Inadequate Regulation Seen in Asia's Banking Crises

Inadequate Regulation Seen in Asia's Banking Crises

by Jeff Gerth and Richard W. Stevenson

WASHINGTON -- Three years ago, when Thailand and South Korea were still considered economic miracles and no one but currency traders paid attention to the baht and the won, the top U.S. banking regulator saw a looming crisis in Asia.

Eugene A. Ludwig, the comptroller of the currency, noticed disturbing parallels between banking practices in fast-growing Asian economies and the mess created in the United States by the deregulation and subsequent collapse of savings and loan associations.

Along with deregulation in both cases came a flood of new money, reckless lending and inadequate government supervision -- a clear recipe for a costly disaster.

But Ludwig's concerns -- passed along informally to a World Bank official at a 1994 meeting of international bankers in Madrid -- were rare flags of caution at a time when international barriers to the flow of capital were fast disappearing, and investors and financial institutions were pouring money into rapidly developing countries in Asia and elsewhere.

If there is one clear lesson from the turmoil that has so badly jolted Asia, it is that the financial systems in many fast-growing countries were no match for the huge, skittish pools of money they attracted.

As they examine what went wrong in Asia, officials around the world see obvious parallels to past experiences like the American savings and loan debacle as well as complicated new problems.

National systems intended to supervise banks in their home countries have proven unable to keep pace with the rapid development of a global financial marketplace that pays little attention to borders.

There is no international body able to play the role of global regulator. The United States and other big countries are also unable to impose changes on the often-reluctant governments and banks in nations at risk.

Efforts to bolster the soundness of financial systems in Asia and elsewhere by encouraging greater disclosure of financial data and by prodding large international banks to demand changes have so far yielded little if any success.

A result is that to a remarkable extent, individual nations and even the worldwide economy are suddenly more at risk because of the ineffectiveness of obscure banking regulators in far-off countries.

South Korea, Thailand and Indonesia are among the countries paying a steep price for the problems with their banks, and Japan is scrambling to avoid the same fate; just last week Japan unveiled a $77 billion plan to shore up its financial institutions. The ripples have crossed the Pacific, unsettling Wall Street, hurting exporters and potentially curbing economic growth in the United States.

"In the early 1980s the United States confused deregulation with supervision, and the same thing happened in Asia," said Charles Bowsher, the former head of the General Accounting Office, the investigative arm of Congress. "You pay a very big price, as we did in 1929 and the 1980s in this country, and what we're now seeing in Asia."

With the International Monetary Fund taking the lead, multinational organizations and national governments have pledged more than $100 billion to bail out countries in Asia, the largest international rescue in history. Yet, paradoxically, there is no global body with the ability or the mandate to manage the problem.

Individual countries monitor what their banks do at home and abroad, and what foreign banks do on their turf. But if central banks and national regulatory agencies can take individual snapshots, no organization is responsible for a global perspective.

The principal body for coordinating international bank regulation -- a committee of worldwide regulators operating under the Bank for International Settlements in Switzerland -- has made little progress until now in getting countries like Korea of Thailand to upgrade their standards.

Even the IMF, which has only recently been thrust into the front lines of the battle to shore up weakened banking systems, is a reluctant savior.

"The amount of detailed knowledge it takes to understand a system is beyond the capacity of a single multinational organization to deal with," said Stanley Fischer, the IMF's first deputy managing director.

The problem is not new. The collapse of big, international financial institutions like the Bank of Credit and Commerce International in 1991 and Barings PLC in 1994 showed the vulnerabilities in the system of supervising multinational banks.

But the stakes now are often much higher, involving not individual banks but entire economies. And while the IMF, other multinational bodies and national governments are willing to come to the rescue, they lack the crucial power that usually goes hand-in-hand with status as lender of last resort -- the ability to demand changes, before crisis hits, in a bank's management.

"In the last few years we've come to realize -- and you may say it's late -- that banking system stability is more important for a wider range of countries," said Andrew Crockett, the general manager of the Bank for International Settlements.

"It's the public sector, whose money is on the line, that prevents a financial meltdown, so the public sector has to have a voice," Crockett said. "How can we get these countries to adopt these standards? The answer is you can't."

The limits of sovereignty concern bankers and others in the private sector, as well.

"National supervision of complex global firms and global markets is inadequate to meet the requirements of the times," said John Heimann, the chairman for global financial institutions at Merrill Lynch.

The solution, according to a recent study by private and public sector experts for which Heimann was co-chairman, is that major financial institutions, in cooperation with supervisors, must take the lead in reducing global financial risk.

"The speed and complexity of innovation in the markets, the supervisors' inevitable position 'behind the curve' and their real handicaps in competing for talented staffers all argue for private institutions to take on greater responsibility," the study found.

The study's conclusions, which were supported by top officials of some of the world's largest financial institutions, including Citibank, Deutsche Bank, Nomura Bank International and Credit Lyonnais, were made public just as the crisis in Asia was emerging this year. But it is unclear whether the private sector will take on such a crucial role.

In South Korea, for instance, large Japanese, European and American banks may have been part of the problem rather than part of the solution. They were among the financial institutions most exposed to huge losses by South Korea's woes, suggesting that they too missed warnings signs and are in some ways the beneficiaries of Korea's $60 billion bailout package.

Meanwhile, the United States and other governments have been expending much political capital and exerting considerable effort to get other countries to open up their financial markets to the Merrill Lynches of the world.

Just recently the World Trade Organization, after long negotiations, concluded a financial services pact that further opens up the banking, securities and insurance industries in scores of nations. Treasury Secretary Robert Rubin wrote the head of the WTO in August to "underscore our view that financial liberalization and the maintenance of financial stability are mutually reinforcing."

Rubin wrote of the "need to develop and maintain strong supervisory regimes and regulatory infrastructures" as the Asian financial crisis was in its first stages.

Some Asians feel that such a message should have been delivered earlier and more forcefully.

The United States, acting at the behest of American banks, pressed South Korea to open its financial markets a few years ago, but the United States "didn't help the Korean government prepare for these things -- it went too fast," said Yoon Dae-euh, a professor of international finance at Korea University and former member of South Korea's Monetary Board.

In some ways the United States may even have contributed to undermining the discipline of the international financial institutions that poured money into South Korea. Washington strongly backed the entry of South Korea in 1996 into the Organization for Economic Cooperation and Development, the elite club of industrial nations.

Membership is largely symbolic, but it carries with it certain perks, among them an assumption, under rules developed by the Bank for International Settlements committee, that bank loans to the organization's members carry no risk of default.

So South Korea's entry into the Organization for Economic Cooperation and Development may have helped give the marketplace a false sense of confidence about South Korea, according to banking experts and an IMF official.

Between 1994, when South Korea received its first green light for membership, and 1996, when it officially joined, foreign banks more than doubled their lending to South Korea, from $52 billion to $108 billion, according to Bank for International Settlements reports.

While organization membership requires open financial markets, it does not require sound financial supervision.

"We ought to strive for higher standards, maybe even hand in glove with OECD membership," said Ludwig. Asia, he added, "shows that the importance of sound and good regulation is much more a factor today than it has ever been before."

But if governments and international organizations find it hard to strengthen such systems, the solution, according to policymakers like Rubin and regulators like Crockett, is to rely on market pressure.

However the problem gets addressed, no one thinks it will be a quick, easy task.

"This is not a one- or three-year job, it is a five-year or 10-year job," Crockett said.