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Implications of the Global Financial Crisis for Financial Reform and Regulation in Asia

Implications of the Global Financial Crisis for Financial Reform and Regulation in Asia

ADBI series on Asian Economic Integration and Cooperation

Edited by Masahiro Kawai, David G. Mayes and Peter Morgan

In light of the experience of the global financial crisis, this book develops concrete recommendations for financial sector reform and regulation in Asian economies aimed at preventing the recurrence of systemic financial crises, improving the ability to manage and resolve crises, managing capital flows and promoting the development of Asian bond markets.

Chapter 4: Dynamic Provisioning: Some Lessons from Experience

Santiago Fernández de Lis and Alicia García-Herrero

Subjects: asian studies, asian economics, economics and finance, asian economics, financial economics and regulation


Santiago Fernández de Lis and Alicia García-Herrero 4.1 INTRODUCTION This chapter deals with lessons drawn from experiences of dynamic or countercyclical provisioning. Section 4.2 summarizes the reasons for the procyclicality of the financial system; section 4.3 deals with policies used to address this problem; section 4.4 describes the experiences of Spain, Colombia and Peru; section 4.5 draws some lessons from this comparison; and section 4.6 reviews the main conclusions. 4.2 WHY IS THE FINANCIAL SYSTEM SO PROCYCLICAL? The global financial storm that hit the banking systems of major developed economies in 2007 and sent dangerous waves to the emerging world has shown clearly that the financial system exacerbates the cyclical movements of an economy. The procyclicality of the financial system is not new. It is caused by a number of different factors, which need to be understood before assessing why some financial systems are more procyclical than others, and how to best combat such procyclicality. First of all, the financial system is prone to more lax assessments of risk in good times than in bad, being influenced by the economy’s general environment. Second, borrowers’ net worth – as well as cash flow – is bound to be higher during upturns, facilitating their access to credit. This mechanism, identified by Kiyotaki and Moore (1997), has been branded the ‘financial accelerator’. In the same vein, the value of collateral is bound to increase in good times and fall in bad times. Such asset price dynamics – and the related wealth effects – clearly increase...

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