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International Overborrowing: A Decomposition of Credit and Currency Risks

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  • McKinnon, Ronald I.
  • Pill, Huw
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Abstract

February 1998 The severity of the financial crises enveloping the ‘tiger’ economies of South East Asia in 1997 came as a surprise to many observers. This paper uses a simple Fisherian model of the ‘overborrowing syndrome’ to compare the Asian crises of 1997 with earlier overborrowing episodes in Mexico and Chile. While important similarities exist, the crises in South East Asia have been exacerbated by the unhedged foreign exchange positions of Asian banks. These open currency positions not only imposed significant additional losses on the banks following devaluation, they also magnified the scale of overborrowing during the cycle’s initial boom phase. Failure to limit the exposure of banks to foreign exchange risk therefore increased the magnitude of the boom - bust overborrowing cycle both ex ante and ex post. The paper highlights the importance of effective regulation and supervision of capital markets, with a focus on limiting the speculative currency positions of banks, especially those that form the core of the domestic payments system and therefore enjoy a (possibly implicit) public guarantee. Improving the institutional infrastructure of financial supervision is the only effective way of mitigating the macroeconomic costs of overborrowing. JEL Classification: O16, F32, F34, E44. Keywords: Overborrowing, capital flows, financial crises, sectoral credit.

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Bibliographic Info

Article provided by Elsevier in its journal World Development.

Volume (Year): 26 (1998)
Issue (Month): 7 (July)
Pages: 1267-1282

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Handle: RePEc:eee:wdevel:v:26:y:1998:i:7:p:1267-1282

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  1. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
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  6. repec:fth:inadeb:318 is not listed on IDEAS
  7. Ronald I. McKinnon & Huw Pill, 1996. "The overborrowing syndrome: are East Asian economies different?," Proceedings, Federal Reserve Bank of San Francisco, pages 322-355.
  8. Kurz, Mordecai, 1994. "On the Structure and Diversity of Rational Beliefs," Economic Theory, Springer, vol. 4(6), pages 877-900, October.
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  12. McKinnon, Ronald I., 1982. "The order of economic liberalization: Lessons from Chile and Argentina," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 17(1), pages 159-186, January.
  13. Rudiger Dornbusch & Alejandro Werner, 1994. "Mexico: Stabilization, Reform, and No Growth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(1), pages 253-316.
  14. McKinnon, Ronald I & Pill, Huw, 1997. "Credible Economic Liberalizations and Overborrowing," American Economic Review, American Economic Association, vol. 87(2), pages 189-93, May.
  15. Diaz-Alejandro, Carlos, 1985. "Good-bye financial repression, hello financial crash," Journal of Development Economics, Elsevier, vol. 19(1-2), pages 1-24.
  16. Ronald I. McKinnon & Huw Pill, 1996. "Credible Liberalizations and International Capital Flows: The “Overborrowing Syndrome”," NBER Chapters, in: Financial Deregulation and Integration in East Asia, NBER-EASE Volume 5, pages 7-50 National Bureau of Economic Research, Inc.
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