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Financial sector inefficiencies and coordination failures : implications for crisis management

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  • Agenor, Pierre-Richard
  • Aizenman, Joshua

Abstract

The authors analyze the implications for crisis management of inefficient financial intermediation in a country (such as Indonesia or the Republic of Korea) where firms are highly indebted. They base their analysis on a model in which firms rely on bank credit to finance their working capital needs and loan contracts entail high state verification and enforcement costs for lenders. They find that higher volatility of output, lower productivity, or higher costs for contract enforcement and verification may shift the economy to the inefficient portion of the debt Laffer curve - with potentially sizable losses in employment and output. What implications does this have for the policy debate on crisis management in East Asia? Debt reduction, in addition to debt rescheduling, may be required to reduce employment and output losses in the presence of inefficiencies in the financial sector. In practice this may be difficult to coordinate among a large group of creditors because of the free-riding problem: Each creditor has an incentive to refrain from offering debt relief on its own claims and wait for others to do so, thereby raising the expected value of its own claims.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2185.

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Date of creation: 30 Sep 1999
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Handle: RePEc:wbk:wbrwps:2185

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Related research

Keywords: Strategic Debt Management; Financial Intermediation; Banks&Banking Reform; Economic Theory&Research; Environmental Economics&Policies;

References

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  1. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  2. Helpman, Elhanan, 1989. "The Simple Analytics of Debt-Equity Swaps," American Economic Review, American Economic Association, vol. 79(3), pages 440-51, June.
  3. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  4. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
  5. Pierre-Richard Agénor & Joshua Aizenman, 1998. "Contagion and Volatility with Imperfect Credit Markets," IMF Staff Papers, Palgrave Macmillan, vol. 45(2), pages 207-235, June.
  6. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, December.
  7. Elhanan Helpman, 1989. "Voluntary Debt Reduction: Incentives and Welfare," IMF Staff Papers, Palgrave Macmillan, vol. 36(3), pages 580-611, September.
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Citations

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Cited by:
  1. Amartya Lahiri & Carlos A. Vegh, 2005. "Output Costs, Currency Crises, and Interest Rate Defense of a Peg," NBER Working Papers 11791, National Bureau of Economic Research, Inc.
  2. Claessens, Stijn & Djankov, Simeon & Xu, Lixin Colin, 2000. "Corporate Performance in the East Asian Financial Crisis," World Bank Research Observer, World Bank Group, vol. 15(1), pages 23-46, February.
  3. Amartya Lahiri & Carlos A. Vegh, 2001. "Living with the Fear of Floating: An Optimal Policy Perspective," NBER Working Papers 8391, National Bureau of Economic Research, Inc.
  4. Laeven, Luc & Klingebiel, Daniela & Kroszner, Randy, 2002. "Financial crises, financial dependence, and industry growth," Policy Research Working Paper Series 2855, The World Bank.

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