IV Monetary and Credit Policies
- Leslie Teo, Charles Enoch, Carl-Johan Lindgren, Tomás Baliño, Anne Gulde, and Marc Quintyn
- Published Date:
- January 2000
The crisis had profound effects on the overall monetary environment and on policymakers’ ability to use financial policies to steer the economy. This section examines the difficulties encountered and discusses the possible interaction between measures to reestablish monetary control and the observed decline in credit to the economy in the crisis countries.
Monetary management is particularly challenging during a banking crisis because the relationships between money and intermediate and final targets of monetary policy tend to become unstable.28 Banking crises can affect the short-run stability of money demand, the money multiplier, velocity, the transmission mechanism, and various signa 1 variables for monetary policy. In the first instance, this occurs because of changes in the composition of money and credit aggregates.29Table 4 shows how the variability of a set of monetary aggregates increased during the period. In addition, the segmentation of the interbank market in some countries complicated the choice of interest rate for the central bank to target. (Figure 6 illustrates how interbank rates diverged significantly across groups of banks in Indonesia in early 1998.) In this context, monetary policy focused on the exchange rate, short-term interest rates and the level of international reserves (see Section VII for a discussion of the implications of the shift in relationships for IMF programs).
|June 1996||June 1997|
|to June 1997||to June 1998|
|Time, savings, foreign currency deposits/M2||0.55||0.96|
|Time, savings, foreign currency deposits/M3||0.44||0.72|
|Time, savings, foreign currency deposits/M2||0.91||3.06|
|Time, savings, foreign currency deposits/M3||0.02||0.02|
|Time, savings, foreign currency deposits/M2||0.39||0.51|
|Money multiplier||0.34||0.58|Figure 6.Indonesia: Daily Interbank Money Market Rates by Type of Bank
Source: Bank of Indonesia.
Note: The market was closed on February 7 and 8.
Whether there was a credit crunch in the Asian crisis countries has been a matter of debate.30 A credit crunch has been traditionally defined as an excess demand for credit under prevailing interest rates, or a situation where credit is rationed through non-price mechanisms. Frequently, however, the term has been used more loosely to describe a fall in real credit to the private sector. In all countries, the growth rate of real credit has indeed declined sharply since late 1997, which has been interpreted as a credit crunch (Figure 7). However, care is needed when measuring and interpreting credit developments in a crisis situation. Measurement of credit developments is generally blurred by such factors as the treatment of loans that are written off or transferred to an asset management company, the rollover of credits, and the effects of bank closures and valuation changes on the data.31
Figure 7.Growth Rate of Real Credit to the Private Sector
Source: IMF, International Financial Statistics.
Note: The spikes in the growth rates between December 1997 and June 1998 in Indonesia, Korea, and Thailand are due to the effect of the exchange rate depreciation on credit denominated in foreign currency.
When an economy is hit by a negative shock, it is often difficult to determine whether a decline in the growth of credit is the result of a shift in demand or in the supply of credit. In Asia, both demand and supply were affected. On the one hand, demand for credit declined as consumption and investment were sharply reduced because of uncertainty, overcapacity, weakening economic conditions, and the negative wealth effect arising from a fall in asset prices.
On the other hand, borrowers lost creditworthiness, which made banks reluctant to lend, even at higher interest rates. A self-reinforcing dynamic may develop where negative economic shocks may lead to a decline in the demand for credit. Such a situation will also affect the financial system—leading to a decline in the supply of credit, which, in turn, will aggravate the distress in the real sector, further weakening the demand for credit. The following paragraphs discuss the supply-side factors in more detail. A full analysis of the demand-side factors is beyond the scope of this paper.
Even though, in aggregate, deposits did not fall, many institutions had liquidity problems because of a shift of deposits to higher-quality institutions. In addition, the drying up of foreign credit lines forced banks to preserve liquidity by recovering assets as quickly as possible and slowing new lending, thus reducing growth in the supply of credit. For example, foreign claims on banks in Indonesia declined by about 43 percent between the end of December 1997 and the end of June 1998; the decline was much slower (21 percent) during the second half of 1998. Corresponding declines for Korea are 27 percent and 15 percent for the same periods, and 31 percent and 27 percent for Thailand.
The need to increase loan-loss provisions and maintain capital adequacy affected banks’ ability to lend. Stricter capital adequacy requirements and/or provisioning rules are likely to have further reduced banks’ willingness to lend. Instead of lending banks would increase their holdings of more liquid and safer assets, which carry lower weights in the computation of capital adequacy requirements, thus reducing the supply of credit.32 To mitigate these effects, in each country banks were given time to phase in tighter prudential standards (see Section V). Banks also became extremely risk averse in a situation where the creditworthiness of potential borrowers rapidly deteriorated.
The closure of financial institutions may also have affected the availability of credit. Customers of closed institutions had difficulty building up a credit relationship with other financial intermediaries in the middle of the crisis. For instance, in Korea and Thailand, groups of borrowers served by merchant banks and finance companies lost access to credit as a result of closures. In addition, liquidation processes can have varying effects on credit availability, in that they can accelerate repayment (as in Korea), or require customers to repay loans on maturity that would otherwise have been rolled over, or, on the contrary, remove pressure from repayment or servicing the debt for some or all customers. To reduce the negative effects on credit, regulators at first closed only those institutions that were most deeply insolvent, applying other resolution procedures that would allow customers to continue their credit relationship (such as nationalization, intervention, mergers, purchase and assumption operations, or bridge banks; see Box 5) to remaining institutions.
All countries used a variety of measures in an effort to alleviate the credit slowdown in their economies. These include direct measures, such as special credit facilities for small- and medium-sized enterprises, credit guarantees, and mandated credit targets, as well as indirect ones, such as “moral suasion” on banks to lend or keep interest rates or interest margins low and gradualism in the application of prudential rules and public resources to help banks meet their capital adequacy requirements (Table 5).33
|Indonesia||Credit facility to small- and medium-sized enterprises; allow negative interest rate|
|spreads; Indonesian Bank Restructuring Agency (IBRA) takeover of certain insolvent|
|banks; export credit guarantee scheme; recapitalization assistance.|
|Korea||Discount facility at central bank for loans to small- and medium-sized enterprises;|
|credit guarantee scheme; moral suasion to lend to small- and medium-sized|
|enterprises; bridge banks and purchase and assumption operations for bank|
|closures; recapitalization assistance; purchases of nonperforming loans.|
|Malaysia||Moral suasion on banks to lend; lower interest rates (or interest margins); lower|
|reserve and liquid asset requirements; mandated targets on lending to private sector;|
|purchases of nonperforming loans.|
|Philippines||Suspended the general provisioning requirement for loans in excess of outstanding|
|stock at the end of March 1999; lower reserve requirements.|
|Thailand||Special credit facility for small- and medium-sized enterprises and exporters; moral|
|suasion on lending rates; recapitalization support.|
Among the measures taken to overcome the banks’ unwillingness to lend was the attempt by some governments to lower the risk of lending to certain categories of borrowers by taking over part of the credit risk. Such measures, including guarantees on export or import credits or on lending to small- and medium-sized companies, may be useful but have to be designed so that guarantees do not fully eliminate the banks’ credit risk, or relieve them from performing a proper credit assessment, even if this means that guarantee schemes are not fully used. Thus, in Indonesia and Thailand, the partial nature of the export guarantee schemes led banks to more carefully evaluate credit risks, but it has resulted in undersubscription to these schemes because banks are unwilling to increase exposures to corporations that they judge to be insolvent. To address the same concern, the Korean authorities intend to phase in reductions in the coverage of the credit guarantees offered by public guarantee funds, which in most cases had been 100 percent of the loan.
Measures to alleviate the credit crunch that coerce banks to lend, or that result in the compression or elimination of positive interest margins, can only further damage already weak banks. Such measures create perverse incentives in that they make banks more unwilling to lend. Negative spreads in Indonesia made it profitable for clients to borrow and redeposit their proceeds (such “round-tripping” forces banks to ration credit). Low margins will discourage new lending and compromise bank profits and their capital base and, therefore, undermine the entire restructuring process. The soundest way to alleviate a slowdown in credit is through a combination of measures to stabilize the economy and enhance profitability and solvency of banks and their corporate customers.