Financial Sector Regulation: The Lessons of the Asian Crisis

The paper focuses on the lessons of the East Asian crisis for financial sector regulation in the context of developing economies. Section by section it:

• Reviews the role of the financial system in the development process by facilitating efficient resource use and economic growth, and the causes of financial distress;
• Provides a brief anatomy of the Asian financial crisis;
• Discusses competing explanations of the crisis, and draws attention to failures in financial regulatory and supervisory systems as a contributory factor;
• Looks in more detail at failures in prudential regulation and supervision in East Asia;
• Looks beyond the Asian countries directly affected by the current crisis and points out that banking crises and financial instability have been a regular occurrence throughout the developing (and developed) countries;
• Brings together the lessons and conclusions of the East Asian financial crises for prudential regulation of the financial sector.

Policy conclusions include:

• Regulators must enforce effective restrictions on financial institutions' foreign currency exposures;
• Regulators must strictly enforce prudential regulations, in particular those pertaining to credit risk such as insider lending;
• Regulators should enforce the use by FIs of international standards of loan classification and provisioning;
• Regulators must avoid giving any guarantees, implicit or explicit, to bail out financial institutions or to assume their liabilities to all but small depositors;
• Regulators must react promptly to impose remedial measures, including closure where this is appropriate, on distressed FIs.

[Adapted from author]