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Asian Development Outlook 2004 : I. Developing Asia and the World
Resolving Developing Asia's Nonperforming Loans A high share of NPLs can cause systemic risk and possible fiscal liabilities, affecting financial intermediation, investment, and economic growth, as was exemplified during the Asian financial crisis. Public and private sectors in developing Asia have therefore been working to resolve their NPLs and to mitigate the effects of any that may arise in the future. In the face of continuing globalization, further financial sector reforms are vital while macroeconomic conditions are favorable, to minimize problems that future NPLs may cause. High levels of NPLs were accumulated during the Asian financial turmoil of 1997-98 and led to a banking sector crisis in the economies of Indonesia, Korea, Malaysia, Philippines, and Thailand. That provided a wake-up call to the region to address both its NPLs and the underlying financial sector weaknesses so as to be able to meet the growing challenges of globalization and competitiveness. Seven years on, the health of the banking sectors in the crisis-affected economies is still fragile. The measures taken to nurture them back to health have varied across countries and no consensus has been reached on the best procedures. Although these countries have been progressing with banking sector reform, in some other DMCs, reform efforts have been more limited and problems may be looming. NPLs create problems for the banking sector’s balance sheet on the asset side. They also create a negative impact on the income statement as a result of provisioning for loan losses. Ultimately, a riskier loan portfolio combined with lower net income makes new lending more difficult, often resulting in slower credit growth (Figure 1.17). In the worst scenario, a high level of NPLs in a banking system poses a systemic risk, inviting a panic run on If not properly handled, resolution of NPL burdens can also create moral hazard incentives for banks and borrowers alike. Banks can be lulled by the idea that they can always rely on a centralized asset management company (AMC) to accept transfer of their bad loans, even if these resulted from their own recklessness. Borrowers, on the other hand, can be made to believe that once their debts go to a government agency that has limited incentive and inadequate legal powers to run after defaulters, then they are essentially freed from their obligation to pay. These moral hazard incentives perpetuate a nonrepayment culture and nonaversion to risk. Consequently, the cycle of bank collapse and recapitalization, of crisis and restructuring, goes on. Excessive NPLs may also create a contingent or actual fiscal liability resulting from the authorities’ efforts to restore stability and solvency to the banking system by actions to reduce the level of NPLs. Public sector costs of these actions include three different components: the cost of government assistance to the banking sector, the quasi-fiscal cost assumed by the central bank, and the direct cost of depositors’ compensation. Not all of these costs are immediately reflected in the fiscal accounts because government involvement, in a majority of cases, entails bond issues coupled with relatively small actual cash outlays. While the latter will appear in the current fiscal accounts, bond issues would only be taken into account as the government starts paying interest and principal. On the other hand, fiscal cost accounting often fails to incorporate income from recoveries of bad loan assets, which can significantly offset the original fiscal expenses, particularly when the assets were transferred to a government-owned agency. Thus, it is difficult to estimate the true cost to the economy of attempting to remedy financial sector instability. Because of the potential monetary, fiscal, and economic growth implications, governments are usually actively involved in the resolution process, often injecting capital into failing banks and setting up special AMCs. This chapter reviews recent developments in the resolution of developing Asia’s NPLs. Recent trends are presented first, followed by a discussion of efforts to resolve the bad loans and the related costs involved in several groups of developing Asian economies. Finally, measures to prevent the recurrence of an NPL problem in the region are briefly elaborated.
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deposits and sharply limiting financial intermediation, and subsequently investment and growth, in the economy.
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