The Chilean Financial Crisis of the Eighties: Analysis of Its Solutions and Cost

This paper reviews the solutions to the Chilean banking crisis of the eighties and analyses their effects, deriving policy lessons from this experience. The three main solutions to the crisis were the following: (i) foreclosure of insolvent institutions or transfer all their assets and liabilities to a solvent institution; (ii) aquisition of high-risk portfolio (bad loans) under condition of repurchase without provision offresh funds; (iii) acquisition of high-risk portfolio under condition of repurchase through future profits with provision of fresh funds. The results show that the third alternative was the most efficient for the recovery of a significant number offinancial institutions with solvency problems. Supporting bank recapitalization and creating incentives for recovering bad loans helped to accelerate the recovery of the banking industry. Also, the paper analizes the precaucions that policy makers should take into account in order to maximize the recovery of resources transferred to the financial system. Finally, the paper reviews estimations of the cost of the crisis, concluding that it would he 35.2% of GDP.