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By examining Singapore’s successful experience, this paper identifies policies and factors that can avoid or mitigate the borrowing dilemma of double mismatches of currency and maturity. The authors conclude that there are common core principles that could be adopted by other emerging economies, with modifications to reflect their local context and circumstances. Such core policies could include: (i) conservative prudential safe guards, such as higher capital adequacy ratios for banks; (ii) proper sequencing of financial development and spacing of domestic and external financial market liberalizations; and (iii) possibly a credible dichotomized financial system encouraged by reasonable fiscal incentives and management of foreign bank participation.

The authors question the significance of the role of moral hazard in the international financial dimension of the Asian crises. They propose an alternative explanation using a testable model and based on results from a qualitative questionnaire of banks. It is more likely that herd behavior and imprudent competition for market shares by foreign financial institutions explains most of the over-investment and accumulation of short-term liabilities in the East Asian financial bubbles, particularly when the effects of the G-7 business cycles are added. That would suggest international lending in global financial markets requires more policy coordination and data disclosure among institutions and recipient and emission countries, coupled with stronger surveillance of capital flows.

Since the Asian financial crisis, strong and increasingly prevalent views have emerged thatbanks are no more functional and that economic development should rely on capital markets. Suchviews claim that the Asian crisis was caused by heavy dependence of firms’ investment on bank loansand that Asian commercial banks did not function as properly as those operating in some advancedcountries, due to crony relations among banks, firms, and governments. These views conclude thatpolicies should place less emphasis on bank loans and that Asian countries should develop domesticcapital markets as alternative more important sources of financing.This paper attempts to examine whether policy implications suggested by these prevalentviews are justifiable by considering the following two categories of questions. The first category isabout whether banks can be characterized as unsound and unfit institutions for economic developmentas often argued in the context of post-crisis Asia.Provided that existing economic theories andempirical studies clearly define basic functions and reason d’être of commercial banks, one then needsto ask: what went wrong with the banking system in Asia? The second category of questions focuseson why corporate bond markets are underdeveloped in many emerging market economies. Byanalyzing factors deterring the development of corporate bond markets, the paper then examineswhether, why, and how the markets should be developed.

The malignancy of the Asian crisis comes from its characteristics as twin financial crises: currency crisis (external) and banking crisis (internal). It is a capitalaccount crisis combined with domestic credit contraction, as distinct from the traditional current-account crisis. The new nature of the crisis calls for policy responses entirely different from the conventional ones. The traditional current-account crisis is caused by the deterioration of domestic macroeconomic performance, such as price inflation, fiscal deficits and low saving rates. For this type of crisis, conventional policies such as tight money, fiscal consolidation, structural reforms, and output- and expenditure-switching exchange rate policy are appropriate. However, economic performance of pre-crisis developing Asia was quite good as measured by conventional macroeconomic variables. The critical question is: what consequences will result if the policy prescriptions for the traditional current-account crisis are adopted against the Asian-type capital-account crisis which hits even economies without serious macroeconomic imbalances. We argue that such policy misapplication is likely to transform the initial twin crises into something far more serious, namely the collapse of real economic activity. This paper attempts, first of all, to identify the nature and mechanism of the capital-account crisis. The capital-account crisis is characterized by a massive international capital inflow greatly surpassing the underlying current-account deficit, as well as by the composition of such an inflow being dominated by short-term, foreign currency denominated loans. The resultant double mismatches in both currency and maturity in the balance sheets of domestic financial institutions are responsible for the subsequent twin financial crises: currency precipitation accompanied by international liquidity crisis on the one hand and domestic banking crisis leading to credit contraction on the other. Second, we show how and why policy prescriptions for the traditional current-account crisis, if applied to the capital-account crisis, will exacerbate the problems already inherent in such a crisis. Mounting non-performing loans and abrupt financial disintermediation play key roles in this process. Third, we present alternative policy responses for resolving the twin financial crises which must be implemented by both the governments of the crisis-hit countries as well as the international financial community.