How the 1981-83 Chilean banking crisis was handled

The banking crisis in Chile in 1981-83 was widespread - representing about 60 percent of the banking system's total portfolio. The crisis arose because of macroeconomic problems and was exacerbated by unsound financial practices. The government was faced with two extreme solutions: to let insolvent banks go bankrupt, or to bail them out, absorbing their losses. Some institutions were liquidated, and others were rescued and rehabilitated, depending on their solvency. The government used two types of mechanisms to rehabilitate the banking system. One type was aimed at improving borrowers'capacity to repay loans to the banks. The other was aimed at rebuilding the banking system's capital. The government also strengthened banking supervision by improving loan portfolio analysis and increasing the transparency of financial transactions. The decision to recognize and allocate losses quickly, and to implement comprehensive measures to resolve the banking crisis, were the key to Chile's success in surviving the crisis. Had allocation of losses been delayed, or solutions partial, losses would probably have increased and the system would not have recovered so rapidly.