Overstating Moral Hazard: Lessons from Two Decades of Banking Crises

Abstract

Over the past two decades a variety of banking system rescue approaches have been used, including in the 1997 Asian financial crisis, the 2008 global financial crisis, and the 2010 European debt crisis. By analysing the resolution of these crises as well as the approach to addressing bad loans in the People's Republic of China, this paper provides a new perspective on the common belief that bailouts are invariably harmful to public funds or excessively conducive to moral hazard. Depending on the form of bailout, bank restructuring, and fiscal backstop, resolutions can be an effective means to restore a banking system. This paper argues that in a systemic financial crisis, a combination of balance sheet restructuring and the use of asset management companies to deal with non-performing loans is often the best choice. However, a fully-fledged resolution that triggers the bail-in procedure remains the best approach for non-systemically important financial institution failures which take place outside of systemic crises, namely when the failure is idiosyncratic.

Three Decades of International Financial Crises: What Have We Learned and What Still Needs to be Done?

“…Delays in calibrating the appropriate liquidity mechanisms were partially responsible for the credit crisis becoming a systemic one (Arner 2009). The approach of the authorities to rescue systemically important financial institutions was very different to the approach adopted by the IMF in the Asian crisis (Arner, Avgouleas, and Gibson 2017), where governments were required to take drastic steps to close financial institutions and address nonperforming assets.…”

“…No bailout approach proved superior, as the choice depended on market factors, the financial position of the government involved, and the ability to retain or reinforce confidence in the failing financial institution. For example, hesitation in the UK was analogous to that in Indonesia and Thailand and in each case, this hesitation eroded confidence and diminished the success of the delayed bailout of RBS (Arner, Avgouleas, and Gibson 2017).…”

“…As already mentioned, when the global financial crisis erupted in 2008, a series of public bailouts took place, whereby the state took a direct stake in banks, or nationalized them outright (Arner, Avgouleas, and Gibson 2017). But, in contrast with the Asian financial crisis, asset management companies seem to have been out of favor.…”