THE EAST ASIAN countries at the center of the recent crisis were for years admired as some of the
most
successful emerging market economies, owing to their rapid growth and the striking gains in their
populations' living standards. With their generally prudent fiscal policies and high rates of private saving,
they were widely seen as models for many other countries. No one could have foreseen that these
countries could suddenly become embroiled in one of the worst financial crises of the postwar period.
What went wrong? Were these countries the victims of their own success? This certainly seems to have
been part of the answer. Their very success led foreign investors to underestimate their underlying
economic weaknesses. Partly because of the large-scale financial inflows that their economic success
encouraged, there were also increased demands on policies and institutions, especially those
safeguarding the financial sector; and policies and institutions failed to keep pace with these demands
(see table). Only as the crisis deepened were the fundamental policy shortcomings and their
ramifications fully revealed. Also, past successes may have led policymakers to deny the need for action
when problems first appeared.
Weak financial institutions, inadequate regulation and supervision, and lack
of transparency have been at the heart of global financial crises.
We can somehow deduce that a stable financial and banking system is very critical in every economy.
The financial system is an important factor in order to avoid collapse
BANKING AND THE FINANCIAL SYSTEM
Acts as a broker for those who need capital and those who have capital. Its job is to allocate capital in a
certain economy. Those who have capital are households, government, that deposit their money
they’ve invested or they’ve saved to banks
Those who need money includes households for their household purchases and the government for the
recruitment of workers, development of technology, and the building of infrastructures.
A financial system is a network of financial institutions – such as insurance companies, stock exchanges,
and investment banks – that work together to exchange and transfer capital from one place to another.
Through the financial system, investors receive capital to fund projects and receive a return on their
investments.
A country's financial system includes banks and nonbank lenders, insurers,
securities markets, and investment funds. It also includes clearing
counterparties, payment providers, central banks, and financial regulators
and supervisors. These institutions provide a framework to conduct
economic transactions and monetary policy and to channel savings into
investment, thus supporting economic growth.
BSP, Bank of Korea, Monetary Authority of Singapore, Bank Indonesia
(Central Banks - financial institution that doesn't have a commercial focus
but that plays a key role in the economy)
A central bank has been described as the "lender of last resort," which
means it is responsible for providing its nation's economy with funds when
commercial banks cannot cover a supply shortage. In other words, the
central bank prevents the country's banking system from failing.
Central Bank vs Commercial Banks
Basis Commercial Bank Central Bank
An institution that performs An apex body that
different functions like accepting controls, operates,
Meaning deposits, making investments regulates, and directs a
with the motive of earning profits, country’s banking and
and granting loans. monetary structure.
The central bank is
A commercial bank can be owned
usually owned and
Ownership and governed by the private
governed by the
sector or government sector.
government.
A commercial bank is just a unit
The central bank is an
of a country’s banking structure
Status apex institution in the
that operates under the control of
money market.
the Central Bank.
The central bank has a
Issue of A commercial bank does not have
sole monopoly on issue of
Currency the power to issue currency.
currency.
Objective The basic aim of a commercial The central bank does not
Basis Commercial Bank Central Bank
have a profit motive and
bank is maximisation of profits. works in the public
interest.
The central bank does not
Public A commercial bank directly deals
directly deal with the
Dealing with the public.
public.
Financial System
Financial systems were dominated by the banking system and commercial
banks. The government in turn controlled the banking systems. By and large,
commercial banks were either owned or controlled by the government (Land
bank, DBP). This is the case for most east and southeast Asian countries
except Hongkong. This led to the evolution of a banking system called,
financial repression.
During the 1970’s, Asian countries used the ingredients of financial repression to create a recipe
for economic growth.
Financial Repression – Financial repression is a term that describes measures by which governments
channel funds from the private sector to themselves as a form of debt reduction. The overall policy
actions result in the government being able to borrow at extremely low interest rates, obtaining low-
cost funding for government expenditures.
This action also results in savers earning rates less than the rate of inflation
and is therefore repressive. The concept was first introduced in 1973 by
Stanford economists Edward S. Shaw and Ronald I. McKinnon to disparage
government policies that suppressed economic growth in emerging markets.
Financial repression is an economic term that refers to governments
indirectly borrowing from industry to pay off public debts.
These measures are repressive because they disadvantage savers and
enrich the government.
Some methods of financial repression may include artificial price
ceilings, trade limitations, barriers to entry, and market control.
Financial repression may consist of any of the following, alone or in combination.: [5]
1. Explicit or indirect capping of interest rates, such as on government debt and deposit rates
(e.g., Regulation Q).
2. Government ownership or control of domestic banks and financial institutions with barriers
that limit other institutions from entering the market.
3. High reserve requirements.
4. Creation or maintenance of a captive domestic market for government debt, achieved by
requiring banks to hold government debt via capital requirements, or by prohibiting or
disincentivising alternatives.
5. Government restrictions on the transfer of assets abroad through the imposition of capital
controls.
These measures allow governments to issue debt at lower interest rates. A low nominal interest
rate can reduce debt servicing costs, while negative real interest rates erodes the real value of
government debt.[5] Thus, financial repression is most successful in liquidating debts when
accompanied by inflation and can be considered a form of taxation,[6] or alternatively a form
of debasement.[7]
The size of the financial repression tax was computed for 24 emerging markets from 1974 to 1987.
The results showed that financial repression exceeded 2% of GDP for seven countries, and greater
than 3% for five countries. For five countries (India, Mexico, Pakistan, Sri Lanka, and Zimbabwe) it
represented approximately 20% of tax revenue. In the case of Mexico financial repression was 6% of
GDP, or 40% of tax revenue.[8]
Financial repression is categorized as "macroprudential regulation"—i.e., government efforts to
"ensure the health of an entire financial system.[2
China[edit]
China's economic growth has been attributed to financial repression thanks to "low returns on
savings and the cheap loans that it makes possible". This has allowed China to rely on savings-
financed investments for economic growth. However, because low returns also dampens consumer
spending, household expenditures account for "a smaller share of GDP in China than in any other
major economy".[1] However, as of December 2014, the People’s Bank of China "started to undo
decades of financial repression" and the government now allows Chinese savers to collect up to a
3.3% return on one-year deposits. At China's 1.6% inflation rate, this is a "high real-interest rate
compared to other major economies".[1]
Financial repression has been criticized as a theory, by those who think it does not do a good job of
explaining real world variables, and also criticized as a policy, by those who think it does exist but is
inadvisable.
Critics[who?] argue that if this view was true, borrowers (i.e., capital-seeking parties) would be inclined
to demand capital in large quantities and would be buying capital goods from this capital. This high
demand for capital goods would certainly lead to inflation and thus the central banks would be forced
to raise interest rates again. As a boom pepped by low interest rates fails to appear in the time
period from 2008 until 2020 in industrialized countries, this is a sign that the low interest rates
seemed to be necessary to ensure an equilibrium on the capital market, thus to balance capital-
supply—i.e., savers—on one side and capital-demand—i.e., investors and the government—on the
other. This view argues that interest rates would be even lower if it were not for the high government
debt ratio (i.e., capital demand from the government).[11]
Free-market economists argue that financial repression crowds out private-sector investment, thus
undermining growth. On the other hand, "postwar politicians clearly decided this was a price worth
paying to cut debt and avoid outright default or draconian spending cuts. And the longer
the gridlock over fiscal reform rumbles on, the greater the chance that 'repression' comes to be seen
as the least of all evils".[12]
Also, financial repression has been called a "stealth tax" that "rewards debtors and punishes savers
—especially retirees" because their investments will no longer generate the expected return, which
is income for retirees.[10][13] "One of the main goals of financial repression is to keep nominal interest
rates lower than they would be in more competitive markets. Other things equal, this reduces the
government’s interest expenses for a given stock of debt and contributes to deficit reduction.
However, when financial repression produces negative real interest rates (nominal rates below the
inflation rate), it reduces or liquidates existing debts and becomes the equivalent of a tax—
a transfer from creditors (savers) to borrowers, including the government."[2]
Financial Liberalization - designed to remove all the restrictions that characterize financial
repression. These include the lowering of reserve requirements, freeing up interest rates, and allowing
them to respond to market forces.
