Slide1: Case of Credit Risk Management


The 1982 Debt Crisis in Latin America: The 1982 Debt Crisis in Latin America


The story: The story


The Story: The Story On August 20 of 1982, Mexico’s Finance Minister, Jesus Silva-Herzog, declared that Mexico would no longer be able to service its debt. Debt crisis exploded out through Latin America. The loss of a great deal of money was an unthinkable shock to financial institutions in developed countries.


Agenda: Agenda Backgrounds of Latin America The Origins of the debt crisis in the 1970s Staggering Accumulation of Debt The debt crisis in 1982 Influences


Backgrounds of Latin America: Backgrounds of Latin America History－has relied heavily on international capital Economic cycle Economic expansions－the debts is bearable Economic stagnation－unable to service their debts ＝＞debt crisis in 1827, 1873, the 1930s, and 1982 The debt crisis during the 1982 was even worse than before!


Origins of the debt crisis in the 1970s: Origins of the debt crisis in the 1970s Macroeconomics Debt demand side Debt supply side Latin America International banks


Macroeconomics of the 1970s: Macroeconomics of the 1970s The collapse of the Bretton Woods system The first oil shock


Macroeconomics of the 1970s: Macroeconomics of the 1970s The collapse of the Bretton Woods system in 1971  Fixed exchange rate locked into a gold standard Floating exchange rate Financial globalization International capital markets↑ International commercial banks↑


Macroeconomics of the 1970s: Macroeconomics of the 1970s The first oil shock beginning in 1973


Macroeconomics of the 1970s: Macroeconomics of the 1970s International Banks OPEC Nations Non-oil Producing Nations


Debt demand side: Latin America: Debt demand side: Latin America Badly in need of debt Non-productive investments Financial liberalization reforms Vicious circle


Debt demand side: Latin America: Debt demand side: Latin America Badly in need of debt －Relatively poor countries relied heavily on primary commodities for export earnings －Re-financing maturing debts and growing interest payments from fresh loans


Debt demand side: Latin America: Debt demand side: Latin America Non-productive investments －Military expansion －For current consumption, not for productive investments. －Adoption of wrong models of development from the western countries


Debt demand side: Latin America: Debt demand side: Latin America Financial liberalization reforms introduced in several Latin America nations dismantling import controls, exchange controls, capital controls, reserve ratio, free interest rate on loans and deposits, repatriation of profits, etc. without any increase in regulatory oversight… Which led to… Free flow of capital from and to the Americas.


Debt demand side: Latin America: Debt demand side: Latin America vicious circle Developing country economies are fatally dysfunctional with long standing ills that are concealed by capital inflows. High oil price X

Debt supply side: International banks: Debt supply side: International banks Ideological Miscalculations Outdated and insufficient methods for measuring credit risk. The drastic change in the source and composition of debts


Debt supply side: International banks: Debt supply side: International banks Ideological Miscalculations －”Countries could not go bankrupt” －Lending to the Third World became an irresistible fashion *bright bankers *as lenders of last resort －The leadership advocated the fashion.


Debt supply side: International banks: Debt supply side: International banks Walter Wriston contended that a country ‘…how badly off, will “own” more than it “owes”. He maintained that countries could not go bankrupt, nor could they disappear and that even if they had short-term cash flow problems, the cure would be ‘sound programs and time to allow them to work’ －Head of Citibank Corporation, around 1967 Sir Geoffrey Howe once again praised the virtues of private banks in recycling funds to the third world countries. He described lending to the third world as “..the best form of recycling” on account of the fact that external loans “…enabled them (developing countries) to finance their external payments and to raise their living standards”. －Britain’s Chancellor of the Exchequer, in autumn of 1981


Debt supply side: International banks: Debt supply side: International banks Outdated and insufficient methods for measuring credit risk. They didn’t see any credit risk. Minimizing their credit risk by spreading loans to a variety of countries across the third world? Most available method were based on subjective analysis. “The selective premium rates” which was a innovation to measure credit risk did not reflect the true risk attached to each country. eg. Poland paid premium rates of 1%. Argentina and Mexico paid just under 1%, Hungary, France paid just over 0.5% Sweden paid 0.5%


Debt supply side: International banks: Debt supply side: International banks The drastic change in the source and composition of debts Official sources（eg. The World Bank, IMF, OECD）shifted their lending away from Latin America towards poorer countries. Official sources Commercial banks －long term, －shorter maturities, －relatively low interest rates －higher interest rates (1984)


Staggering Accumulation of Debt: Staggering Accumulation of Debt


Staggering Accumulation of Debt: Staggering Accumulation of Debt


The debt crisis in 1982: The debt crisis in 1982 The circumstances The debt crisis broke out in Mexico The debt crisis spread through Latin America. The serious consequences IMF stepped in


Macroeconomics: Macroeconomics The second oil shock occurred in 1979


The circumstances: The circumstances Capital flight: The private sector of Latin America nations was suddenly aware of the international economy, shifting its assets abroad, even after borrowing heavily. =>Depreciating domestic currency =>Ability to pay debt ↓


The debt crisis broke out in Mexico: The debt crisis broke out in Mexico An oil producing nation In the 1970s and 1979 -- benefited from the oil shock From 1981 -- oil prices began to fall continuously financial crisis the government finally reacted in 1982：raising import controls, cutting spending, devaluing the peso peso depreciated 80％＋capital flight＝stagflation more than 50% of foreign debt was due Central Bank’s reserves were almost exhausted. International banks refused to lend to the Mexican Government On August 20, 1982, Mexico’s Finance Minister declared that Mexico could no longer be able to service its debt.


The debt crisis spread through Latin America: The debt crisis spread through Latin America In the wake of Mexico’s default, most commercial banks refused to lend to Latin America. Creditors began demanding payment. Third world debtors collectively experienced a liquidity gap and became unable to repay loans when they matured. Nationalizing the masses of debt accumulated by the private sector


The serious consequences: The serious consequences For developing countries A vicious debt trap per capita GDP experienced negative growth of almost 9%


The serious consequences: The serious consequences For developed countries －Troubling financial markets (Table) －Either total collapse of the banks, or a government take-over followed by a consequential credit contraction that would adversely affect output, hence employment.


Slide32: Exposure as a Percentage of Capital, Major Banks, end of 1982 Source: William R. Cline, International Debt: Systemic Risk and Policy Response (Washington, DC: Institute for International Economics, 1984), p. 24.


IMF stepped in: IMF stepped in To stabilize international finance situation Developing countries had to meet the policy objectives of the IMF in order to obtain the funds －Severe austerity programs － industries traditional export industries Eroding standard of living of debtor nations


Influences: Influences Open the doors to a more radical development to international finance Bankers have learned the lesson －Pay more attention on credit risk management －Increased their reserve holdings to offset any potential losses from a major loan default Eg.1982, exposure as a percentage of capital= 287% 1988, 108% Eg. Citicorp first announced that it was enlarging its loss reserve in 1987, and the other major banks quickly followed suit


Slide35: DEPARTMENT OF FINANCE AT NTU


A case Study of Korean Financial Crisis: A case Study of Korean Financial Crisis Ⅰ. Overview of the Korea’s Economic Situation Ⅱ. Main Causes of Korean Financial Crisis Ⅲ. Korean Financial Reform Ⅳ. Conclusion and Remarks Ⅰ DEPARTMENT OF FINANCE AT NTU


Overview of the Korea’s Economic Situation: Overview of the Korea’s Economic Situation Ⅰ DEPARTMENT OF FINANCE AT NTU Source: Bank of Korea Financial Crisis 10,013 The Korea-War 6 Five-Year-Economic- Development Plans 2002 1980 1962 1970 1995 5,000 67 87 11,385 6,743 1953 Per Capita (US$) GNI 1990 1945 OECD Member 100(1964) 1,000(1977) Economic Overview


Overview of the Korea’s Economic Situation: Overview of the Korea’s Economic Situation Economic Overview The Role of Government in Economy : Government-led Development Strategy Conglomerate-Dominated Economic Structure : Cultivation of Star-Players Administered-Finance : Heavy Intervention by Government Ⅰ DEPARTMENT OF FINANCE AT NTU


Chronicle of  Korean Financial crisis : Chronicle of Korean Financial crisis Ⅱ DEPARTMENT OF FINANCE AT NTU


Main Causes Of Korean Financial Crisis: Main Causes Of Korean Financial Crisis A. Underdevelopment of Capital Market and Surging Short-Term Debt B. A Partial Liberalization of The Capital Account C. Lack of Transparency in Financial Information D. Near Depletion of Foreign Currency Reserves Ⅱ DEPARTMENT OF FINANCE AT NTU


Korean Financial Reform: IMF Programs in Action The Korea government and the IMF agreed on a financial aid package on December3, 1997and had ever since nine times of reviews for the Economic Program. Ⅲ DEPARTMENT OF FINANCE AT NTU Korean Financial Reform


Korean Financial Reform: The First Reform: (1998~2000) It was intended to address the immediate instability of the financial market. The Second Reform: (2000~2001) Framework for continuous restructuring was established to normalize the financial market Ⅲ DEPARTMENT OF FINANCE AT NTU Korean Financial Reform


Korean Financial Reform: Strategies of Financial Reform [1] Recapitalization [2] Resolution of non-performing assets [3] Strengthening of Regulatory Norms [4] Improving the Governance Structure of Banks DEPARTMENT OF FINANCE AT NTU Ⅲ Korean Financial Reform


Korean Financial Reform: Consolidation of troubled financial institutions a) Commercial banks b) Merchant banks c) The Investment Trust Companies d) Insurance and other NBFIs Ⅲ DEPARTMENT OF FINANCE AT NTU Korean Financial Reform


Slide45: Ⅲ DEPARTMENT OF FINANCE AT NTU Commercial Bank Consolidation Source: Bank Management Statistics, 2001, Financial Supervisory Service.


Slide46: Ⅲ DEPARTMENT OF FINANCE AT NTU Consolidation of Troubled Financial Institutions Source: Bank Management Statistics, 2001, Financial Supervisory Service.


Slide47: Ⅲ DEPARTMENT OF FINANCE AT NTU Foreign Debt & Reserve Source: Ministry of Finance & Economy, Bank of Korea


Slide48: Establishing the perception Strengthening of the regulatory norms Improvement of the governance structure Capital market opening Improvement of the corporate environment Conclusion and Remarks Ⅳ DEPARTMENT OF FINANCE AT NTU


Part III: Part III The case of Chung-Xing Commercial Bank


Outline : Outline 1、The background of Chung-Xing BANK 2、What makes it fail? 3、Financial Situation 4、Solution to this problem 5、Implication & Suggestion 6、Conclusion, Q ＆ A


1、The background of  Chung-Xing BANK: 1、The background of Chung-Xing BANK Introduction： A. Foundation trend of private banks B. The bank products and services C. Increasing branches from 7 to 35 (1997)


1、The background of  Chung-Xing BANK: 1、The background of Chung-Xing BANK The major founders


1、The background of  Chung-Xing BANK: 1、The background of Chung-Xing BANK Composition of stockholders A. Individuals B. Major stockholder: The Wang family 10% (Good policy relationship) Jin Ding security groups 5% (market trading 1998)


2、 What makes it failed?: 2、 What makes it failed? “Money goes to China, debts leave Taiwan” “Insider trading” Causes: A. Manager cheat B. Intensive lending C. Not breakeven


2、 What makes it failed?: 2、 What makes it failed? 1.Managers cheat A. Collude with Taiwan Pineapple Corporation Omnibus accounts(人頭戶) (Limit to borrowing quota) B. Credit without checking (March.20.2000 ) C. Stop closing vault


2、 What makes it failed?: 2、 What makes it failed?


2、 What makes it failed?: 2、 What makes it failed? 2.Intensive Lending


2、What makes it failed?: 2、What makes it failed? 3.Not breakeven A. There is no interest income on NT$80billions low-quality loan. B. Still need to pay NT$140billions liability’s interest expense and other operation expense .


3、Financial Situation: 3、Financial Situation


3、Financial Situation: 3、Financial Situation


3、Financial Situation: 3、Financial Situation


3、Financial Situation: 3、Financial Situation


4、Solution to this problem: 4、Solution to this problem The First stage :(April 2000) Central Deposit Insurance Corp. involves in protecting deposits and gains public confidence. The Second stage :( October 2001) Landbank takes over Chung-Xing bank to stabilize liquidity by lowing interest rate. The Third stage: (December2004) RTC separates the bank’s assets into good and bad parts and Union bank bids the good parts. (40+47=87) (NT7.18billion/47=NT0.15billion)


5、Implication & Suggestion: 5、Implication & Suggestion Bank: Credit rating Individual: Consideration of the risk Manager: Well-internal control Employee: Say NO!* Union support


6、 Conclusion: 6、 Conclusion How to avoid credit risk? No Concentrated credit loan Compliance to credit policy and operation process Know and take care of the customers much. If they have some problems in paying back the loans, negotiate with them without forcing them.


6、Conclusion: 6、Conclusion Independent financial supervisory system is important. Require financial institution to have some risk control system and risk measure system Strengthen information disclosure Early intervention to problems banks