Financial systems and development

that may be necessary. The authorities in several Most governments have decided to replace mancountries,
among them Bolivia and Ghana, com- agement as well, in the hope that new managers,
missioned external auditors to conduct indepen- distanced from the mistakes of the past, will be
dent audits of domestic banks. But lack of precise able to make the changes necessary to restore the
information is not a reason to refrain from taking banks to profitability. In addition to loan forecloaction.
The government of the Philippines relied sure and recapitalization, measures to lower operupon
the management of the two largest banks ating costs and improve profitability were
(the Development Bank of the Philippines and the needed-for example, closing branches and reduc-
Philippine National Bank, which are publicly ing staffing levels, establishing new interest rate
owned and together hold about half of the banking structures, and eliminating loss-making activities.
system's assets) to identify nonperforming assets. The Development Bank of the Philippines cut its
It then assumed responsibility for all nonperform- staff by 50 percent, closed thirteen of its seventy
ing loans above a certain value, along with a cor- branches, and plans to privatize all but thirteen of
responding amount of liabilities.
its remaining branches. In Guinea the number of
At the heart of any review of a bank's financial people employed in the financial sector fell from
condition is the issue of accrual of unpaid interest 2,350 to 530, and lending to the public sector (inand
the provisioning of loans. Because loan roll- cluding state-owned enterprises) has virtually
overs and interest capitalization have been com- ceased.
mon, the quality of loan portfolios can be judged Failure to hold bank owners and managers reonly
if loans are classified by the probability of sponsible for past problems may encourage excestheir
being serviced rather than simply by whether sive risk taking in the future and thereby cause
they are current or in arrears. In practice, adjusting further financial instability. In large markets such
for accrued but unpaid interest has been the single as the United States, finding new owners and
largest correction to banks' accounts following in- managers willing to take over weak institutions is
tervention. This underlines the importance of forc- usually straightforward, but in smaller markets
ing banks to stop accruing interest and to make there may be few potential buyers and few manprovisions
for bad loans as soon as debt service is agers with the necessary expertise. Moreover, arinterrupted.
ranging the transfer to new management may take
some time. So governments have sometimes
ALLOCATING LOSSES. Once governments inter- found themselves responsible for the institutions
vened, they had to decide how to allocate losses in in which they intervened. Both the Spanish and
excess of capital and provisions. Regardless of for- Chilean governments, for example, became the
mal obligation, most governments protected de- owners and operators of several restructured
positors against loss to avoid bank runs. Foreign banks until suitable buyers were found.
creditors were also protected, even where they
had lent to domestic banks without the benefit of COST CONSIDERATIONS. At the time of intervengovernment
guarantees, as in Chile. Taxpayers tion the economic costs of financial distress have
had to absorb the losses instead.
already been incurred in the form of poor past in-
Most governments have decided that the private vestments and slower growth in output. Restrucowners
of insolvent institutions should be re- turing has no economic cost. On the contrary, it
placed or at least have their ownership diluted. brings an economic gain in that the economy may
The techniques for doing this vary. In the United once again enjoy the benefits of a well-functioning
States the courts appoint the deposit insurance financial system. The budgetary cost of restrucagency
as receiver, and that agency arranges for turing consists of the government's cash outlays,
the sale of institutions. In Colombia and Spain the which are a transfer from taxpayers to the creditors
law allows the government to write off the value of of insolvent banks.
shares and to issue new shares to other than This cost has depended on the extent to which
former shareholders. In Thailand existing share- the banks' losses exceeded their capital. In the
holders were allowed to keep their shares, but the United States, for example, the expected cost of
issuance of many new shares greatly reduced their dealing with the remaining insolvent S&Ls is
value. After restructuring insolvent banks, the equivalent to approximately 2 percent of GNP, and
Chilean government provided cheap credit and in Spain the estimated losses of banks were equivgenerous
tax incentives to those willing to buy alent to 16.8 percent of GNP. In some developing
shares in the two biggest banks.
countries banks' losses as a percentage of GNP
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