Weaknesses in the Countries’ Financial Systems

The financial systems of Indonesia, Korea, and Thailand are different from systems in many industrialized countries in several ways. Weaknesses in the Financial Systems of Indonesia, Korea, and Thailand

Prior to their financial crises, all three countries we studied fell short of meeting several of the criteria for a robust financial system and the principles for effective bank supervision. While these three countries’ economies relied heavily on debt financing, they had inadequate procedures for the enforcement of loan contracts and workouts, according to IMF and World Bank documentation. Countries Are Taking Steps to Improve Operation of Their Financial Sectors

The governments of Indonesia, Korea, and Thailand have taken or are taking a variety of actions in response to their ongoing financial crises. Financial sector restructuring in Indonesia, Korea, and Thailand has involved efforts to restore confidence in the countries’ banking system by guaranteeing deposits, strengthening regulatory structures, adopting internationally accepted accounting standards, and creating legal frameworks for bankruptcy and governance. Each of the countries moved to close and/or merge failing institutions. For example, prior to the crisis, Indonesia did not have an agency with the authority to resolve failing financial institutions. Decisions on bank closures and recapitalization have been made on the basis of these audits. International Bank Supervisory Principles Partially Implemented

All three of the countries we examined have begun changing their bank supervisory and regulatory systems to meet international standards. Further, some of the changes in supervision and regulation are inherently long term. In the financial sector the World Bank played an especially important role in formulating and implementing the strategy for dealing with commercial banks, finance companies, and for specialized institutions; assessing the solvency of the banking system and the standing of main institutions, based on bank audits; developing plans for dealing with insolvent institutions, for disposing of the assets of closed banks, and for handling the nonperforming assets of banks that were to be publicly supported; improving the overall financial infrastructure including strengthening bank supervision and redesign of prudential regulation according to the Basel standards; providing expertise on instituting deposit insurance schemes; updating banking laws to include provisions that had been lacking, including limitations on cross-ownership between banks and enterprises; and stengthening the development of money markets and capital markets through the encouragement of new institutional investors, asset securitization, standardization of government bond issues, and improvement of securities market prudential regulation and self- regulation. Conclusion

Full implementation of the reform agenda will take many years to accomplish due to the extent of the problems and the enormity of the changes required. Objectives, Scope, and Methodology

Our objectives were to determine (1) the nature of weaknesses in the financial sectors of the three countries, (2) the extent to which the countries have reformed their financial systems, (3) the extent to which international principles for banking supervision have been implemented by the countries, and (4) U.S. government and multilateral efforts to effect changes in the financial sectors of these emerging markets. Additional copies are $2 each. U.S. General Accounting Office P.O.
Why GAO Did This Study

Pursuant to a congressional request, GAO analyzed the efforts to improve the financial sectors of the emerging market countries of Indonesia, South Korea, and Thailand, focusing on: (1) the nature of weaknesses in the countries' financial sectors; (2) the extent to which the countries have achieved reforms in their financial systems; (3) the extent to which the countries have implemented international principles for banking supervision; and (4) U.S. government and multilateral institutions' efforts to effect changes in the financial sectors of these emerging markets.

What GAO Found

GAO noted that: (1) the governments of Indonesia, Korea, and Thailand are implementing multiple changes to reform their financial institutions and markets and banking supervisory structures; (2) many of these changes are being undertaken in response to a financial crisis; (3) some regulatory and legal changes have been implemented in the short term, while other objectives may take many years to accomplish due to the extent of the problems and the enormity of the changes required; (4) how robust the countries' financial systems are to future disruptions is an open question, given the risks to the financial systems posed by the continued weaknesses of the corporate sectors of all three countries; (5) the economies of each country relied heavily on debt financing and restricted the access of foreign financial institutions; (6) at the same time, the countries' legal systems did not provide adequately for the enforcement of contracts or provide mechanisms for resolving defaulted corporate debt; (7) the countries did not have adequate legal and institutional frameworks ensuring their bank supervisors' independence and enforcement authority; (8) the countries did not have deposit insurance systems that forestalled runs on bank deposits; (9) Indonesia, Korea, and Thailand have made or are making changes to address banking system and related weaknesses, with early priority given to resolving nonviable banks and debtor companies; (10) some insolvent or weak banks have been closed or merged; (11) ongoing efforts include the sale of assets of failed banks and the recapitalization of banks, with the latter partially dependent on the corporate debt workout process; (12) all three countries are changing laws to expedite resolution of loans in default; (13) Korea and Thailand have changed or strengthened accounting practices by adopting internationally accepted accounting standards; (14) each of the three countries has partially implemented international principles for effective bank supervision, but it is too early to determine the effect of this on actual management or supervisory practices; and (15) efforts of the U.S., the International Monetary Fund, the World Bank, and the Asian Development Bank to effect changes in emerging markets have focused on the countries' immediate needs to resolve nonviable banks and debtor companies as well as long-term goals to improve financial systems.