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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Paper provided by Stanford University, Department of Economics in its series Working Papers with number
98004.
Find related papers by JEL classification: O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements F34 - International Economics - - International Finance - - - International Lending and Debt Problems E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
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