Given their incidence and variety over the past 15 years, banking crises (in both developing and industrial economies) are clearly not random or isolated events. Around the world, banks have had high levels of non-performing loans, there has been a major destruction of bank capital, banks have failed, and massive support operations have been necessary. The failure rate among banks has been greater than at any time since the great depression of the 1920s. In the case of Indonesia, Malaysia, South Korea and Thailand, non-performing loans of banks recently amounted to about 30 per cent of total assets. Banking crises have involved substantial costs. In about 25 per cent of cases the cost has exceeded 10 per cent of GNP (for example, in Spain, Venezuela, Bulgaria, Mexico, Argentina, Hungary). Evans (2000) suggests that the costs of crises amounted to 45 per cent of GDP in the case of Indonesia, 15 per cent in the case of Korea and 40 per cent in the case of Thailand. These figures include the costs of meeting obligations to depositors under the blanket guarantees that the authorities introduced to handle systemic crises, and public sector payments to financing the recapitalization of insolvent banks.
Almost always and everywhere banking crises are a complex interactive mix of economic, financial and structural weaknesses. Lindgren et al. (1996) give an excellent survey of the two-way link between banking systems and macro policy. The trigger for many crises has been macroeco-nomic in origin and has often been associated with a sudden withdrawal of liquid external capital from a country. As noted by Brownbridge and Kirkpatrick (2000), financial crises have often involved triple crises of currencies, financial sectors and corporate sectors. Similarly, it has been argued that East Asian countries were vulnerable to a financial crisis because of 'reinforcing dynamics between capital flows, macro-policies, and weak financial and corporate sector institutions' (Alba et al., 1998, p. 38). The link between balance of payments and banking crises is certainly not a recent phenomenon and has been extensively studied (for example, Kaminsky and Reinhart, 1998; Godlayn and Valdes, 1997; Sachs et al., 1996).
Almost invariably, systemic crises (as opposed to the failure of individual banks within a stable system) are preceded by major macroeconomic adjustment, which often leads to the economy moving into recession after a previous strong cyclical upswing. While financial crises have been preceded by sharp fluctuations in the macro economy, and often in asset prices, it would be a mistake to ascribe financial instability entirely to macroeco-nomic instability. While macro instability may be the proximate cause of a banking crisis, the crisis usually emerges because instability in the macro economy reveals existing weaknesses within the banking system. The seeds of a problem (for example, overlending, weak risk analysis and control and so on) are usually sown in the earlier upswing of the cycle: mistakes made in the upswing emerge in the downswing. The downswing phase reveals previous errors and overoptimism. In South East Asia, for instance, a decade of substantial economic growth up to 1997 concealed the effects of questionable bank-lending policies.
A common experience in countries that have experienced banking crises is that expectations have been volatile, and asset prices (including property) have been subject to wild swings. A sharp (sometimes speculative) rise in asset prices is often followed by an equally dramatic collapse. An initial rise in asset prices has often induced overoptimism and euphoria, which in turn have led to increased demand for borrowed funds and an increased willingness of banks to lend (Llewellyn and Holmes, 1991).
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