Financial Policies and the Prevention of Financial Crises in Emerging Market Countries

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Financial Policies and the Prevention of
Financial Crises in Emerging Market Countries

• Frederic S. Mishkin

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1. Understanding Financial Crisis

• Definition
• Factors promoting financial crisis
• Dynamics of financial crisis

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2.Financial Policies to Prevent Financial Crisis
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Definition
1.Understanding Financial Crisis

• Financial crisis is a disruption to financial
  markets in which adverse selection and moral
  hazard problems become much worse, so that
  financial markets are unable to efficiently
  channel funds to those who have the most
  productive investment opportunities.

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Asymmetric Information occurs when one party to
a financial contract has much less accurate
information than the other party.

• Adverse selection occurs before the financial
  transaction takes place when potential bad credit
  risks are the ones who most actively seek out a
  loan, take out even at a high interest rate.
• Moral hazard occurs after the transaction takes
  place because a borrower has incentives to invest
  in risky project, in which borrower does well if
  project succeeds, but lender bears most of the
  loss if project fails, to misallocate funds for
  personal use, to shirk, and to undertake
  unprofitable investment that will increase
  personal power or stature

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These problems of asymmetric information forces
the lenders to reduce the quantity of loans that
they will make which means that the lending and
investment will be at suboptimal levels and if
the problems becomes so bad that the financial
markets are unable to channel funds, we will step
into a stage of financial crisis, in which there
is a sharp contraction of economic activity.
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Definition
Financial crisis is a disruption to financial
markets in which adverse selection and moral
hazard problems become much worse, so that
financial markets are unable to efficiently
channel funds to those who have the most
productive investment opportunities.
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Factors Promoting Financial Crises
1.Understanding Financial Crisis

• Deterioration of financial sector balance sheets
• Increase in interest rates
• Increase in uncertainty
• Deterioration of non-financial sector balance
  sheets

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1.Deterioration of Financial Sector Balance Sheets
Results 1.Substantial contraction in their
capital Two choices -cutting back their
lending or -try to raise new capital However,
when these institutions experience a
deterioration in their balance sheets, it is very
hard to raise new capital at a reasonable cost
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Therefore, the typical response is to cut back
their loans. This lending contraction will slow
down overall economic activities. 2.Bank Panics
Depositors, fearing the safety of their deposits
and not knowing the quality of banks portfolios,
withdraw their deposits from the banks system,
causing a contraction in loans and a multiple
contraction in deposits, which then causes other
banks to fail. The failure of a bank means the
loss in the number of financial intermediation.
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The outcome is an even sharper decline in lending
to facilitate productive investment projects with
an additional contraction in economic activity.
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2.Increase in Interest Rates
Results 1.Greater adverse selection As interest
rates rise, prudent borrowers are more likely to
decide that it would be unwise to borrow, while
borrowers with the riskiest projects are often
those who are willing to take out loans with high
interest rate. Thus, the higher rate increases
the likelihood that the lender is lending to bad
credit risk. Therefore, the lenders are likely
to react by taking a step back from their
business and limiting the number of loans they
make.
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2. A decline in banks balance sheets Since the
banking business involves borrowing short and
lending long, a rise in interest rates cause a
decline in net worth, because in present value
terms, the interest rate rise lowers the value of
assets with their longer duration more than it
raises the value of liabilities with their
shorter duration.
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3. Increase in Uncertainty,caused by a failure
of a prominent financial or non-financial
institution, or from a recession, or the
uncertainty about the future direction of
government policies

• Results
• Worse problems of asymmetric information (adverse
  selection and moral hazard) and the lessened
  ability to screen out good from bad credit risks.
• Less willing to lend and the decline in economic
  activity.

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4.Deterioration of Non-financial Sector Balance
Sheets
This is the most critical factor that worsen the
asymmetric information problem. It is caused by
the increase in interest rate which raised
households and firms interest payments, and an
unanticipated exchange rate depreciation which
increases the debt burden of domestic
firms. Results 1.The decrease of the role of
collateral as an important way of solving
asymmetric information problems. This is because
if asset prices in an economy fall, and the value
of collateral falls as well, then the lender will
not be able to sell the collateral to make up for
the loss on the loan, in case that a borrower
defaults.
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2. The decline in the role of net worth as the
incentives for borrowers not to commit moral
hazard. This is because if the firms balance
sheets are in good shapes,which means that they
have high net worth, then they will have to lose
more if they default on their loans.
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• Deterioration of financial sector balance sheets
• Increase in interest rates
• Increase in uncertainty
• Deterioration of non-financial sector balance
  sheets

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Dynamics of Financial Crises

• 1. Initial stage Runup to currency crisis
• 2. Second stage Currency crisis
• 3. Third stage Currency crisis to full-fledged
  financial crisis

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1.Initial Stage Runup to Financial Crisis

• In this stage, emerging market countries adopted
  financial liberalization, which involved lifting
  restrictions on both interest rate ceiling and
  the type of lending allowed.
• Consequences
• The dramatic and rapid increase of lending by
  financial institutions and excessive risk taking
  due to,
• -the lacking in the well-trained loan officers,
  risk assessment systems to evaluate and respond
  to risk properly.
• -the weak financial regulation and supervision
  which could not limit the moral hazard created by
  government safety net, assuring the financial
  institutions that they will be bailed out if they
  fail.

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• This leads to the increase of the number of
  nonperforming loans in these emerging market
  countries.
• A huge increase in leverage in the corporate
  sector.
• For example, in Korea, debt relative to equity
  for the corporate sector as a whole shot up to
  350 before the crisis.
• The result is the increase in the vulnerability
  to negative shocks which could lead to financial
  crisis.
• Another additional factor that promotes a crisis
  in this initial stage is the uncertainty created
  by stock market declines, political instability,
  and other negative shocks, including the failure
  of a major business firm.

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2. Second Stage Currency Crisis
From the first stage, we observe the weaknesses
of banks and other financial institutions. With
weak banking system, the Central Banks of these
countries were unwilling to defend domestic
currencies by raising interest rates. Since it
will worsen banks balance sheets and increase
the cost of financing. Investors also recognized
this and expected that profits from selling the
currency will rise. This led to speculative
attacks and eventually currency depreciations.
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3.Third Stage Currency Crisis to Financial Crisis
There are three mechanisms that link currency
crisis to financial crisis. 1.The Direct effect
of a currency depreciation on the firms balance
sheets A currency depreciation increases the
debt burden of domestic firms since the debts
were denominated in foreign currencies and were
often short term borrow.
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2. Further deterioration in the balance sheets of
financial sector, provoking a large-scale banking
crisis.
Bank and other financial institution balance
sheets were squeezed from both asset and
liability sides. Results Sharp contraction of
lending, bank panic, and failure of banks and
financial companies.
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3. Higher inflation due to a currency
depreciation
A sharp currency depreciation Immediate upward
pressure on import prices A dramatic rise in both
actual and expected inflation A rise in nominal
interest rates Huge increase in interest payments
by firms Further weakening balance
sheets Increased adverse selection and moral
hazard problems
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These three mechanisms show how a currency crisis
causes a sharp deterioration in both financial
and non financial sector balance sheets, which
then translated to a contraction in lending and a
harsh economic downturn. This means that
financial markets are no longer able to channel
funds to productive investment opportunities.
This leads to devastating effects on the
economies and financial crises.
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2.Financial Policies to Prevent Financial Crises

• 1.Prudential Supervision
• 2.Accounting Standards and Disclosure
  Requirements
• 3.Legal and Judicial Systems
• 4.Encourage Market-Based Discipline
• 5.Entry of Foreign Banks
• 6.Capital Controls
• 7.Reduction of the Role of State-Owned Financial
  Institutions

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• 8.Restrictions on Foreign-Denominated Debt
• 9.Elimination of Too-Big-To-Fail in the Corporate
  Sector
• 10.Sequencing Financial Liberalization
• 11.Monetary Policy and Price Stability
• 12.Exchange Rate Regimes and Foreign Exchange
  Reserves

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1.Prudential Supervision
As we have seen in the first part, the weak
banking system is an important factor promoting
financial crisis. Therefore, government must
create a strong bank regulatory and supervisory
system to prevent the crisis. This includes seven
basic forms. 1.1Prompt Corrective Action -Quick
action by prudential supervisors to stop
undesirable activities by financial
institutions. -Closing down institutions that do
not have sufficient capital.
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• It is very important to close down insolvent
  institutions since these institutions have moral
  hazard incentives to take excessive risk because
  they have nothing to lose by taking on huge risk.
  
• If they get lucky, they will get out of
  insolvency. But if not, their losses will mount.
  This will weaken further the financial system and
  lead to higher taxpayer bailouts in the future.

-Early and vigorous intervention creates
incentives for institutions not to take on too
much risk in the first place. Since they knew
that they will be punished
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• The Example of Prompt Corrective Action USA.
• -Provision in the FDICIA( Federal Deposit
  Insurance Corporation Improvement Act)
  legislation implemented in 1991.
• Banks in USA are classified into five groups
  based on bank capital.
• Well capitalized Banks that significantly exceed
  minimum capital requirements and are allowed
  privileges such as insurance on brokered deposits
  and the ability to do some securities
  underwriting.
• Adequately capitalized Banks that meet minimum
  capital requirements and are not subject to
  corrective actions but are not allowed the
  privileges of the first group.

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3.Undercapitalized Banks that fail to meet
risk-based capital and leverage ratio
requirements. 4.Significantly undercapitalized
and 5. Critically undercapitalized The last two
groups are not allowed to pay interest on their
deposits at rates that are higher than average.
In addition, all of the undercapitalized groups
must submit an acceptable capital restoration
plan within 45 days and implement the plan. A
key element of making prompt corrective action
effective is that bank supervisors have
sufficient funds to close down the insolvent
institutions.
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The way to recapitalize the banking system is to
close down all insolvent and weak institutions
and sell off their assets to healthy
institutions. The public funds are used to make
the assets whole. If this is not possible, a
public corporation e.g. the Resolution Trust
Corporation(RTC) in the US.or KAMCO in Korea can
be created to take responsibility to sell off the
assets of these closed banks as promptly as
possible. It is also important that
stockholders, managers, and large uninsured
creditors must be punished when financial
institutions are closed to prevent moral hazard
problem.
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1.2 Focus on Risk Management The traditional
approach to bank supervision focusing on the
quality of banks balance sheets at a point of
time is no longer adequate because, 1. Capital
may be extremely hard to measure. 2. New
financial markets and instruments which make it
easy for financial institutions and their
employments to make huge bets quickly. Therefore,
though being well capitalized, an institution can
be driven into insolvency extremely rapidly from
trading losses as we saw from the failure of
Barings in 1995.
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• Four Elements of Sound Risk Management
• The quality of oversight provided by the board of
  directors and senior management.
• The adequacy of policies and limits for all
  activities that present significant risks.
• The quality of the risk measurement and
  monitoring systems
• The adequacy of internal controls to prevent
  fraud or unauthorized activities on the part of
  employees.

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• In USA, banks practice for risk management are
  rated from 1 to 5 considered the above elements
  in order to measure overall management .
• Bank supervisors in Emerging Market Countries
  should also adopt this similar measures to
  promote safer and sounder financial systems.
• 1.3 Limiting Too-Big-To-Fail
• Too-Big-To-Fail implies that all depositors at
  a big bank, both insured and uninsured are fully
  protected if the bank fails.
• It occurs because the failure of a very large
  financial institution makes it more likely that a
  major systemic financial disruption will occur.
  Therefore, supervisors are naturally reluctant to
  let a big financial institution to fail.

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• This leads to decreased market discipline on
  large financial institution and thus increased
  moral hazard incentives to take on excessive
  risk.
• We also observed Too-Politically-Connected-To-Fa
  il in emerging market countries , where there
  are great connections between government and
  large financial institutions, thus making it is
  more likely for them to be bailed out if facing
  difficulties. In some cases, even equity holders
  and other creditors have also been protected when
  large institutions have been subject to failure.

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To prevent moral hazard problem from having
too-big or too-politically-connected-to-fail
institutions in emerging market countries,
-Large institutions must be scrutinized more
rigorously than smaller ones, also losses must be
imposed on shareholders and managers when these
institutions are insolvent. -Supervisory
agencies must announce that there is a strong
presumption that when there is a bank failure,
uninsured depositors would not be fully protected
unless this is the cheapest way to resolve the
failure. This means that, though the bank may be
too big to liquidate, they can be closed with
losses imposed on uninsured creditors.
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-Although there is a concern about systemic risk
possibilities, there will be a strong assumption
that the first large bank to fail will not be
treated as too-big-to-fail. Instead of bailing
out the uninsured depositors of the first large
bank that fails, the authorities will stand ready
to extend the safety net to the rest of the
banking system if they perceive that there is a
serious systemic risk problem. By adopting these
measures, the moral hazard problem from having
too-big-to-fail institutions should be reduced.
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1.4 Adequate Resources and Statutory Authority
for Prudential Regulators/Supervisors -In
emerging market countries, we observed the
absence of sufficient monitoring of banking
institutions because of insufficient resources
and incentives. -Bank supervisors salaries are
quite low and smaller relative to private sector
salaries. Therefore, the likelihood that they can
be bribed by the institutions they supervise will
be very high. -There is also a lack of
resources, especially in information technology,
to monitor financial institutions.
statutory authority is the ability to issue
cease and desist orders and to close down
insolvent banks.
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1.5 Independence of Regulatory/Supervisory
Agencies -This is an important factor for
preventing regulatory forbearance. -To ensure
against regulatory forbearance, -The role of
bank supervision must be given to a politically
independent central bank. But some central banks
might not want to have this task because they
worry that it might increase the likelihood that
the central bank would be politicized. -Alternati
vely, this supervisory task could be housed in a
bank regulatory authority that is independent of
the government.
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-Sufficient resources are also important for the
independence. If supervisory agencies have to
come to government for funds to close down
insolvent institutions, they will be more subject
to political pressure to engage in regulatory
forbearance. 1.6 Accountability of
Supervisors -In order to achieve this, financial
system faces a particular type of moral hazard
problem, the principal-agent problem. -In the
interest of the principal, regulators must set
restrictions on holding assets that are too
risky, impose sufficient capital requirements,
and close down insolvent institutions.
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Because of the principle agent problem,
supervisors have incentives to do the opposite,
which is corresponding to their own
interest. -The first incentive is their desire
to escape blame for poor performance by their
agency. Thus, they hide the problem of an
insolvent bank and hope that the situation will
improve, or what is so called bureaucratic
gambling. -The second incentive is to protect
their career from the politicians who have strong
influence on their position. These incentives
lead to regulatory forbearance.
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To solve this problem, supervisors must be
accountable in order to improve their
incentives. In case of USA., the supervisory
agencies must produce a mandatory report if the
bank failure imposes costs on FDIC. And this
report is opened up to public scrutiny, thus
making the regulatory forbearance less
attractive. In addition, supervisors must be
subject to criminal prosecution if they involves
bribery. 1.7 Restrictions on Connected
Lending -Connected Lending means lending to the
financial institutions owners or managers or
their business associates.
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Clearly, the financial institutions have less
incentives to monitor these loans, thus
increasing moral hazard incentives for the
borrowers to take on excessive risk. In addition,
large loans from connected lending can result in
a lack of diversification for the institution,
therefore increasing the risk exposure to the
bank. To reduce risks due to connected
lending, -Disclosure of connected lending
requirements must be imposed. -There must be
limits on the amount of connected lending as a
share of bank capital. However, there are
problems in practice.
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In emerging market countries, connected lending
limits are not enforced effectively because of
the lack of authority for the supervisors to
trace where the funds are used. Another factor
promoting connected lending is having commercial
business owning large shares of financial
institutions.
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2.Accounting Standard and Disclosure Requirements
Implement proper accounting standards and
disclosure requirements is an important first
step in promoting a healthy financial
system. Because without the appropriate
information, including all key financial data and
consolidated financial exposure, both markets and
supervisors will not be able to adequately
monitor financial institutions to prevent
excessive risk-taking and to sort out healthy and
unhealthy institutions.
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New Zealand Case Every bank in New Zealand must
supply a comprehensive quarterly financial
statement that provides information on the
quality of its assets, capital adequacy, lending
activities, profitability, and its ratings from
private credit rating agencies. -This statement
must be audited twice a year. -It must be
provided to the central bank, and must be made
public. -The bank directors are subject to
unlimited liability if they have made misleading
statements.
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3.Legal and Judicial System
These are important for promoting the efficient
functioning of the financial system. In emerging
market countries, we can see many problems with
their legal system that does not foster the role
of financial system. -In many developing
countries, the role of collateral as a mechanism
to reduce asymmetric information problems is
limited because of the legal system that prevents
the use of certain assets as collateral or makes
attaching collateral a costly and time-consuming
process. -Bankruptcy procedures in developing
countries are frequently cumbersome, or even non
existing, resulting on delays in resolving
conflicting claims.
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This bankruptcy procedures need to be improved
since the resolution of bankruptcies in which the
books of insolvent firms are opened up and assets
are redistributed can decrease asymmetric
information in the market place. 4. Encouraging
Market-based Discipline Two problems relying on
supervision to control risk-taking by financial
institutions 1.Financial institutions have
incentives to keep information away from bank
supervisors. 2.The principal-agent problem which
gives supervisors incentives to engage in
regulatory forbearance.
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• To solve these problems, we need to increase
  market discipline in financial system.
• Two steps
• Require all financial institutions to have credit
  ratings, provided by a rating agency registered
  to the central bank.The lack of a credit rating
  or a poor credit rating is expected to cause
  depositors and other creditors to be reluctant to
  put their funds in the bank. This measure gives
  the bank incentives to reduce its risk taking and
  boost its credit rating.
• Require that they issue subordinated debt
  (uninsured debt that is junior to insured
  deposits, but senior to equity). If the bank is
  exposed to too much risk, it is unlikely to be
  able to sell its subordinated debt. This is the
  direct way for the market to force banks to limit
  their risk exposure.

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5.Entry of Foreign Banks
Instead of viewing this as a threat, their entry
should be seen as an opportunity to strengthen
the banking system. -Foreign banks have more
diversified portfolios than those of domestic
banks, in which their lending is concentrated in
the home country. This means that they expose to
less risk and less affected by negative shocks to
the home countrys economy. Therefore, having a
large foreign component to the banking sector
helps insulate the banking system from domestic
shocks, and makes the financial system less
fragile. -Entry of foreign banks can encourage
adoption of best practice in the banking industry.
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Having foreign banks to demonstrate the latest
risk management techniques can lead to improved
control of risk in the home countrys banking
system. -There are also benefits from the
increased competition in banking industry in that
the domestic banks are encouraged to improve
management techniques to be more efficient.
6. Capital Controls The asymmetric information
analysis of the crisis suggests that
international capital movements can have an
important role in producing financial
instability. But as we have seen that this is
because of the presence of a government safety
net with inadequate supervision of banking system
that encourages capital inflows, and leads to a
lending boom and excessive risk taking on the
part of banks.
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As well as the rapid capital outflows after
crises, which are just a symptom of underlying
fundamental problem rather than a cause of the
crises. In order to prevent lending boom and
excessive risk-taking activities, banks might be
restricted in how fast their borrowing could grow
and this will have the impact of limiting capital
inflows. -This form of capital control is
different than the typical one, adopted by
Malaysia since it focuses on the sources of
financial fragility, rather than the symptoms.
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7. Reduction of the Role of State- Owned
Financial Institutions

• Problems of State-Owned Financial Institutions
• Governments have less incentives to solve adverse
  selection and moral hazard problems, and to lend
  to borrowers who have productive investment
  opportunities. Since they are not driven by the
  profit motive, thus they are less likely to
  cannel funds to those borrowers who will help
  produce high growth to the economy.
• The absence of profit motive also means that
  state-owned banks are less likely to manage risk
  properly and be efficient.

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Therefore, the countries with the highest share
of state-owned banks usually have a higher
percentage of non-performing loans and higher
operating costs, which lead to weak banking
systems. -Privatization of banking sector is
essential and must be managed properly. -The
purchasers of banks must be required to put a
significant amount of their own capital into the
bank so they will not have incentives to engage
in risky activities. -The chartering or
licensing process must be sufficient to screen
out bad owners.
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8.Restrictions of Foreign-denominated Debt
A debt structure with large amount of
foreign-denominated debt makes the financial
system more fragile. Currency crises and
devaluations do trigger financial crises in
countries with foreign-denominated debt. The
presence of foreign-denominated debt also makes
it difficult for a country to recover. -A
central bank cannot use expansionary monetary
policy to promote recovery. Because it is likely
to cause the domestic currency to depreciate
sharply, thus raising the debt burden of banks
and firms.
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-A central bank also cannot play a role of
lender of last resort to promote recovery.
Because, instead of restoring liquidity and
improving balance sheets of financial
institutions, expansion of domestic credit might
lead to a substantial depreciation. Thus, to
enhance financial stability, there must be
regulations to both restrict bank lending and
borrowing in foreign currencies. Also,
restrictions on corporate borrowing in foreign
currencies, or tax policies to discourage foreign
currency borrowing should be imposed. There is
also a suggestion to restrict financial
institutions in industrialized countries to limit
lending to emerging market countries.
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9.Elimination of Too-big-to-fail in the Corporate
Sector
The same incentives of big financial institutions
clearly apply to corporations. Lenders expect
government to bail out a large corporation if it
gets into trouble. So they will not monitor the
corporation and withdraw funds if it is taking
too much risk. Therefore, it is imperative that
too-big-to-fail policies be eliminated. This
implies a greater separation between the
corporate sector and the government which means a
change in business culture in many emerging
market countries.
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10.Sequencing Financial Liberalization
If the proper bank regulatory/supervisory
structure, accounting and disclosure
requirements, restrictions on connected lending,
and well-functioning legal and judicial systems
are not in place when liberalization comes, the
appropriate constraints on risk-taking behavior
will be far too weak. This results in bad loans
and disastrous consequences for bank balance
sheets. Therefore, proper sequencing of financial
deregulation and liberalization is
essential. Before financial market are fully
liberalized, it is important that all above
policies be implemented. However, those measures
are not easy to install quickly.
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Therefore, when financial liberalization is put
into place, the growth of credit should be
restricted. - Put upper limits on loan-to-value
ratios or for consumer credit. -Set
maximum repayment periods and minimum downpayment
percentages. -Restrict on how fast certain types
of loan portfolios are allowed to
grow. -Restrict on foreign-denominated debt. As
the appropriate infrastructure is put in place,
these restriction can be reduced.



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11.Monetary Policy and Price Stability
When countries have a past history of high
inflation, debt contracts are often denominated
in foreign currencies. This feature of debt
contracts makes the financial system more fragile
because currency depreciation can trigger a
financial crisis. Achieving price stability is
necessary for having a sound currency and with a
sound currency, it is easier for banks, non
financial firms and the government to raise
capital with debt denominated in domestic
currency.
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Moreover, a central bank which has successfully
pursued price stability has sufficient
credibility. Therefore, its expansionary policy
or a lender-of-last-resort operation during a
crisis is likely to cause a rise in inflation
expectations and a sharp depreciation which would
harm balance sheets. Thus, price stability will
enhance an ability of central bank to use
monetary policy to promote recovery.
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12.Exchange Rate Regime and Foreign Exchange
Reserves
Some methods of pursuing price stability can
unfortunately promote financial instability. One
commonly used method to achieve price stability
is to peg the value of its currency to that of a
large low-inflation country so that its inflation
rate will eventually gravitate to that of the
other country. Although a fixed exchange rate
regime can be a successful strategy for
controlling inflation, this strategy can be very
dangerous for an emerging market countries with a
large amount of foreign-denominated debt.
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This is because when a successful speculative
attack occurs, the decline in the value of the
domestic currency is usually much larger, more
rapid, and more unanticipated than when it occurs
under a floating exchange rate regime. -The debt
burden of firms increase dramatically, thus
making it very difficult to remain solvent. The
deterioration of non financial firms balance
sheets leads to a deterioration in bank balance
sheets because the borrowers are less likely to
be able to pay off their loans. This collapse in
balance sheets resulted in sharp economic
contractions. Moreover, by providing a more
stable value of the currency, it may lower risk
for foreign investors and thus encourage capital
inflows. This might promote lending boom and
increase the size of banking sectors.
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If the bank supervisory process is weak, as it
often is in emerging market countries,the
likelihood that the capital inflows will produce
a lending boom is much greater. And with
inadequate bank supervision, the outcome of a
lending boom is substantial loan losses, a
deterioration of bank balance sheets, and a
possible financial crisis. The advantage of a
flexible exchange rate regime is that the
movements in the exchange rate are much less
nonlinear than in a pegged exchange rate
regime. -The daily fluctuations in the exchange
rate make clear to private firms, banks, and
governments that there is substantial risk
involved in issuing debts denominated in foreign
currencies. -A depreciation may provide an early
warning signal to policymakers that they might
have to adjust their policies to prevent a
financial crisis.
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To prevent financial crisis, countries using this
pegged exchange rate regime as a strategy to
control inflation must actively pursue policies
that will promote healthy banking system. An
accumulation of large amounts of international
reserves is another policy suggestion to prevent
crisis. Since another feature of recent crisis
countries is that they had low amounts of
international reserves relative to short-term
foreign debts. Although this might make emerging
market countries less vulnerable to currency
crises, it is unlikely to insulate them from a
financial crisis if the financial sector is
sufficiently weakened.
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Conclusion?
In recent years, we have seen a growing number of
banking and financial crises in emerging market
countries. The good news is we now have a much
better understanding of why these crises occur
and how they can be prevented. If these financial
policies are adopted in emerging market
countries, then we should see healthier financial
systems in these countries in the future, with
substantial gains both from higher economic
growth and smaller economic fluctuations.