the resolution of the east asian crisis: financial and corporate sector restructuring

The resolution of the East Asian crisis: financial andcorporate sector restructuring

Masahiro Kawai*

World Bank, Washington, DC 20433, USA

1. Introduction: the context of financial and corporate restructuring

The extraordinary turbulence in East Asia over the past 3 years has sparked a wide-ranging debate on the causes of the crisis, lessons to be learned, and the desirable architectureof the global financial system. Among policy makers, international financial institutions andprivate organizations, and in academic circles, views are converging on the causes of the EastAsian crisis: The crisis was the result of interactions between massive capital inflows andoutflows and weak domestic institutions, notably in the financial sector, in emerging marketeconomies. As a result, discussions are proceeding on how the international financial systemand domestic policy frameworks and institutions can be improved to maximize the benefitsof, and reduce the risks posed by, global economic and financial integration.

While issues on the international financial architecture primarily involve ways and meansto improve the international economic and financial system, they also call for the strength-ening of emerging markets’ domestic institutions: (1) Financial markets must improvetransparency and supervision and do a better job of self-regulation and risk management. (2)Authorities must develop effective frameworks for resolving bank and corporate insolvenciesat minimum costs and without creating moral hazards. (3) Corporate governance must beimproved through the adoption of international standards and best practices for accounting,auditing and disclosure. Key focus has been on financial and corporate sector improvements.

The East Asian crisis adversely impacted banks and corporations in the affected econo-mies. Most banks are still heavily burdened with large nonperforming loans (NPLs), manyof which may ultimately have a relatively low recovery rate. A large number of corporationsstill have debt levels beyond their capacity to service and inefficient investments that are

* Corresponding author. Tel.: 212-458-1107.E-mail address:[email protected] (M. Kawai).

Journal of Asian Economics 11 (2000) 133–168

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economically nonviable. The holes in the balance sheets of banks and corporations are huge,and it will take some time to write off problem loans and failed investments.

Financial and corporate sector restructuring is an essential element of the strategy forsustainable recovery and stable growth in crisis-affected economies. Without a healthyfinancial system, the current economic recovery could founder because of an inadequatesupply of credit. Without corporate debt and operational restructuring, potentially viablecorporations will not be considered creditworthy. Combined with sound macroeconomicmanagement and reforms to strengthen the financial system and corporate governance,financial and corporate sector restructuring would hasten the pace at which market confi-dence and robust economic growth are restored.

The progress on financial and corporate restructuring in each of the crisis-affectedcountries has been significant and should not be underestimated. In the financial sectors inIndonesia, Korea, Malaysia and Thailand, authorities have intervened in nonviable financialinstitutions, recapitalized most viable but weak institutions, shifted their emphasis fromresolution of problem banks to rehabilitation of weak ones and begun taking steps to improveprudential regulation and supervision. On the corporate side, voluntary restructuring frame-works based on variants of “London rules” have been adopted, many legal impediments tocorporate restructuring have been eliminated, and court-based insolvency procedures havebeen strengthened.

However, the pace of implementation and the effectiveness of these measures have variedsignificantly across the countries. While the benefits of reform programs thus far may bereflected in improved macro indicators—currency appreciation, lower interest rates, higherequity prices and positive GDP growth rates—the process has not yet resulted in soundrecapitalized banking systems and strong corporate balance sheets, much less a resumptionof growth in bank lending and corporate investment, except in Korea. Moreover, the depthof the problems—and their eventual costs—have only begun to be recognized.

The slow pace of restructuring in East Asia is not atypical for countries experiencingsystemic financial and corporate sector crises. It takes time for governments and the populaceto grasp the reality and to build a consensus on how to move forward. Solutions must befound that can gain and hold political support during difficult economic times. The public isusually reluctant to accept the substantial fiscal costs of bank and recapitalization and/or tobail out “rich bankers,” and interests that stand to lose from the restructuring process try toblock reforms.

2. Agenda for restructuring

Financial sector restructuring was one of the most important policy foci from the earlystages of crisis management and response in East Asian crisis-affected economies. It wasonly at relatively later stages that corporate sector restructuring became prominent in thepolicy agenda. Financial and corporate sector restructuring in a systemic crisis is a complex,difficult process that takes time to accomplish.

Strategies for financial and corporate sector restructuring need to be closely linked.Financial sector restructuring must either precede or be done in tandem with corporate

134 M. Kawai / Journal of Asian Economics 11 (2000) 133–168

restructuring, particularly when the scale of corporate insolvency is huge and the size ofNPLs large. The reason is that owners of failed or weak banks have no incentive torestructure their borrowers’ debt (or the banks’ NPLs) because, if they realize losses, theresulting writedown of capital will bring on government intervention and force a loss ofcontrol of their banks. Another reason is that if illiquid corporations, along with assets ofinsolvent corporations, are not restructured in such a way as to put them back into produc-tion, distress in the financial sector will continue and the costs of debt restructuring will riseas assets lose value and recovery rates fall.

Financial sector and corporate sector restructuring must be driven by the incentives ofcreditors and debtors.

2.1. Financial sector restructuring: Stabilization and recapitalization

The initial priority of financial sector restructuring was to stabilize the financial system bytaking steps to restore the confidence of depositors and creditors. Where a deposit insurancesystem did not exist, governments often had to guarantee deposits (and possibly otherliabilities) to prevent bank runs, further capital flight and a potential breakdown of thepayments system. Governments also provided liquidity support to troubled banks.

The next step was to “stop the bleeding,” by intervening in clearly nonviable and insolventinstitutions, that would cause substantial losses to continue to accumulate. These interven-tions involved closures (liquidation), mergers with healthier banks and temporary national-ization of nonviable banks. Authorities attempted to put in place the clear legal andoperational groundwork for these interventions so that their impact restores rather thanundermines public confidence in the financial system.

Then, governments developed a strategy and plan for the recapitalization and rehabilita-tion of weak but viable financial institutions. In a nonsystemic crisis, the majority of privatebanks have weak but positive equity and are recapitalized by private investors. The govern-ment needs to deal with only a few institutions that are insolvent. In a systemic crisis,

Table 1Key Financial and Corporate Sector Statistics

Indonesia Korea Malaysia Philippines Thailand

1998 GDP, billion, US$ equivalent 105 309 69 68 121Banking sector’s external debt, billion US$ equivalent 50.3 72.4 23.0 17.8 46.8Average 1998 banking deposits/GDP, % 46 38 104 57 94Average 1998 private sector loans/GDP, % 43 75 111 50 114Total corporate debt, billion US$ equivalent 118.0 444.0 120.2 47.5 195.7

External debt 67.1 64.0 40.0 23.3 32.5Domestic debt 50.9 380.0 80.2 24.2 163.2

Debt-to-equity ratio 1996, % 200 350 110 140 240Estimated peak NPL,a % of loans 65–75 15–25 20–25 12.5 45–55Estimated cost of bank recap,a % of 1998 GDP

Gross 30–40 10–20 15–25 — 30–40Net 25–35 5–15 5–15 — 20–30

a World Bank staff estimates.

135M. Kawai / Journal of Asian Economics 11 (2000) 133–168

however, the required capital far exceeds that available from the private sector, and sufficientprivate investment to recapitalize banks may not be forthcoming. In these instances, thegovernment must develop a recapitalization plan that includes public funds to supplementprivate funds. The use of public funds can be justified on the grounds that the restoration ofa healthy financial sector and payments system is a fundamental public good necessary torestore credit flows and to induce economic recovery in the real sector. Bank recapitalizationmust require recognition of losses on NPLs and must first rely on private capital and then onpublic funds to supplement private resources. Government financial support should beprovided only to viable institutions where it can be most effectively used in restoring thehealth of the system. It should be accompanied by costs to existing owners to avoid a futuremoral hazard. The plan may include forced consolidation of institutions and, where appro-priate, changes in ownership and management. After recapitalization, owners of financialinstitutions must have an incentive to restructure NPLs of viable borrowers. Nonperformingloans must be managed either within the bank (or at a wholly owned “bad bank” subsidiary)or through sale to a centralized government-run asset management company as part of therestructuring process. Different modalities and variations on this approach are being used ineach of the East Asian crisis-affected countries.

It is not enough to deal with nonviable financial institutions and recapitalize weak ones.Capital adequacy, loan classification, provisioning rules and improvements in accounting anddisclosure rules need to be brought up to international standards so that the true condition ofbank balance sheets can be assessed. Prudential regulation and supervision, with accompa-nying improvement in supervisory agencies, is essential to monitor the progress of bankrestructuring and, for the future health of the financial system, to prevent the unsoundpractices that led to problems in the first place. To the extent that regulatory forbearance isin place, as in most East Asian countries, supervision of banks must be particularly stringent.The banks themselves must go through a process of operational restructuring so that they arepositioned to be profitable as they move forward. Finally, banks must, under the eye ofsupervisors, build a stronger credit culture—sound corporate governance, prudent riskmanagement and sound lending practices. Without these measures, recapitalization of bankscan simply result in a repetition of inefficient injections of capital.

An important principle of financial sector restructuring is that the longer it takes, the largerthe eventual economic costs. Weak banks may continue to accumulate assets that are likelyto go bad, or owners may lend to connected enterprises in the optimistic expectation that theloans will be repaid some time in the near future. Financial system weakness constrains creditflows and economic activity, thereby creating economic losses. Assets underlying NPLsshould be sold in a reasonable time period so that asset markets can be cleared. Otherwise,depressed asset prices may continue indefinitely.

2.2. Corporate restructuring

Corporate restructuring is a complex process as well. To avoid an unnecessarily longperiod of uncertainty, slow growth and erosion of asset values in NPL’s, governments triedto establish enabling environments for corporate restructuring; facilitate both formal and


informal debt restructuring; introduce an effective legal, regulatory, accounting and institu-tional framework for bankruptcy and foreclosure; and improve corporate governance.

The phrase “corporate restructuring” is used to indicate both corporate debt restructuringand corporate operational restructuring. Corporate debt restructuring includes debt resched-uling (an agreed-on rollover of loan principal and interest payments), debt-for-equity swaps,foreclosure and forgiveness of principal and/or interest. Corporate operational restructuringincludes asset sales to reduce debt levels, large reductions in employment, reduction ofproduction capacity, changing the line of business, closing production facilities and so on.

The governments of East Asian crisis-affected countries are at various stages of imple-menting a broad, complex agenda for corporate restructuring. The first step was to eliminatelegal, tax and regulatory obstacles to corporate restructuring. These obstacles included taxpolicies that impeded corporate reorganizations, mergers, debt-for-equity swaps or debtforgiveness; restrictions on the participation of foreigners as holders of domestic equity andinvestors in domestic banks; and labor laws and other existing laws and regulations thathindered debt restructuring.

The next step was to establish a policy framework that would facilitate out-of-courtsettlements. Given the costs and risks associated with even the most developed bankruptcysystems, out-of-court settlements were considered efficient. It was believed that the govern-ment could play an effective yet informal role in facilitating an orderly voluntary restruc-turing of debts, sometimes referred to as the “London approach.”

The third step was to introduce effective bankruptcy procedures. Bankruptcy proceduresneeded to be strengthened as part of debt resolution processes to ensure that nonviable firmswould not continue to absorb credit and that a creditor could recover the maximum value ofthe claims submitted to the insolvent debtor corporation. Moreover, the presence of aneffective bankruptcy system was considered necessary to create appropriate incentives forcreditors and debtors to reach out-of-court settlements. Enforcement of bankruptcy proce-dures should be a credible threat as an alternative to out-of-court settlements.

The last step was to improve corporate governance. Better corporate governance shouldhelp attract investment, improve efficiency and lead to increasing longer-term growth. Basedon experience in other countries, corporate governance improves when the extent of disclo-sure is increased, the power of large inside shareholders is curbed, a sizable number ofoutside shareholders are present and the financial system is competitive and efficient.Broadening ownership by introducing a sizable number of outside (often foreign) sharehold-ers tends to create a structure more efficient than one in which ownership remains highlyconcentrated. This practice was complemented with reforms in board composition, structureand responsibility, as well as with improvements in minority shareholder rights in order toensure effective board oversight of management. Legislative changes were encouraged topursue these reforms.

3. Progress and issues: country briefs

Countries have followed differing approaches to financial and corporate sector restruc-turing. Aggressive government-led restructuring has been most pronounced in Korea. There,


the government has played an active role in bank recapitalization, NPL carve-out, andcorporate debt and operational restructuring because of the need to counterbalance thepresence of powerful chaebols. Though costly, with inadequate due diligence and potentialfor moral hazard, the process has been rewarded with strong signs of economic recovery.Malaysia has also allowed government-led agencies to take decisive measures to acquireNPLs from banks and to recapitalize banks. Indonesia has followed a hybrid approachinvolving government agencies, as well as a voluntary, market-based framework, for cor-porate restructuring. In the case of Thailand, the government intervened in the worst financialinstitutions, initially relying on private investment for bank recapitalization, and subse-quently announced a recapitalization plan with the injection of public funds subject tosafeguards.

Let us examine in some detail the progress that has been achieved in financial andcorporate sector restructuring in each of the five Asian countries affected by the crisis.Appendix Tables 1 and 2 provide a summary of progress in a systematic way.

3.1. Indonesia

Indonesia’s economic crisis was triggered by depreciation of the rupiah during the secondhalf of 1997. The crisis exposed deep systemic weaknesses in the banking and corporatesectors, which required aggressive and wide-ranging policy measures and institutionalreforms. The roots of the crisis can be traced back to 1988 when the government launchedfinancial sector deregulation and the number of commercial banks suddenly expandedwithout adequate supervision and transparency. Problems were manifested as early as 1993,when NPLs were estimated to be 14 percent of total loans. Domestic banking sectorweaknesses were exacerbated by large external borrowing by Indonesian corporations in thefew years leading to the crisis.

3.1.1. Progress in financial sector restructuringIndonesia’s strategy for bank restructuring initially focused on closing insolvent commer-

cial banks and then shifted to stabilizing the banking system, dealing with remainingnonviable banks, recapitalization and rehabilitation of weak but viable banks and enhance-ment of supervisory and regulatory capacities.

The very first action was the closure of 16 insolvent commercial banks in November 1997(out of a precrisis total of 238 in July 1997). As the public accelerated the withdrawal ofdeposits following the closure, Bank Indonesia (BI) provided substantial liquidity support,including credits to some large private banks.

On January 27, 1998, authorities announced a blanket guarantee for depositors andcreditors (excluding subordinated debt) of locally incorporated banks, creation of the Indo-nesian Bank Restructuring Agency (IBRA), elimination of restrictions on foreign ownershipof domestic banks, and a temporary voluntary suspension of corporate external debt pay-ment. The blanket guarantee on deposits was designed to stem bank runs and thus stabilizethe banking system. IBRA was given two main functions: to lead the restructuring efforts forthe most illiquid and insolvent banks and to manage the assets acquired. For the latterpurpose, the Asset Management Unit (AMU) was established within IBRA to acquire NPLs


from frozen or merged banks. All outstanding liquidity support from BI to the banks,equivalent to 10 percent of gross domestic product (GDP) by the end of January 1998, wastransferred to IBRA. New risk-based asset classification and provisioning regulations werelater announced, and all banks were required to have their loan portfolios reviewed byinternationally recognized audit firms by the end of 1998. The Banking Law was amendedto give the AMU the power needed to deal with problem banks. The AMU legally receiveda total of Rp156 trillion category 5 loans from the 10 banks closed in 1998, 7 state-ownedbanks, and 4 banks taken over (BTOs) by IBRA. It subsequently received additional loansof newly closed banks and of the 8 additional BTOs.

In February 1998, 54 distressed banks (consisting of 4 state banks, 39 private nationalbanks and 11 regional development banks) were transferred to IBRA’s control. In earlyApril, IBRA took management control of 7 of these banks, suspending the rights of theshareholders. Another 7 were effectively closed. In May, IBRA took over the managementof Indonesia’s largest private bank, Bank Central Asia (BCA).

In August 1998, authorities announced a package of resolving the state of (1) 7 majorbanks taken over by IBRA in April and May, and (2) 6 nonlisted state-owned banks. Withregard to (1), both BCA and Bank Danamon International (Danamon) would be partiallyrecapitalized by the former owners through the contribution of physical assets and theconversion of central bank liquidity support to equity; two other smaller banks (Bank PDFCIand Bank Tiara Asia) were to be offered for sale; and three other banks (Bank Dagan NegaraIndonesia, Bank Umum Nasional and Bank Modern) would be frozen (i.e., closed). In eachof these cases, NPLs were to be transferred to the AMU. With regard to (2), 4 state-ownedbanks [Bank Dagan Negara (BDN), Bank Ekspor Impor Indonesia (EXIM), Bank BumiDaya (BBD) and Bank Pembangunan Indonesia (Bapindo)] would be merged into one newbank; and the new bank would assume the corporate loan business of Bank Rakyat Indonesia(BRI). The NPLs of these 5 state-owned banks were to be transferred to the AMU.

The state-owned banking sector, which accounted for 36 percent of total banking sectorassets in 1996 to 1997, had significant asset quality problems and weak operations. Thegovernment announced in September 1998, the formal merger of 4 state-owned banks (BDN,EXIM, BBD, Bapindo) and the corporate business of a fifth state bank (BRI) into a newinstitution, Bank Mandiri, which was established on September 30 as the holder of 100percent of the shares of the component banks, with the legal merger process completed inJuly 1999. Following the legal merger, the government began to prepare to issue the firsttranche of recapitalization bonds in September and the second tranche in December in orderto balance the book value of assets transferred to IBRA (a total of Rp80 trillion). TheMinistry of Empowerment of State Owned Enterprises (MOSOE) announced interim mea-sures in June 1999 to strengthen management of the 3 remaining state-owned banks (BNI,BRI, BTN) and developed business plans for these banks. Bank Mandiri and the 3 state-owned banks would ultimately be privatized.

All privately owned banks were classified into three groups: In the A category were thosewith a capital ratio of at least 4 percent of risk-weighted assets; in the B category, those witha capital ratio of between negative 25 percent and positive 4 percent; and in the C category,the remaining private banks. The government would assist in the recapitalization of B banksthat were able to provide business plans demonstrating prospects for future viability. Viable


B banks with “fit and proper” owners and management would be eligible to receive from thegovernment up to 80 percent of the funds required for recapitalization. C banks andnonviable B banks were to be closed.

As a result of thorough portfolio reviews of 128 private banks, completed in February1999, the government announced in March 1999, that it would close 38 banks (21 B banksplus 17 C banks, accounting for 5.2 percent of total banking system liabilities) and take over7 B banks (Duta, Nusa Nasional, Risjas Salim International, Tamara, Pos Nusantara, JayaBank International and Rama, accounting for 2.4 percent). It identified 9 B banks for possiblegovernment-assisted recapitalization (11.5 percent). Of the 9 banks eligible for recapitaliza-tion, 1 could not come up with the necessary capital and was taken over by IBRA, and theremaining 8 required about Rp25 trillion for recapitalization. Of the 74 A banks (the original73 plus a newly upgraded 1), 52 were reviewed by May 1999, and 27 were identified asneeding changes in their director and/or management.

IBRA announced in July 1999 that 8 BTOs (PDFCI, Duta, Pos Nusantara, Rama, BNN,Tiara Asia, Tamara and Jaya) would be merged into Danamon, and RSI merged with BCA.The three surviving BTOs, as well as Danamon, BCA and Bank Niaga, were to be privatizedby the end of 1999 or mid-2000.

The estimated cost of bank restructuring has risen to over Rp550 trillion (US$66 billion)or about 50 percent of GDP. About 75 percent of this is for recapitalizing state-owned banksand the 4 BTOs taken over by IBRA in August 1998. In May 1999, the government took oneof the most significant actions to date: It issued bonds worth Rp157.6 trillion (US$22.5billion) to recapitalize 7 of the 8 private banks eligible for the “joint” recapitalizationprogram (Rp22.1 trillion), 4 BTOs taken over in 1998 (Rp80.5 trillion) and 12 regionaldevelopment banks (Rp1.2 trillion), and to resettle interbank claims. In addition, a substan-tially larger amount would be needed to recapitalize state-owned banks and to restore thestate of 66 banks already closed (64 domestic private banks and 2 joint venture banks). Thegovernment also announced a list of the 200 largest defaulting borrowers and began toactively collect from the 20 largest defaulters.

Bank Indonesia has committed to approve and begin implementation of a master plan toenhance its regulatory, supervisory and examination capabilities by the end of September1999. Some of the important regulations involved foreign exchange positions, liquiditymonitoring, legal lending limits, debt restructuring operations, connected lending, capitaladequacy ratios, foreign ownership of banks and the operation of branch networks.

3.1.2. Progress in corporate sector restructuringOf the US$118 billion corporate debt, nearly 60 percent was owed to foreign creditors and

about half of the domestic debt was denominated in foreign currency. As a result, thelarge-scale rupiah depreciation that took place in late 1997 and early 1998 drove almost halfof Indonesian corporations into insolvency and caused many more corporations difficultiesin meeting debt-servicing obligations.

The Indonesian government’s strategy for corporate restructuring included three elements:Introduction of the Jakarta Initiative and the Jakarta Initiative Task Force (JITF) in Septem-ber 1998 to facilitate voluntary negotiations between debtors and creditors for corporate


restructuring and to provide a regulatory “one-stop shop” for administrative procedurespertaining to debt resolution; introduction of a new and improved bankruptcy system and aspecial commercial court to provide a credible threat (out-of-court settlements); and estab-lishment of the Indonesian Debt Restructuring Agency (INDRA) under the Frankfurt Agree-ment in June 1998 to provide foreign exchange cover for Indonesian corporations withforeign currency-denominated debt once they have reached debt restructuring agreements.

As of the end of June 1999, about 234 firms, with a combined external debt of US$21billion plus Rp14 trillion in domestic debt, applied to work through the Jakarta InitiativeTask Force, and either a temporary or final agreement was reached for 22 of them, whichaccounted for US$3 billion in foreign debt and Rp2 trillion in domestic debt. The mostimportant corporate restructuring deal agreed on to date, involving JITF, concerned Indo-nesia’s largest automaker, PT Astra International, which successfully concluded a US$1.2billion agreement. Other examples included PT Danareska (US$438 million), PT Lippo Tbk.(US$100 million) and PT HM Soepoerna (US$140 million).

However, significant progress has yet to emerge. In addition, the resolution of only oneexternal debt has been dealt with under the Frankfurt Agreement–INDRA scheme, and thedeadline for entry into INDRA was extended from the end of June to the end of Decemberof 1999. The slow pace of corporate restructuring could be attributed to several factors:Creditors (particularly foreign creditors who hold 60 percent of corporate debt) do not haveaccess to full information on the financial conditions of their debtor corporations; foreigncreditors believe providing a hair cut (i.e., debt relief, would induce further strategicdefaulting; domestic banks are largely undercapitalized or insolvent and do not have suffi-cient financial capacity to strike a negotiation deal; and corporate debtors still feel a lack ofpressure to take necessary action because bankruptcy and foreclosure laws have not been aneffective threat to them and because there are not enough economic incentives for debtnegotiation. Political uncertainty because of the impending presidential elections may alsohave dampened the pace of debt agreements.

The government has taken several steps to accelerate corporate debt restructuring andasset recovery. In particular IBRA has been playing an increasingly proactive role incorporate restructuring. First, an interagency committee, comprising representatives from BI,IBRA, and the Ministry of Finance (MOF), has been established to implement and monitorthe restructuring and asset recovery process. Second, the names of debtors have been madepublic to induce borrowers to begin settlement negotiations. With regard to the second point,for example, all state-owned banks, BTOs and recapitalized private banks, together withIBRA, published in June the names of their largest nonperforming corporate borrowers.IBRA also published the names of all its 1689 borrowers together with the amounts owed.By the end of July, all these corporate debtors were expected to sign letters of commitmentindicating a willingness to negotiate a settlement. The government said it would take legalactions against noncooperative corporations failing to reach a restructuring agreement withIBRA.

3.1.3. Outstanding issues in financial and corporate sector restructuringThe progress of resolving banking sector problems is relatively slow in comparison to that

in other countries. The serious process of recapitalization (and to a lesser extent, rehabili-


tation) of weak banks has just begun. Progress in finalizing corporate restructuring deals hasbeen slow. Indonesia faces key challenges including the following.

Y The bank restructuring process must move from the stabilization and recapitalizationstage to the rehabilitation and operational restructuring stage. IBRA and the AMU mustmove forward on bank restructuring, debt recovery and corporate restructuring.

Y As IBRA’s authority is empowered, its governance and transparency need to bestrengthened.

Y Additional problem banks will need to be dealt with, and additional injections ofcapital will be required.

Y The authorities (MOSOE, IBRA, and BI) must implement the operational restructuringof Bank Mandiri, the 3 remaining state-owned banks and the 12 existing BTOs. Theymust also ensure that recapitalized state-owned banks and private banks are managedprudently in accordance with the investment and performance contracts detailed in therecapitalization agreement.

Y IBRA must aim to maximize proceeds from loan recovery and asset sales in order toreduce the net fiscal costs of banking sector restructuring and to maintain the long-termobjectives of fiscal sustainability.

Y Bank Indonesia must design and implement a master plan to enhance its supervisoryand regulatory capacities.

Y Foreign creditors (who hold 60 percent of corporate debt) and Indonesian corporatedebtors must agree on external debt resolution, without which bank and corporatesector restructuring will be difficult.

Y Bankruptcy laws must be effectively enforced in the commercial court to forcecorporate debtors to voluntarily come to the negotiation table.

Y Disclosure of the financial condition of debtors has to be made to discourage strategicdefaulters who are solvent but unwilling to make repayment.

Y Access to new working capital financing is desirable to induce debtors to come to thenegotiation table. For this purpose, introduction of a new secured transactions law iscritical for creditors who are potentially willing to provide new working capital torestructured corporations because it enables registration of a security interest rankingahead of existing creditors.

Y Social and political stability must be maintained in the face of regional autonomy andindependence movements.

3.2. Korea

Though Korea began to witness a relatively rapid economic recovery in the first half of1999, financial and corporate sector restructuring is far from complete. The country is stillstruggling to resolve large NPLs in the financial system and high debt-to-equity ratios in thecorporate sector.

While extensive financial sector problems surfaced in the second half of 1997, the seedshad been sown much earlier. These weaknesses were the result of years of bad lendingpractices and an inadequate supervisory and regulatory framework. Problems included


imprudent lending practices, poor credit risk management by banks, poor funding riskmanagement by borrowers and lax or ineffective oversight by regulators. One importantfeature was the close relationship between government, businesses and the financial sector,particularly through groups of affiliated businesses known as chaebols. These groups arecharacterized by extensive cross-holdings of equity, intragroup lending and guarantees andbusiness transactions. With the support of government policies and the banking sector,chaebols rapidly developed into many diverse lines of business and played a dominant rolein the Korean economy. But because of poor business planning and operations and unsoundfinancial decisions, they began to experience serious financial difficulties.

Though the use of the banking system to support the government’s industrial policies hadbeen much reduced in the 1990s, the practice left a legacy of poor risk management andimprudent credit analysis. The structural weaknesses of Korean banks became increasinglyapparent throughout 1997 as a number of major chaebols went bankrupt. By September, sixhighly leveraged chaebols had failed or been placed under bankruptcy protection, raisingserious concerns about the quality of bank assets which are mostly concentrated in themanufacturing and trade sectors. Concerns were also raised about the condition of merchantbanks which were heavily exposed to chaebols and suffered severe funding difficulties asdomestic and foreign lenders reduced their exposure to them.

3.2.1. Progress in financial sector restructuringIn August 1997, the government announced a set of measures aimed at increasing

confidence in the Korean financial market. First, official support was provided by the Bankof Korea, in the form of special loans and capital injection in exchange for governmentbonds, to Korea First Bank. In addition, a special funding facility was created to assist 21merchant banks (out of the original 30) whose exposure to bankrupt companies exceeded 50percent of their equity. Second, the government announced guarantees covering the foreignliabilities of Korean financial institutions, including both commercial and merchant banks.Third, a special fund was set up within the Korea Asset Management Corporation (KAMCO)to which banks would be allowed to sell their NPLs. These measures were perceived by themarket as insufficient, and international creditors froze or withdrew their credit lines.

From late 1997, financial sector restructuring in Korea was designed to meet five objec-tives: restoring the confidence of depositors, investors and creditors; establishing effectiveframeworks for dealing with nonviable banks and for recapitalizing weak but viable banks;introducing an effective NPL resolution mechanism, including the use of a centralized assetmanagement company; the introduction of international standards and best practices forfinancial regulation and consolidated supervision; and capital markets development. Thefollowing actions have been taken.

Y First, the government created an independent agency, the Financial Supervisory Com-mission (FSC), in June 1997 with a mandate to supervise and restructure all banks andnonbank financial institutions. This agency was later expanded into the FinancialSupervisory Service (FSS) in January 1999 by merging four financial supervisoryagencies (banks, nonbanks, securities and insurance).

Y Second, the government removed KAMCO from the Ministry of Finance and Economy


(MOFE) and reestablished it under the control and supervision of FSC in November1997 as a public agency to manage nonperforming assets transferred from distressedfinancial institutions. The government reoriented its function as a “bad bank” toincrease efficiency in asset purchase, management and disposition in August 1998.

Y Third, authorities successfully rescheduled or restructured commercial bank externaldebt vis-a-vis external creditor banks at the beginning of 1998 under a government-ledprogram. This laid a favorable foundation for subsequent bank and corporate restruc-turing.

Following portfolio reviews of merchant banks and their rehabilitation programs, inDecember 1997 the government closed 14 merchant banks and required the other 16 tofollow a timetable to achieve capital adequacy ratios of at least 6 percent by the end of June1998 and 8 percent by the end of June 1999. A bridge merchant bank, Hanareum BankingCorporation (HMBC), was established to assume all deposits and selected liabilities and toaccept in payment the “good” financial assets of the suspended merchant banks. Any assetsand liabilities remaining after the transfer to HMBC were sent for bankruptcy, and acourt-appointed receiver sold the NPLs to KAMCO. The government then merged 1merchant bank and suspended another, while closely monitoring the remaining 14.

In June 1998, 5 commercial banks (Dongwa, Dong Nam, Dae Dong, Chung Chong andKyungki) were deemed nonviable and subsequently acquired by 5 stronger banks (Shinhan,Korea Housing, Kookmin, Hana and Koram) under purchase and assumption transactions. InOctober, the Korea Deposit Insurance Corporation (KDIC) injected W5.78 trillion (US$4.8billion) into these 5 commercial banks, which acquired one ailing bank each. KDIC laterinjected an additional W2.26 trillion (US$1.9 billion) into the same 5 banks, expecting to addmore resources twice in 1999. The 7 undercapitalized banks (Korea Exchange, Hanil, ChoHung, Commercial, Kangwon, Chungbuk and Peace) received conditional support. These 7banks were required either to merge with healthy banks or to arrange mergers among theundercapitalized banks with government assistance and resulting government ownership.Korean Exchange signed a memorandum of understanding (MOU) with FSC and wasrequired either to raise capital or merge to obtain equity capital support. Hanil and Com-mercial merged and established a new bank called Hanvit. Through fiscal support, thegovernment became its major shareholder. Cho Hung planned to merge with HyundaiInternational Merchant Bank and Kagwon.

In December 1998 two commercial banks in distress (Korea First and Seoul) were takenover by the government and de facto nationalized in early 1999. These 2 nationalized bankswere expected to be privatized, and MOUs were signed with foreign consortia, NewbridgeCapital and Hong Kong and Shanghai Banking Corporation (HKBC), respectively. Butagreement on the price was not finalized because revival of the Korean economy induced thegovernment to ask for a higher price. In August, FSC announced that negotiations withHKSB for the sale of Seoul Bank had been called off because of the unbridgeable differencesin the two parties’ valuation of the bank’s assets. According to FSC, Seoul Bank would bedeclared insolvent and its capital written down prior to another injection of public funds. OnSeptember 17, after 10 months of negotiations, the government finally signed a bindingagreement to sell to Newbridge Capital a controlling stake of 51 percent in Korea First Bank.


In this deal the government decided to take on all NPLs, add to the bank’s reserves shouldits existing reserves fail to meet new accounting standards that will be imposed in the futureand take on loans that go bad over the next 2 years and, for a particularly risky class of loans,for 3 years.

The government set aside W64 trillion (US$49.2 billion or 14 percent of GDP) forresolving the crisis in the banking and financial sectors. Of the original allocation of W32trillion, KAMCO had purchased NPLs from distressed financial institutions with a face valueof W46 trillion (US$35 billion) and at a purchase price of W20.3 trillion by the end of June1999. KAMCO had sold W5.8 trillion and is planning to sell W16 trillion in the second halfof 1999. KAMCO’s recent announcement that it would establish joint ventures with sevenforeign investors to dispose of distressed assets, if implemented effectively, is expected toaccelerate corporate restructuring and asset recovery. Of the original allocation of W32trillion, KDIC spent W24 trillion through capital injections and loss coverage support.

According to FSS, NPLs of Korean financial institutions accounted for W65.4 trillion atthe end of March 1999, including commercial bank NPLs of W26 trillion and all othernon-bank financial institutions (NBFIs). However, the number of NPLs could rise signifi-cantly as further progress is made in corporate restructuring. Market analysts expect that thegovernment will have to allocate a substantial amount of public resources in addition to theW64 trillion it has already provided for banks. First, loan losses at financial institutions couldincrease significantly as a result of corporate restructuring. Second, at the end of 1999, FSSimplemented new forward-looking criteria for loan classification in the banking sector,which would result in higher provisioning requirements. Large creditors of Daewoo couldface substantial new provisioning requirements.

3.2.2. Progress in corporate restructuringThe Korean government’s basic strategy for corporate restructuring consists of three

principles: (1) introduce necessary legal and policy changes that would allow corporaterestructuring without hindrances; (2) take a facilitating role in corporate restructuring andprovide policy and administrative guidance for lead banks who would act for all domesticcreditors of individual corporates; and (3) institute certain agreed-on measures for structuralcorporate governance reform.

In Korea 64 chaebols accounted for the bulk of corporate debt. The 5 largest chaebolsagreed to Capital Structure Improvement Plans (CSIPs), under which they would (1) reducethe debt-to-equity ratio to 2.0 by the end of 1999, (2) be subject to sanctions if they fail tomeet the deadline, and (3) remove existing cross-guarantees between subsidiaries engaged indifferent lines of business. In addition, the government promoted the exchanging of busi-nesses with other chaebols (“Big Deals”) and the shedding of noncore businesses.

Though creditor banks accepted the CSIPs of the top 5 chaebols, they have not played arole in the restructuring process until recently. The top 5 chaebols reduced their combineddebt-to-equity ratio to 386 percent at the end of 1998, down from 470 percent at the end of1997, but failed to meet the 320 percent target. While the unwinding of cross-guarantees isproceeding satisfactorily, the amount of foreign capital raised was less than planned. Thearranging of Big Deals was slower than initially thought.

CSIP implementation reviews revealed that LG and SK had shown notable progress since


the latter half of 1998, while Daewoo and Hyundai had not. In particular Daewoo’sdebt-to-equity ratio increased substantially from 474 percent at the end of 1997 to 527percent at the end of 1998 and to 588 percent at the end of June 1999. The lack of seriousrestructuring efforts led Daewoo to near bankruptcy in the summer. Although its debt-to-equity ratio was reduced from 572 percent at the end of 1997 to 449 percent at the end of1998, and then to 341 percent at the end of June 1999, Hyundai still maintained a high debtratio. Hyundai provided more serious and drastic restructuring steps than Daewoo.

In July 1999, the near-bankruptcy of the Daewoo conglomerate rocked Korean financialmarkets, dramatizing the importance of immediate and assertive action to promote restruc-turing. Daewoo is Korea’s second largest chaebol, with businesses in automobiles, heavyindustry, electronics, telecommunications, construction, trade, finance and hotels. With adebt-to-equity ratio of 526 percent (excluding asset revaluation) at the end of 1998, itsdomestic debt was about $40 billion and its officially reported foreign currency debt wasabout $10 billion. Daewoo remained resistant to change, betting on economic recovery andfurther borrowing to tide it over its financial predicament. It repeatedly ignored the restruc-turing commitments it made to its creditor financial institutions under its CSIP. By the endof July, it could no longer service its debt and hovered near bankruptcy.

The government stepped in to work with creditors to prepare an emergency financingpackage predicated on a substantial restructuring plan. As part of the package, Daewoo hasadopted an accelerated restructuring program, comprising a spin-off of affiliates, asset sales,raising of more equity including foreign investment, debt-for-equity swaps, and a breakup ofthe chaebol into several independent corporate entities. It has also put up new collateral ofW10 trillion, including W1.3 trillion of Chairman Kim’s personal shareholdings, whichcreditors will be free to sell if Daewoo fails to live up to its commitments under the agreedrestructuring and financing plan. Daewoo’s creditor financial institutions have set up aDaewoo restructuring team at Korea First Bank (Daewoo’s leading bank), which will beassisted by international advisors. An estimated US$5 billion of the foreign currency debt isdue for repayment before the end of 1999, of which about US$3 billion is held by foreigncreditors. Daewoo will need to reschedule some of this debt. Rescheduling discussions withforeign creditors are not yet fully under way and will likely raise difficult issues of guaranteesand collateral. Reports indicate that Daewoo will sell off all businesses outside its coreautomotive lines, and if this transpires, it will mark the most dramatic restructuring to datein East Asia.

The “6-64” chaebols also agreed on CSIPs with their creditor banks in the first half of1998. By the end of June, 90 companies had applied to the formal workout program withinthe Corporate Restructuring Coordination Committee (CRCC) framework. About half ofthem were subsidiaries of 16 chaebols; 7 of the 90 companies dropped out at some point,leaving 82 companies in the program. All but 2 of the 82 companies have by now reachedan agreement on a debt resolution plan. These plans were based on the London rules type ofout-of-court settlement.

Small and medium enterprises (SMEs) accounted for only a small fraction of outstandingbank loans, hence their restructuring has not attracted sufficient attention. The situation wascomplicated by their close ties with chaebols, on which they were dependent for survival. Sofar, efforts have focused on extending emergency loans of working capital to keep SMEs


from going bankrupt, thereby gaining time and preserving employment. Those that have notgone bankrupt, however, have lost employees, in many cases leaving the owner as the soleemployee. Last year SMEs were twice extended a temporary debt moratorium. SME debtresolution and operational restructuring are urgently needed.

Korea needs continued corporate restructuring at all levels of the corporate sector. The topfour chaebols have to reduce their debt-to-equity ratios to 200 percent by the end of 1999 andto undergo meaningful restructuring. The 6-64 chaebols must continue their efforts toimplement CSIPs or to continue debt resolution with their leading banks. SMEs also have torely on financial and operational restructuring. Successful conclusion of economic reformsand institutionalization of the benefits of corporate restructuring now hinge on the imple-mentation of agreed-on workout plans, the adoption of new models of corporate governanceand management and labor issues not impinging on fundamental change.

3.2.3. Outstanding issues in financial and corporate sector restructuringThe Korean economy has experienced strong signs of economic recovery. However, there

is a danger that the pace of reform in both the financial and corporate sectors may be relaxedand that the remaining structural problems of both sectors may not be adequately addressed.Successful corporate restructuring now hinges on satisfactory restructuring of the top fivechaebols. This in turn depends on the implementation of agreed-on workout plans, adoptionof new models of corporate governance and the management and labor issues impinging onfundamental change. The remaining agenda is extensive and complex.

Y More public funds may be required to restructure or recapitalize the banking sector.Y KAMCO must expand its capacity to ensure the disposition of existing and potential

new NPLs as quickly and as efficiently as possible and to limit the fiscal cost offinancial crisis resolution. Involvement of private asset managers and restructuringexperts should improve asset recovery and to minimize costs.

Y KDIC needs to design a strategy for selling its existing equity participation in bankinginstitutions in the medium and the long term.

Y FSS must strengthen institutional capabilities to adopt international standards and bestpractices on prudential regulation, to carry out consolidated supervision, and moregenerally to develop a risk-based, quantitative supervision process for the entirefinancial system.

Y Capital markets need to be developed with efficiency, safety, transparency, and com-petitiveness. Efforts have to be focused on the establishment of a new regulatoryframework, strengthening of self-regulatory organizations, redefining the architectureof the securities market and establishing incentives to enhance demand for bonds.

Y The top five chaebols must comply with their CSIPs, i.e., achieve a reduction of thedebt-to-equity ratio to 2.0 without asset revaluation by the end of 1999, and a reductionof cross-guarantees.

Y The agreed debt workout programs for 6-64 chaebols require new reviews and mea-sures to ensure that they are followed through to completion.

Y SMEs need debt and operational restructuring.


Y To reduce labor opposition to restructuring, effective action and plans are required todemonstrate adequate protection for workers who may lose their job security.

3.3. Malaysia

3.3.1. Progress in financial sector restructuringIn mid-1998, the government created an institutional framework to implement banking

sector recapitalization and restructuring. Danaharta was established as an asset managementcompany in May 1998 to acquire NPLs from banking institutions in order to strengthen theirbalance sheets and enhance their ability to lend. Danaharta was designed to purchase NPLsfrom financial institutions whose NPLs-to-total loan ratio exceeds 10 percent. It was alsogiven the power to appoint special administrators to manage the affairs of distressedcompanies in order to facilitate and speed up the restructuring of those companies. In July,Danamodal was established as a special-purpose vehicle with the task of recapitalizingfinancial institutions whose capital adequacy ratios fell below 9 percent. The last componentof the restructuring framework was the Corporate Debt Restructuring Committee (CDRC),which was established in August to facilitate voluntary restructuring of corporate debtoutside the courts through voluntary agreements between creditors and debtors.

Progress has been made on these fronts. Danaharta acquired and managed RM24.8 billionface value of NPLs out of a total of RM80 billion (3-month classification of NPL) at the endof April 1999, or about 30 percent of the total NPLs in the system. NPLs in the bankingsystem stood at 19.5 percent of total loans (on the 3-month definition). Danaharta has not yetbegun to dispose of assets in a substantial way but expects to begin that process in 2000.However, it has begun to issue government-guaranteed zero coupon bonds in four series tofinance its requirements. Its recent issue was RM1.05 billion in bonds, whose yield has comedown to 5.487 percent from 7.150 percent during the first issue in November 1998, reflectingimprovements in the economy and a decline in inflation and interest rates). A total amountof RM7.39 billion in nominal value of bonds has now been issued out of a target amount ofRM15 billion.

Danamodal has injected RM6.4 billion in capital into 10 financial institutions in the formof exchangeable subordinated capital loans (ESCLs). Of these 10 institutions, Danamodalhas signed definitive agreements with 9 institutions for the conversion of ESCLs intopermanent tier 1 and/or tier 2 capital. The capital Danamodal has injected into these financialinstitutions, an equivalent of approximately 14 percent of the total tier 1 capital of thebanking sector at the beginning of 1998, has served to help boost the capital adequency ratio(CAR) of the banking system to 12.3 percent at the end of April 1999. The government hasannounced that Danamodal will need significantly less than the original estimate of RM16billion to ensure sufficient capitalization of the industry.

In July 1998, the government announced a plan to bring about a consolidation of thefinancial industry covering fifty-eight institutions (21 banks, 25 companies and 12 merchantbanks). The purpose was (a) to improve the competitiveness, and thereby ensure the survival,of the domestic banking industry in the face of increasing foreign competition in the future;and (b) to avoid the potentially destabilising consequences of a number of domestic bankbankruptcies under the weight of market forces in an increasingly competitive market


environment. Initially the program was formulated around several anchor banks designatedby the government. Encountering resistance from the banking community, the governmentrevised its policy in October 1999 to allow the banks shareholders a greater role in shapingthe consolidation of the industry. Under the revised scheme, banking institutions wereallowed to choose their own leader in each group to lead the merger process. Bankinginstitutions were required to inform Bank Negara Malaysia by the end of January 2000 oftheir respective merger groupings. All the merger exercises are to be completed by the endof December 2000.

3.3.2. Progress in corporate restructuringCDRC received applications from 60 corporations with more than RM30.8 billion in debt

by the end of May 1999. Of these, 6 have been either withdrawn by the applicants or rejectedby CDRC as not being viable. The debts of 11 companies amounting to RM10.9 billion havebeen restructured as of the end of May 1999 (such as Renong Bhd with a debt of RM8.4billion, Tongkah Holdings Bhd with a debt of RM0.6 billion, Nam Fatt Corp Bhd, TencoBhd, Tanco Holdings Bhd, Orlando Holdings Bhd and a couple of private companies). Of the11 finalized cases, 8 restructuring proposals were accepted by the creditors, while CDRCassisted in the 3 cases that were restructured by Danaharta under its special administrativepowers. Of the remaining 43 cases comprising debts of RM20 billion, 13 companies withtotal debts of RM3.3 billion are expected to be restructured during June.

3.3.3. Outstanding issues in financial and corporate sector restructuringWith an adequate legal system and a well-structured institutional framework for bank

recapitalization in place, the prospects for Malaysia successfully carrying out the restruc-turing of its financial system are encouraging. While the corporate debt restructuringframework is in place, debt workout and operational restructuring through CDRC have beenslow. The key challenge the government faces is to drive the restructuring process forwardat a measured pace to allow the financial and corporate sectors to adjust to lower asset priceswithout letting the economy stagnate for years with heavily indebted companies.

Y As Danaharta has completed its acquisition phase, it must accelerate the process ofrestructuring the acquired loans to viable companies and begin foreclosing on nonvi-able debtors and auctioning off their assets. For this, Danaharta needs to enhance itsskills in the management and disposal of NPLs and in asset turnover.

Y All transactions in which Danaharta and Danamodal are involved should take place ina transparent manner in order to maintain public confidence in the impartiality of thegovernment throughout the restructuring process. Burden sharing by existing share-holders should be maintained throughout the restructuring process.

Y The pace of operational restructuring within banks needs to gather forward momentumto ensure increased efficiency and profitability of the banking sector. Danamodal mustuse its equity positions in the financial institutions it assists to bring about consolidationin the banking sector.

Y The CDRC process should ensure that financial restructuring of corporate borrowers isaccompanied by operational and ownership restructuring.


3.4. The Philippines

3.4.1. Progress in financial sector restructuringThe Philippines did not experience systemic crises in the banking or corporate sector and,

as a result, did not face the need to develop a systemic approach to banking and corporatesector crisis resolution. However, realizing the economy’s structural weaknesses, the gov-ernment has acted to strengthen the banking sector and the supervisory and regulatoryframework (e.g., higher minimum capital and stricter provisioning requirements). Thepreferred approach to insolvencies has been through engineered mergers. While a number ofsmall thrifts and rural banks are liquidated annually, there has been forbearance in closingcommercial banks stemming from past (and present) central bank aversion to bank closuresand legal threats to regulators that discourage prompt resolution and liquidation. Thus, thegovernment approach has been to follow a wholly decentralized approach, relying on privatemarkets.

To date, bank restructuring has been limited because of the stronger balance sheetpositions than in other countries. Authorities have committed to privatizing the government’scontrolling stake in a large commercial bank (Philippines National Bank), which requiressignificant restructuring before seeking a buyer. The government is moving to establish anenvironment more conducive to resolving problem banks in the event that conditions worsen.

Nonperforming loans of commercial banks continued to be large at 12.5 percent inDecember 1999. The majority owners of PCI Bank (the fifth largest) have agreed to sell their72 percent stake to Equitable Bank (jointly with two state-run pension funds). The new bankwill be the second largest on approval of the acquisition by the monetary board, which isexpected. A small thrift bank declared a “holiday” in June faced with a run following theannouncement of a stalled merger deal.

3.4.2. Progress in corporate sector restructuringDebt restructuring is usually carried out on an informal or formal basis according to

procedures dictated by the existing legal framework for insolvency. When informal debtresolution proves to be impossible, a distressed corporation can petition the Securities andExchange Commission (SEC) for protection from its creditors. SEC then has the power toimpose stays of actions by creditors against corporate debtors, to permit debtors to suspendpayments to their creditors, to decide whether a debtor should be liquidated or be permittedto attempt rehabilitation and to liquidate debtors and appoint receivers, members of man-agement committees and liquidators.

During the period from January 1997 through October 1998, 52 companies with liabilitiesof P123 billion petitioned the SEC for suspension of payments. Of these 52 cases, 20 havebeen dismissed or were withdrawn, 30 remain unresolved and under suspension of paymentsand liquidation was decided in 2 cases.

3.4.3. Outstanding issues in financial and corporate sector restructuringThere are a number of problems associated with the quasi-judicial process for corporate

restructuring including the way it is administered.


Y Secured creditors are prevented from exercising their contractual rights without dueprocess or indemnification against loss.

Y The process lacks clear and coherent rules and time-bound procedures.Y No standards exist defining the minimum qualifications of individuals appointed as

receivers, liquidators or management committee members.Y Implementation of rehabilitation plans often requires infusion of cash into the business,

but unlike the situation in some other countries, there is no possibility of grantingpriority, in terms of repayment, to lenders willing to provide such cash.

Y The inability to obtain fresh funds often obliges the management of companies underthe protection of SEC to break the law by using proceeds from the sale of goodscovered by trust receipts to finance continuing operations rather than using them torepay the creditor whose loan was secured by the receipts.

3.5. Thailand

3.5.1. Progress in financial sector restructuringThe Thai government adopted a program to stabilize and restructure the financial sector

in August 1997. The program included a wide range of measures for dealing with, andrestructuring of troubled financial institutions, improvements in financial supervision, finan-cial infrastructure reforms, capital market development.

The government established the Financial Sector Restructuring Agency (FRA) and theAsset Management Corporation (AMC). These agencies were created to handle the 58 failedfinance companies and dispose of their assets. Of the 58 suspended finance companies, 56were closed down and their assets taken over to be auctioned by FRA. The first two FRAauctions of failed finance companies’ assets were considered successful, with 45 to 48percent of the value of the assets being recovered. However, reflecting the lower quality ofthe assets, the December 1998 and March 1999 auctions were less successful, with only partof the assets purchased and at a price between 18 and 25 percent of their nominal value.AMC purchased loans at the March 1999 auction for the first time. The May 1999 auctioncomprising construction loans with an aggregated principal value of Bt9.13 billion (US$250million) was a further disappointment: FRA did not accept bids (between 5.0 and 8.8 percent)because they were below the reserve prices. These unsold assets will be offered for sale atthe next auction to be held in June.

After suspension of the 58 finance companies, the Bank of Thailand (BOT) adopted amarket-led approach for recapitalizing the remaining financial institutions that formed thecore of the financial system. The strategy was based on the progressive strengthening ofprovisioning requirements designed to prompt financial institutions to obtain fresh capitaland supervisors to take over institutions that would not be able to recapitalize. Initiallyauthorities expected that the increased transparency of financial institutions and tighterprudential rules would attract new investors, both domestic and foreign. However, thecontinued difficulties in the real sector and rising numbers of NPLs have made potentialinvestors extremely cautious (only two small banks were purchased by foreign investors in1998). In the meantime, BOT intervened in the operation of 4 medium-size banks (BangkokMetropolitan Bank, Bangkok Bank of Commerce, Siam City Bank and First Bangkok City


Bank) and 7 finance companies. It became clear then that market-driven recapitalizationwould not be sufficient and further government support would be required.

On August 14, 1998, the Thai government announced a “financial sector restructuring foreconomic recovery” program for the recapitalization of troubled financial institutions with aninjection of public funds (Bt300 billion) subject to safeguards. The recapitalization planconsisted of two parts. For tier 1 recapitalization, the government would recapitalize theinstitution up to 2.5 percent of capital provided it adopted upfront the end-of-2000 loanclassification and provisioning (LCP) rules, fully wrote off NPLs, and fell below 2.5 percentin its tier 1 CAR. Beyond this level, the government would inject tier 1 capital by matchingprivate investors’ fresh capital. For tier 2 recapitalization, the government would injectcapital as the institution wrote off NPLs as a result of corporate debt restructuring orincreased net lending to the private sector.

As part of the program, BOT intervened in 2 additional banks (Union Bank and LaemThong Bank) and five additional finance companies. A merger of government-owned entities(Krung Thai Bank and Krung Thai Tanakit) with failed financial institutions and theirrestructuring formed part of the strategy. One bank (BBC) would be liquidated, 2 banks(FBCB and LTB) would be absorbed by two state banks (KTB and Radhanasin Bank), 1bank (UBB) and the 12 finance companies that were taken over would be eventuallyintegrated with a state-owned finance company (KTT) and three banks (RAB, BMB andSCIB) would be privatized. The mergers around KTB and KTT were achieved, and actionplans were developed for the eventual privatization of these 2 institutions. Work on privat-ization of 3 banks (RAB, BMB and SCIB) is progressing, albeit with some delay.

Siam Commercial Bank applied for tier 1 assistance under the August 14 recapitalizationschemes. It raised enough capital in the private market, and this was matched by thegovernment. Other private banks, however, have so far remained reluctant to take advantageof the August 14 program—particularly the tier 1 scheme that would require banks torecognize losses upfront and write down capital, hence diluting ownership. Thai FarmersBank (TFB), Bank of Ayudhya (BAY), Bangkok Bank (BBL) and Thai Military Bank(TMB) recently raised tier 1 capital through the issuance of innovative instruments calledsuperCAPs. However, this may not be enough to move the substantial burden of NPLs offthe balance sheets, whether through debt restructuring or transfer to privately-owned assetmanagement corporations.

The level of NPLs began to decline after reaching its peak in May 1999, though it is stillhigh at 38.5 percent in December 1999. New lending is scarce. Each deadline for stepped-uploan loss provisioning continued to place pressure on banks to recapitalize. With theliberalization of foreign bank ownership, private recapitalization is expected to play a largerrole.

The legal and regulatory framework for the supervision of financial institutions is beingrevised. The government is attempting to strengthen the role of BOT in the supervision andregulation of financial institutions, including prompt corrective action authority, and put thesupervisory regime in line with international standards. BOT supervisory capacity is alsobeing strengthened. As part of financial institution reform, the Thai government is alsopreparing a draft deposit insurance law.


3.5.2. Progress in corporate rector restructingIn June 1998, the government established the Corporate Debt Restructuring Advisory

Committee (CDRAC) to coordinate debt restructuring and developed the Framework forCorporate Debt Restructuring, an adaptation of the London rules approach used in Thailand.This permits debtors to negotiate with multiple creditors to reach voluntary agreements.Relative to the magnitude of the problem, corporate debt restructuring through this frame-work is only slowly beginning to yield results. The value of completed corporate debtrestructuring as of March 1999 is 10.3 percent of the total NPLs. Approval of the bankruptcyamendment has helped to accelerate the pace of in-court reorganizations, with 7 newbankruptcy reorganization petitions received in the month following the approval comparedwith only 21 petitions accepted from May 1998 to April 1999. The opening of the bankruptcycourt on June 17 is expected to further increase the rate of formal reorganization filings.

In contrast to the situation in other crisis-affected countries, SMEs in Thailand account formore than two-thirds of aggregate corporate debt; therefore, restructuring requires far moreeffort.

3.5.3. Outstanding issues in financial and corporate sector restructuring shownimprovement

While macroeconomic indicators have shown improvement, the bank restructuring pro-gram in Thailand still faces risks, including a lack of enthusiasm by banks to enter the August14, 1998 recapitalization program, lack of incentives on the part of debtors to come to thenegotiation table and prolonged deterioration of the real sector. Relative to the magnitude ofthe problem such as the size of NPLs, corporate debt restructuring has only begun to yieldsome visible results. Commercial banks are undercapitalized and reluctant to absorb losses.

Y Further government support may be required, in addition to the Bt300 billion August14 program, before the Thai banking sector is restored to health.

Y The legal and regulatory framework for supervision of financial institutions needs to bestrengthened.

Y For the market-based strategy of corporate debt restructuring to work, the rightincentives have to be provided to both creditors and debtors so that they can maximisetheir returns, preserve their asset values, and deploy them efficiently.

Y The Thai judiciary system must demonstrate determination in enforcing the revisedbankruptcy and foreclosure procedures in order to prompt strategic defaulters toresume repaying their bank loans.

Y With the proliferation of bank-based AMCs, there is a great benefit of coordinationamong the holders of NPLs to the same borrower by avoiding excessive competitionof quick asset disposal which tends to yield low asset recovery.

Y Mechanisms must be sought to deal with the very large numbers of distressed SMEs.Y At the same time, long-term fiscal sustainability is being threatened owing to the rapid

rise in government debt due mainly to the cost of resolving a financial sector crisis.This consideration needs to be balanced against further fiscal recapitalization offinancial institutions.


4. Relaxing constraints on restructuring

To accelerate the pace of financial and corporate sector restructuring, it is important toidentify and relax existing constraints to further progress.

Corporate restructuring is primarily an issue between creditors and debtors, and thegovernment’s primary role is to create an enabling framework that provides both creditorsand debtors with sufficient incentives for restructuring. Here, I would like to identifyconstraints on corporate restructuring from the points of view of the creditors, debtors,governments and the international community and then recommend how these constraintscould be relaxed.

4.1. Creditor constraints

The most important constraint on corporate restructuring from the perspective of creditorsis their unwillingness to recognize losses and their ownundercapitalization. Large NPLs anda need to provision adequately for loan loss reserves and maintain the prescribed CARs makeit difficult for creditor banks to aggressively restructure corporate debts if it entails recog-nizing further losses. Nor could financially weak banks provide working capital financing torestructured corporations. Recognizing these losses and recapitalizing the banks may resultin the possible replacement of management and a loss of potential upside gains.

The second important constraint facing domestic creditor banks is their unwillingness toparticipate in publicly funded recapitalization programs. This unwillingness stems from thecontrolling shareholders’ overridingdesire to avoid dilution of ownership and loss of controlover bank management. Participation in public recapitalization schemes almost alwaysrequires a dilution of owner equity and control or management replacement, which existingshareholders do not welcome.

The third constraint is the unwillingness of creditor banks to agree on certain debtrestructuring that involves favored treatment of particular corporate borrowers, such as ahaircut interest reduction and payment rescheduling, because this may inducestrategicdefaultingby other corporate borrowers. Essentially, corporate debt forgiveness for certainborrowers can increase the expectation that other borrowers will also receive similar treat-ment and therefore can reduce incentives on the part of good borrowers to stop repayment.This fear makes creditor banks reluctant to even negotiate on debt workout that may favordebtors.

1. Recapitalize banks adequately.To relax these constraints, it is important that weakbanks be adequately recapitalized by public funds, if necessary. There are several waysto recapitalize banks: One way is for the government to purchase subordinated debtsor nonvoting right equity from a bank using government bonds as payment while thebank keeps the NPLs. An alternative is for the government to have its AMC purchaseNPLs (at market value) from banks in exchange for subordinated or convertiblegovernment bonds. The first alternative allows creditor banks to utilize pertinentinformation about the corporate borrower for successful restructuring; but if the bankdoes not have the capacity or the incentive to resolve corporate debts, the AMC has


merit. AMCs have been operational in Korea and Malaysia, and Thailand (in acquiringand disclosing of assets of closed finance companies).

2. Provide incentives for bank shareholders.Recapitalizing banks should be part of acoherent banking reform strategy. The modest response to the Thai tier 1 recapital-ization plan suggests that although the concept of linking corporate debt restructuringwith bank capitalization may be acceptable, it works best if there are strong incentives.A fear of ownership dilution discourages banks from raising new capital. The govern-ment can give shareholders an incentive to recognize losses fully by injecting capitalvia instruments that give them an option to purchase the stock back and retain controlif the restructuring is successful.

3. Punish bad borrowers and reward good borrowers.It is important for a creditor bankto clearly distinguish between good and bad borrowers. The establishment of creditbureaus and publicizing the names of strategic defaulters and non-cooperative debtorsmay help provide the incentive not to default.

4.2. Debtor constraints

An important constraint on the debtor side is thelack of a credible threat from the legalor judicial system. A debtor needing no new funds has no incentive to negotiate when he isnot servicing existing debts. Creditors have no effective power to foreclose on the collateralin court. In the absence of the trusted court alternative and of clearly spelled-out rules for avoluntary out-of-court mechanism, the status quo would simply continue or strategic de-faulting would rise with a resulting increase in corporate debt overhang.

The second constraint is thereluctance on the part of a debtor to dilute ownership and tolose control over the corporation. This results in the debtor’s resistance to operationalrestructuring of the distressed corporation because the debtor may be concerned aboutmanagement replacement, resistance from labor unions and loss of potential upside gains.

The third constraint is thelack of adequate disclosure of financial informationon thedebtor corporation’s (or its group’s) balance sheet, especially assets and cash balances. Thelack of disclosure by debtors is often considered by external creditors as one of the mostfundamental impediments to debt negotiations. In the absence of such information, it isdifficult to evaluate the debt-servicing capacity of debtors as a prerequisite to corporate debtworkout.

The fourth constraint is that the debtor corporation may not be attracted to restructuringwithout adequate guarantees of working capital financing after restructuring. If the debtorknows that even after restructuring the corporation’s business will not be viable because ofa lack of working capital financing, he may not have sufficient incentives to agree torestructuring.

1. Establish a credible threat of bankruptcy.For a voluntary process of corporaterestructuring to work, the alternatives to an agreement must be made clear and credible.In particular, creditors must be able to enforce their legal claims, and this requirescourts to function well. Improvement of the functioning of courts, not just in bank-ruptcy but especially in foreclosing on collateral, and registering security interests,


greatly helps to protect creditor rights and provides the debtor with a credible threatforcing him to negotiate in good faith. When the creditor is empowered, he or she hasthe incentive to treat the debtor fairly, and the debtor has every incentive to abscond.

2. Provide working capital for restructured corporations.It is crucial that creditworthycorporations have access to adequate sources of working capital financing. Oneapproach is the formation of a working capital facility available to corporations thathave successfully restructured their debt with creditors. Funds from such a facilitycould be supplied on a commercial basis with a first-priority collateral position. Thiswould provide sufficient incentives to the debtor to restructure debt. Debt restructuringcombined with working capital provision is expected to help accelerate the economicrecovery process.

3. Improve corporate governance.A longer-term, but important, issue is to improvecorporate governance. Successful restructuring processes depend on the corporategovernance structure of banks and corporations. This should begin now because ittakes time to accomplish. The main task involves broadening ownership by introducinga sizable number of outside shareholders, improving the quality of accounting stan-dards and information disclosure and the wider dissemination of information of interestto noncontrolling owners. In the past, neither creditors nor minority or outside share-holders have had access to reliable information, and this situation is being improved byrequiring all listed firms to have at least a few outside directors on their boards.

4.3. Government and international constraints

The first constraint from the perspective of the government isfear of a mounting fiscalburden of bank recapitalization.The perception of ever-rising public debt (relative to GDP)during an economic crisis usually makes government reluctant to acknowledge the size of theproblem and to add further fiscal resources for bank recapitalization. Furthermore, recapi-talizing banks is politically unpopular because it is perceived to bail out rich bankers. Bothpolitical fear and concern forfiscal sustainabilityprevent the government from undertakingeffective recapitalization programs.

The second constraint on corporate restructuring is thelack of capacity or willingness touse a public AMC for active corporate restructuring.All countries (except for Thailand,which has a public AMC only for finance companies, and the Philippines) have establishedpublic AMCs to acquire NPLs from banks, but they have not performed adequate functionin corporate restructuring negotiations. In particular, Korea’s KAMCO and Malaysia’sDanaharta have not begun active corporate restructuring. Also, AMCs often lack humanresources and a technical capacity for restructuring. This constraint also applies to creditorbanks, which lack NPLs restructuring expertise, particularly in relation to the number ofborrowers whose loans and operations need to be restructured.

The third constraint is thelack of adequate coordination and information sharingamongstakeholders. This includes a lack of well-balanced sharing of losses among the debtor,equity holders, domestic and foreign creditors and the government; the lack exchange ofinformation among creditors about their preferences and strategies; and the lack of sharingof information about the debtor’s financial conditions and about the amount and seniority of


other creditor claims. In the absence of such coordination and information exchange, it wouldbe difficult for multiple creditors to agree on their stance vis-a`-vis the debtor and toefficiently engage in corporate debt restructuring.

1. Acknowledge the need for active bank recapitalization.It is important for the gov-ernment to acknowledge the scale of NPLs and the need for recapitalization as soon aspossible. Delaying such an acknowledgement and action can result in economic costsin the form of a protracted recession and foregone output. The governments of EastAsian crisis-affected countries have had the capacity to absorb such costs because ofthe low level of public debt (relative to GDP) in the precrisis period.

2. Use public AMCs as possible catalysts for corporate restructuring.The scope ofparticipation of public AMCs in resolving corporate debt problems is potentially large.By accumulating NPLs from various debtors to a single creditor, AMCs may becomethe largest domestic creditor for a significant number of corporations. Thus, thegovernment can use AMCs to demonstrate its commitment to corporate restructuring.AMCs may as a result be a major force in corporate restructuring, with considerableinfluence over reluctant debtors through the threat of bankruptcy.

3. Strengthen intercreditor coordination and information sharing.Actions to improvethe mechanics of an out-of-court settlement with multiple creditors include closeconsultation, coordination and information sharing among these creditors. Creditorsmust make decisions reflecting different preferences, specific conditions, and legal andregulatory frameworks. By acting as a clearing house for such coordination andinformation sharing, the government and the international community can reduceavoidable delays.

5. Recapitulation and summary

The uneven progress of financial and corporate restructuring in East Asian crisis-affectedcountries and the detailed explanations above underscore the main issues. First, corporaterestructuring requires creditors and debtors to have the right incentives to preserve theirassets and to manage their businesses efficiently. With such incentives, creditors could thenjudge whether, when and how to restructure their debt claims so that borrowers wouldoperate corporations efficiently and repay. Agreements have to be voluntary.

Second,banksmust have adequate capital to set the stage for more aggressive restruc-turing of NPLs on their balance sheets. Government recapitalization programs, conditionalon some costs to bank owners but without jeopardizing their willingness to recognize losses,are essential.

Third, borrowersmust face a credible threat of bankruptcy for a voluntary process ofcorporate restructuring to work. The alternatives to an agreement must be made clear andcredible. In particular, creditors must be able to enforce their legal claims, and this requirescourts to function well. Borrowers will have more incentive to agree to a restructuring ifworking capital financing is available subsequently.

Fourth,governmentsshould acknowledge the scale of NPLs and take steps to restructure


Appendix Table 1Progress on financial sector restructuring

Indonesia Korea

I. Establish institutionalframework

Indonesian Bank RestructuringAgency (IBRA) created andempowered to deal with problembanks, provide guarantees of creditlines and manage and dispose offrozen bank assets. AssetManagement Unit (AMU) createdto focus on debt recovery.

KAMCO reestablished to manageand dispose of NPLs. FinancialSupervisory Commission (FSC),now Financial Supervisory Service(FSS), created to oversee financialand corporate restructuring andsupervision of financial institutions.

II. Resolve nonviable banksa. Liquidate 16 closed in November 1997, 7

closed in April 1998, 3 closed inAugust 1998, 38 closed in March1999 and 2 joint venture banksclosed in April 1999.

16 of 30 merchant banks, 4 of 25leasing companies, 28 of 231mutual savings companies, 128 of1666 credit unions. No commercialbank has been liquidated.

b. Nationalize or absorb intoother institutions

12 banks taken over; 4 of 7 statebanks to merge into Bank Mandiri.

2 commercial banks nationalized, 5weak commercial banks forced tomerge with healthier banks, 7banks encouraged to merge withgovernment equity assistance; 4 lifeinsurance companies and 7investment trust companiesabsorbed by strongerintermediaries.

III. Recapitalize viable banksa. Capital support programs

from government8 banks identified for possiblegovernment-assistedrecapitalization.

W64 trillion allocated forrecapitalization of which W40trillion has already been used.

b. Foreign bank or strategicbuyers

Foreign and joint venture banksenjoy 9.7 percent market share ofdeposits; no major new investors.

Foreign investors are innegotiations to acquire Korea FirstBank and Seoul Bank.

c. Stop-loss, put-back forstrategic buyers

None. Offered in the case of Korea FirstBank. Government to assume fullcost of losses in the first year aftertakeover and a portion of NPLsarising in the second year.Government to transfer NPLs to abad bank.

d. Foreign or domesticequity capital markets

None. 5 successful banks in 1998 indomestic market.


Malaysia Philippines Thailand

Danamodal created to recapitalizebanks and fincos. Danahartacreated to purchase, manage anddispose of NPLs. Corporate DebtRestructuring Committee (CDRC)created to oversee voluntarycorporate debt restructuring.

Central Bank Monetary Boarddecides on bank closures.Philippine Deposit InsuranceCorporation, established in 1963,is responsible for receivership andliquidation of banks.

The Financial Sector RestructuringAuthority (FRA) and the AssetManagement Company (AMC)established in October 1997 for thehandling of 56 closed fincos andthe sale of their assets.

None. No closure of any of 39fincos or 35 banks. Malaysia hasopted instead for absorption.

1 commercial bank, 7 thrifts and44 rural banks under receivershipsince July 1997.

56 of 91 fincos, 1 of 15 banks(Bangkok Bank of Commerce).

3 of 35 banks (Bumiputra, Sime,Periwira Affin bank) absorbed bystronger entities; 16 fincosabsorbed by parent banks.

None nationalized; voluntarymergers encouraged.

2 of 15 banks nationalized, 3 banksabsorbed (2 by state-owned banksand 1 by a state-owned finco), 12finance companies nationalized andabsorbed by the same state-ownedfincos.

Set up in July 1998; in use.RM6.2bn already injected into 10financial institutions. Estimatedrecapitalization cost is RM16bn.

None; incentives for mergers. Bt300 billion, program set up inAugust 1998 to provide tier 1 andtier 2 capital for banks, in additionto Bt1.1 trillion in liquidity supportto closed or failed institutions. Paceof recaps slow; 4 banks applied fortier 1, and 3 banks applied for tier2.

None, but 13 foreign banks enjoy20 percent1 deposit marketshare.

None yet; planned for governmentstake in the Philippine NationalBank.

2 out of 15 sold, 5 more for sale.

None. None yet. Government willing to offer with limitsNone; banks enjoined to useDanamodal if they need capital.

None through mandatoryrecapitalization programs; severalcommercial banks seekingadditional capital via privateplacements and equity markets.

At least 5 banks have foreign equity(2 controlling shares, 3 minorityshares); 3 banks have recently issuedtier 1 capital through a domesticinnovative capital instrument (aboutBt100 trillion).

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Appendix Table 1(continued)

Indonesia Korea

IV. Resolve or restructure NPLsa. Recognize full extent of

NPLsNo, but comprehensive systemwideportfolio reviews have beenperformed.

Partially. A new forward-lookingsystem of loan classification will beintroduced in 1999.

b. Systemwide carve-out ofNPLs

Not yet, but NPLs from state banksand banks to be recapitalized to betransferred to IBRA.

KAMCO has used W17.7 trillion topurchase W44 trillion of NPLs (7percent of all bank loans); morepurchases of NPLs expected.

c. Restructuring of viableNPLs

Under the Jakarta Initiative andother voluntary programs.

Loans under workouts amount toW23 trillion due by chaebolcompanies and SMEs. Debtrestructuring options includeinterest rate reduction, debt-to-equity conversions, debt forgivenessand longer maturity periods.Government led restructuring effortsfor top five chaebols.

d. Tax and other incentivesfor NPL restructuring

New bankruptcy law, but notworking.

In place (mainly tax waivers andreductions).

e. Enable or facilitate foreclosureof nonviable NPLs

Exists in theory but not yetenforced in the legal system.

Good framework, but limited usedue to unemployment impact.

f. Create secondary market forbank NPLs (sale to financialinvestors)

No. KAMCO has recovered W1 trillionof W19.5 trillion spent to acquireNPLs. W227 billion recovered byissuing debt instruments backed byassets, and the remaining W779billion through public auctions,voluntary debt repayments andadditional asset acquisitions. Thisyear, KAMCO plans to sell W16trillion of bad loans.

V. Revamp regulatory frameworksfor banking systemsa. Strengthen prudential norms Yes. New regulations on loan

classification, provisionins debtrestructuring, connected lendingand capital adequacy). But not yetimplemented.

New regulations issued onconnected lending, loanclassification and provisioning,exposure to foreign exchangerisks, coverage of deposit insurancescheme and accounting standards.Regulation and supervision are stillbehind minimum internationalstandards. New forward-lookingloan classification system expectedduring 1999.

b. Strengthen bankingsupervision and examination

Not yet; work in progress. Merger of the four financialsupervisory agencies (banking,nonbanks, securities and insurance)became effective January 1999.



In progress, enforcement vs.forbearance is the key issue.

Yes, but for treatment ofrestructured loans.

Yes, with implementation of a newset of loan classification rulesissued in March 1998.

Danaharta has bought RM8.1bnand manages a further RM11.6bnof the gross value of NPLs.

Not yet; the government hascontingency plans for an AMC.

A boutique approach. Acentralized, publicly managedAMC not planned for bank assetsdespite high NPLs (FRA auctionsof closed finco assets).

Government-led for strategicgroups (e.g., Renong); Danahartato play key role for NPLs; CDRCfor private sector workouts.

Market-based and bilateral, exceptfor companies filing for suspensionof payments with SEC.

Market-based, but guidelines andincentives put in place. Bt36bn ofBt570 billion scheduled forrestructuring completed.

In place (capital support, stampduties waived).

Favorable loan loss provisioningtreatment for restructured loans.

In place (tax waivers, capitalsupport).

Good framework. Danaharta Actspeeds foreclosures.

Foreclosure possible but slow(delayed by redemption period);framework under review.

New foreclosure law passed inMarch 1999.

Danaharta to restructure NPLs andunderlying asests; sales to follow.

Not yet. Auction process for US$20 billionof shutdown fincos loans. Nocentralized mechanism for banksNPLs (only private sector-based).

Stronger norms before re-crisis;only key concern is reversion ofNPL definition.

Standards strong and strengtheningto close to international bestpractice.

Process underway to fully revampthe legal and regulatory frameworkfor supervision by 2000.

Good before crisis; enhanced byDanamodal, Danaharta.

Fairly good before crisis;strengthening with externalassistance.

On-going reorganization of BOTwith TA provided by donors tobuild up its supervisory capacity(training and enhancing ofsupervisory procedures).

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Indonesia Korea

c. Strengthen enforcement ofbanking regulations

Implementation is key issue. Financial Supervisory Service, thenew supervisory agency, hasreceived some additional powers toenforce regulation.

VI. Strengthen bank creditcultures and managementa. Encourage or force

consolidationsNew willingness to closeinstitutions creates incentives forconsolidation.

Encouraged; 3 mergers so far; 5banks absorbed by stronger banksso far and more likely.

b. Allow or encourage foreignbank buy-ins

Yes, up to 100 percent, butadherence to the reform program,equitable treatment of investorsregardless of ethnic origin, politicaland economic stability are neededfirst.

Yes, 3 cases (Korea First/NewBridge, Seoul/HSBC Holdings andKorea Exchange/Commerz Bank).

c. Establish CAMEL ratingfor banks

Traditionally used, but thewillingness and capacity toexamine banks and assign ratingsbased on transparent criteria havebeen lacking.

Used by BOK and expanded toother financial institutions, FSSfocusing now on NPLs, CAR.

d. Proper NPL definition,interest accrual,provisioning norms

Implementation still a key issue. Partially. New rules define NPLs asall loans in arrears for more than 3months. A forward-looking systemthat takes into account theborrower’s ability to repay will beintroduced.

e. Require credit risk rating/scoring/monitoring systems

No progress as of yet. Only minor progress at individuallevel; entry of foreign banks to help.



Yes, but forbearance on NPLs. Regulations enforced, but delaysin closure of weakest banks.

Yes with temporary forbearance onNPL provisioning (up to end of2000).

Actively encouraged; 16 fincosmerged into parent banks; 2 largebank mergers.

Actively encouraged via mergerincentives and higher capitalrequirements.

Done for 3 nationalized banks and12 nationalized fincos. Voluntaryfor others.

New foreign banks not allowed orencouraged.

Yes, but extent and duration areunder debate.

Yes for ownership limit of 49percent lifted for a 10-year period.

Traditionally used by BNM. Established practice, currentlybeing upgraded to improvedCAMEL system.

CAMEL rating already used byBOT, but needs to be upgraded;planned in the reform ofsupervision.

Put in place in 1998, exceptreversion to 6-month NPLdefinition.

Yes. The NPL definition tightenedto 3 months in 1998. General loanloss provisioning requirementsbeing phased in; currently slated torise to 2 percent by October 1999.

Proper norms issued in March1998; classification immediatelyimplemented; interest accrual rulesimplemented in January 1999;provisioning requirement phased inthrough 2000.

Only minor progress at largerbanks.

Risk monitoring systems requiredof banks.

Only minor progress at individualbank level.


Appendix Table 2Progress on corporate sector restructuring

Indonesia Korea

1. Establish enabling environment for corporate restructuring

a. LegalRemoving obstacles formergers

Obstacles largely replaced. Obstacles largely replaced.Incentives for Big Deal mergers.

Ease of debt equity swaps Swaps allowed. Swaps allowed.

Security interests Regulation on registration adoptedin April 1999.

Information not available.

b. Tax Mergers are tax-neutral.Simplification of tax administration.

Tax Exemption and ReductionControl Act (February 1998)provides breaks for corporaterestructuring.

c. Foreign ownershipliberalization

Few formal restrictions on foreignownership. Difficult in practice dueto attitudes and slow approvalprocess.

FDI and Foreign CapitalInducement Act permits foreignersto take over nonstrategiccompanies.

d. Labor market flexibility Not a barrier. Frequent strikes despite tripartiteagreement.

e. Social and political stability Uncertainties surrounding politicaltransition.

Fragile stability; tensions withNorth Korea.

2. Strengthen out-of-court mechanisms

a. Basic voluntary frameworkin place

Jakarta Initiative launched Sept.1998. JITF advises and facilitatesnegotiations.

Lead banks responsible forvoluntary workouts under agreedrules. Corporate RestructuringCoordination Committee (CCRC)in place.

b. Adequate incentives toparticipate

INDRA established in June 1998,and allowed extension to end ofDec. 1999. Used only for onecorporate restructuring.

Bankruptcy Law and Fair TradeAct provide ready alternatives, andthe government has also interveneddirectly (e.g., Big Deals.) Mandateddeadlines for standstills.

Significant progress Some progress, more needed Limited progress



Obstacles largely replaced. Information not available. Need to review tax treatment ofnoncash transactions.

Swaps allowed. Information not available. Swaps taking place. Needmodification of the civil code tolegalize.

Court administration registersinterests.

Information not available. Need to broaden use andregistration of security interests.

Tax incentives for restructuringare available.

Provisions for loan losses are nottax-deductible unless debtor hasfiled for insolvency.

Temporary tax relief for debtrestructured between Jan. 1, 1998and Dec. 31, 1999.

FDI policies for property andmanufacturing sectors relativelyliberal. Other restrictions still inplace.

Rules on foreign investment andproperty ownership have beenliberalized.

Rules on foreign investment andproperty ownership have beenliberalized.

Not a barrier. Not a barrier. Not a barrier.

Possible political difficulties. Reasonable stability. Reasonable stability.

Voluntary, London rules styleapproach, with Corporate DebtRestructuring Committee(CDRC) oversight.

Lead bank responsible for leadingvoluntary workout efforts.

Bangkok rules: Bank recapitalizationschemes tied to corporate debtrestructuring. Corporate DebtRestructuring Advisory Committee(CDRAC) formed to encouragecorporate restructuring.

Functioning Bankruptcy Lawand courts provide credible altern-ative. Government pressure onbanks to roll over or restructuredebt. Allegations of governmentinterference in some cases.

Debtors use fear of SEC’s venue forsuspension of payments to obtainfavorable terms from creditors.SEC grants interim and definitivesuspensions of payments; canappoint receivers and liquidators.

Bank recapitalization schemes tiedto corporate debt restructuring.BOT should work more throughbanks to promote corporaterestructuring.


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Indonesia Korea

3. Strengthen bankruptcy and foreclosure systems

a. Quality of bankruptcy law Bankruptcy Law satisfactorilyamended and a new Commercialcourt introduced in August 1998.

Bankruptcy Act, Composition Act,Reorganization Act passed inFebruary 1998. Consideredsatisfactory.

b. Enforcement and judicialcapacity in bankruptcysystem

Initial cases controversial. Trainingfor judges underway. New ad hocjudges appointed.

Increased use of courts; specialcommission at Seoul court.Businesses rarely rely on courts,but this is changing.

c. Foreclosure and insolvencyprocedures

Foreclosure difficult. Foreclosure is possible.

4. Improve corporate governance

a. Effectiveness of ownershipoversight and boards ofdirectors

All publicly traded companies musthave at least one nonexecutiveboard director, 25 percent of boardseats must be nonexecutive in 1999.

b. Shareholder rights andprotection

Legal liabilities for board membersclarified in 1997. In practice,considerable self-dealing byinsidersand controlling shareholders.

The minimum equity holdingrequirements for call action suitswas drastically reduced from 1percent to 0.01 percent.

c. International accounting,auditing and disclosurestandards

While current auditing andaccounting standards largely followinternational standards, there isvery poor compliance withstandards due to lack ofenforcement.

Statements of listed companiesmust be prepared and audited usinginternational standards.Conglomerates must publishconsolidated statements.




Laws satisfactory, with theBritish legacy of commonlaw.

Bankruptcy law adopted in 1909has some features of a modern lawbut does not provide for stays ofactions by secured creditors. Since1976; only liquidation can besupervised by courts.

New bankruptcy law passed inMarch 1999. A separate”bankruptcy court” introduced.

Judicial system is well-functioning, but specializedskills need to be improved.

Not applicable since courts no longergrant suspensions of payments orsupervise implementation ofrehabilitation plans.

Initial cases controversial. Trainingfor judges currently underconsideration.

Foreclosure is possible. Foreclosure actions can be frustratedby stays issued by the SEC.

Foreclosure laws passed in 1998.

Malaysian Institute of CorporateGovernance (MICG) founded inMarch 1998 to promoteawareness and practices.

Moderate progress. Exchange has issued a code of bestpractice for directors. Requirementsof two independent board directorsby end of 1999.

In addition to suits by aggrievedparties. Exchange can actagainst negligent directors.

Exchange can take direct actionagainst negligent directors. Lawsallow share buy-backs.

Although laws give extensive rightsto shareholders, enforcement islimited by very weak judicialsystem.

International standards mademandatory. Standards of theMalaysian Accounting StandardsBoard backed by the force oflaw.

International standards mademandatory. Standards of thePhilippine Board of Accountancybacked by force of law. Small finesfor nonsubmission of reports.

Financial statements of publiccompanies with assets over 1billion baht use international bestpractices. All listed companiesmust have an audit committee.Enforcement limited.



and recapitalize banks more rapidly to avoid delays that will ultimately increase the fiscal andeconomic costs of the financial crisis. An early infusion of such funds may raise the measuredbudget deficit, but this must be weighed against the likelihood that taxpayer costs couldincrease if banks operate with inadequate capital and incentives. Recapitalization must beaccompanied by measures to strengthen bank risk management and supervisory oversight.Coherent strategies for the management of NPLs should be developed, including reliance onAMCs. The legal and judicial framework supporting creditor rights must be strengthened,and policies to improve corporate governance should be made part of the policy package.

Notes

1. The Radhanasin Bank was established in January 1998 under 100 percent governmentownership to participate in sales of the good assets of the 56 closed finance companies.

Acknowledgment

This paper was prepared as background material for the 23rd ACAES InternationalConference, “The Post-Financial Crisis Challenges for Progressive Industrialization of AsianEconomies,” sponsored jointly by the American Committee on Asian Economic Studies,Seoul National University, and the Korea Institute for International Economic Policy andheld in Seoul on December 15–17, 1999. Earlier versions were presented at the Bank NegaraMalaysia seminar, “Banking Sector Restructuring in Malaysia,” held in Kuala Lumpur onApril 19, 1999, the World Bank Workshop, “Systemic Corporate Distress and Its Resolu-tion,” held in Washington DC on June 17–18, 1999 and the Australian National Universityconference, “Reforms and Recovery in East Asia: The Role of the State and EconomicEnterprise,” held in Canberra on September 21–22, 1999.

The author is grateful to Hoon Mok Chung, Richard Duncan, Jonathan Fiechter, DaleGray, Jacques Loubert, Gerald Meyerman, S. Ramachandran, and Richard Zechter for theircontributions. The findings, interpretations, and conclusions expressed in this paper are thoseof the author and do not necessarily represent the views of the World Bank, its executivedirectors, or the countries they represent.


the resolution of the east asian crisis: financial and corporate sector restructuring

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