Conclusions And Lessons

One important lesson from the financial crisis is that, in Thailand, financial liberalization in an uncontrolled financial sector resulted in misallocation and mismatching of funds. In general, the Thai financial crisis reflected the failure of the banking sector, expressing itself partly in increasing current account problems but mainly in careless lending/borrowing and the accumulation of non-performing loans. By the time the real economy started to show signs of weakening, with sluggish exports and an increase in the current account deficit, 'hot money' flowed in and covered the deficit; but this also led to careless investments. Consistent with the conclusion by Lensink et al. (2000), it may be argued that political instability, indecisive-ness and mismanagement at the political and administrative level also contributed to capital flight and the financial meltdown in Thailand.

Lack of effective financial regulation played an important role in aggravating the financial crisis. Thus, the important lesson is that failure to impose proper regulatory and legal control over the operations of banks has serious consequences. In particular, excessive lending by domestic banks (sometimes financed by international investors) and a lack of control over the actions of the borrowers need to be addressed. Poor policy making, both at the central bank and within commercial banks, encouraged overinvestment and hence aggravated the fragility of the banking sector as firms were unable to service their debts.

One inevitable consequence of the financial crisis in Thailand has been the renaissance of informal credit in Thailand (Vatikiotis, 1998). New BoT rules introduced at the end of March 1998 to tighten borrowing have led to sharply higher interest rates. The tougher regulations will mean a fundamental - perhaps painful - change in Thailand's business culture. For generations, Thais have taken out loans using assets, rather than cash flow, as collateral. To change all this may require more than a simple decree from the central bank. The personal nature of banking in Thailand means that local branches often act independently of head offices, setting their own interest rates and managing their own clients.

Another important lesson from this chapter is that, under a liberalized financial system, the central bank's role in supervision and examination of financial institutions is complex and demanding. Prudential regulation must be robust, up to date and well balanced in order not to hinder the future development of financial institutions and innovations. Regulation must also be effective in maintaining stable and sound operation of financial institutions.

Financial End Game

Financial End Game

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