURGXFWLRQ LQ and beyond;
second, once the recovery accelerates, then macroeconomic policies will
have less impact; the demand in domestic private sector will remain strong.
China, the heavyweight of the region, is expected to record double digit

growth in 2010. Strongly growing China translates to increased imports of
commodities and capital goods from other nations in the region. However,
IMF warns about possibilities of some economies overheating due to
significant level of capital inflows to the region and widening interest rate
212

gap differential between the region and the G- $OWKRXJK &KLQD¶V
economy is enormous in the region, it cannot possibly be expected to
compensate the weaker demand from advanced economies with its import
IURP WKH UHJLRQ EHFDXVH &KLQD¶V LPSRUW PL[ UDWKHU FRQVLVWV RI PDLQO\
consumer products than electronics (one-third of exports), machinery, or
other manufacturing related supplies. Countries in the region will have to
introduce structural reforms to create new or increase the existing domestic
demand which may call for increase of consumption or investments.
Basel I, formerly known as ³7KH ,QWHUQDWLRQDO &Rnvergence of Capital

0HDVXUHPHQWV DQG &DSLWDO 6WDQGDUGV´ PDLQO\ IRFXVHG RQ DFKLHYLQJ
regulatory standards harmonization and capital adequacy within the
member nations%DVHO,¶VH[FOXVLYHQHVVRIPHPEHUQDWLRQVRQO\UHFHLYHGD
lot of criticism. Then, the Committee introduced Basel II which allowed
banks to develop their own internal rating mechanism to assess the risk of
credit, operation, and management of capital. The four key Pillars
introduced under Basel II were; ³7KH &RQVWLWXHQWV RI &DSLWDO´, ³5LVN
WeLJKWLQJ´, ³$ 7DUJHW 6WDQGDUG 5DWLR´, and ³7UDQVLWLRQDO DQG
Implementing Agreements.´ As of 2012, 21 members of total 27 countries
have so far implemented Basel II and Turkey became the 22 nd when it
finally adopted Basel II capital requirements in July 2012 (the U.S. pledged
its acceptance of Basel II, but it has not implemented the four Pillars yet).
The BCBS announced in December 2009 a set of consultative proposals

targeted to strengthen the resilience of the banking sector worldwide. The
proposals covered five fundamentally important areas; 1) capital should be
quality, transparent, and consistent; 2) Risk coverage and the capital
requirements for counterparty credit risk exposures arising from derivatives
should be strengthened; 3) A leverage ratio is introduced to contain the
213

build-up of excessive leverage in the banking system; 4) Capital buffers are
introduced to encourage banks to build-up capitals to be used at times of
financial stress; 5) A liquidity coverage ratio is introduced (LCR) which
require banks to have high-liquid assets (cash, or short-term securities) to
cover operation for at least a 30-day period during acute financial stress.
A decade earlier (before 2002), Turkey has always been associated with
political instability, chronic high inflation and frequent economic crises
which were just usual scenes as part of daily life in Turkey; but not today,
thanks to brilliant work of the Banking Regulation and Supervision Agency
(BRSA or BDDK in Turkish), Turkey now has a much envied banking
system that is both resilient and capable of absorbing financial and
economic shocks during a global scale stress. Four key elements were
FUHGLWHGEHKLQG7XUNH\¶VUHFHQWHFRQRPLFVXFFHVVthe crucial role of the
IMF and the World Bank; 2) transformation of the relationship between the
VWDWH DQG 7XUNH\¶V ILQDQFLDO VHFWRU WKURXJK UHJXODWRU\ UHIRUPV
significant inflow of foreign direct investment; and lastly 4) introduction of
QXPHURXVUHIRUPVDLGLQJ7XUNH\¶VELGWRMRLQLQWRWKH(8
The Banking Regulation and Supervision Agency (BRSA), as the

independent authority by law to regulate and supervise the banking sector,
identified four fundamental areas to work on to strengthen the banking
system; (1) improve the position of the devalued Turkish lira-TL against
other currencies; (2) resolve inadequate capital base in public sector; (3)
develop a state bank reform; (4) create a sound, well working regulatory
and supervisory framework. The deficiencies or banking flaws have been
successfully addressed by the BRSA in a decade-long relentless process.
Despite its impressive economic progress, Turkey still faces huge issues
regarding fiscal and current account imbalances. Turkey's budget deficit
214

was set to widen sharply to 33.5 billion lira ($18.5 billion) in 2012, and
Finance Minister Mehmet Simsek said that this was exceeding the official
forecast by more than half. Last October (2011), the current account deficit
ballooned to a record $78.3 billion, or 10% of GDP, spooking investors and
prompting a heavy currency selloff that by December led to double-digit
inflation for the first time in three years. However, government officials say
that the current account deficit is expected to narrow until October 2012
and the year-end target remains to be $59.1 billion. The unemployment rate
in urban cities is still above 11% (rural, around 7%).
The capital adequacy ratio of banks in Turkey on average is substantially

higher than the banks in the U.S. or in the Euro region. According to a
press release on August 6, 2012, the BRSA reported that the asset size of
the Turkish banking sector has reached 1.27 trillion TL or $727.87 billion
($1 = 1.75 TL used). 7KH 7XUNLVK EDQNLQJ VHFWRU¶V FDSLWDO DGHTXDF\
standard ratio (CAR) has been higher than Basel II (8%) or Basel III
(10.5% by 2019) requirement since 2002. As the BRSA reported recently,
WKHEDQNLQJVHFWRU¶V&$5LVDVRI-XQHZKLFKLVsignificantly
higher than the 10.5% CAR requirement under Basel III which will be in
full effect by January 2019.
7XUNH\¶V GHFDGH Oong social, economic and political stability (no military
intervention and one-party government in last three elections since 2002)
fostered a great deal of economic development, which in turn created
positive progress in various parts of the society. However, Turkey must
continue its mission of enhancing structural and macroeconomic policies to
further improve the resilience of its banking system. Becoming the 16th
largest economy in the world puts extra pressure on Turkey to prove to the
world that its unique story of economic success is not a fluke as some
215

people might think. Turkey now needs to take the advantage of favorable
macro and microeconomic environment to tackle four problematic areas
constraining long-term growth; high urban unemployment rate, current
account deficit, budget deficit and trade deficit.
It is extremely tough for Turkey to prevent having a large current account

deficit because it highly depends on energy import to continue its economic
growth which in turn tends to create a massive current account deficit at
present hovering around little over $70 billion. However, Turkish
economists believe that the deficit will improve and continue its gradual
descend until end of 2012 to meet the central bank guidance for the year.
As far as the banking industry is concerned, the BRSA must encourage
further development of the Turkish banking sector in order to become a
full-fledged financial system consisting some of the following critical
components of a modern financial industry:
x The insurance sector is very limited and it is not sufficient; therefore, it

needs further development.
x An over the counter (OTC) market for securities does not exist and its
establishment is necessary.
x Venture capitalist firms should be formed and the initial public offering
(IPO) should be expanded.
x Privatization work needs to continue, maybe even a bit accelerated.
x The securities market needs to be further developed to include options,

derivatives, and other financial investment instruments.
216

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Basel III: Road To Resilient Banking (Book)

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John Taskinsoy has been teaching business communication, marketing,

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ASEAN-4 Indonesia, Malaysia, the Philippines, and Thailand.

ACU Asian Currency Unit

I appreciate the financial support provided by Universiti Malaysia, Sarawak

I would like to acknowledge the support of the following important people:

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The primary function of financial systems is to facilitate and allocate funds

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Levine (1997) believes that market frictions regarding information and

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According to Polizatto (1990), prudential regulation and banking

If the globalization of finance is the future direction, where financial

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