International Finance

Financial crises limit emerging countries' economic growth and foreign trade and strain their ability to repay international obligations. Developed nations, including the United States, have felt the repercussions of these crises through loans to and investments in emerging markets and through diminished exports to these countries. This report focuses on three countries--Indonesia, South Korea, and Thailand--that had been receiving large capital flows, were experiencing financial crises, and were making changes in their financial systems. GAO focuses on the banking sectors in these countries because their economies, like those in most developing and transition countries, relied more heavily on bank financing than on stock or bond issuance or other types of market financing. GAO discusses (1) the nature of the weaknesses in the countries' financial sectors, (2) the extent to which the countries have achieved reforms in their financial systems, (3) the extent to which the countries have implemented international principles for banking supervision, and (4) efforts by the U.S. government and multilateral institutions to bring about changes the financial sectors of these emerging markets.

GAO noted that: (1) the governments of Indonesia, Korea, and Thailand are implementing multiple changes to reform their financial institutions and markets and banking supervisory structures; (2) many of these changes are being undertaken in response to a financial crisis; (3) some regulatory and legal changes have been implemented in the short term, while other objectives may take many years to accomplish due to the extent of the problems and the enormity of the changes required; (4) how robust the countries' financial systems are to future disruptions is an open question, given the risks to the financial systems posed by the continued weaknesses of the corporate sectors of all three countries; (5) the economies of each country relied heavily on debt financing and restricted the access of foreign financial institutions; (6) at the same time, the countries' legal systems did not provide adequately for the enforcement of contracts or provide mechanisms for resolving defaulted corporate debt; (7) the countries did not have adequate legal and institutional frameworks ensuring their bank supervisors' independence and enforcement authority; (8) the countries did not have deposit insurance systems that forestalled runs on bank deposits; (9) Indonesia, Korea, and Thailand have made or are making changes to address banking system and related weaknesses, with early priority given to resolving nonviable banks and debtor companies; (10) some insolvent or weak banks have been closed or merged; (11) ongoing efforts include the sale of assets of failed banks and the recapitalization of banks, with the latter partially dependent on the corporate debt workout process; (12) all three countries are changing laws to expedite resolution of loans in default; (13) Korea and Thailand have changed or strengthened accounting practices by adopting internationally accepted accounting standards; (14) each of the three countries has partially implemented international principles for effective bank supervision, but it is too early to determine the effect of this on actual management or supervisory practices; and (15) efforts of the U.S., the International Monetary Fund, the World Bank, and the Asian Development Bank to effect changes in emerging markets have focused on the countries' immediate needs to resolve nonviable banks and debtor companies as well as long-term goals to improve financial systems.