Financial Crisis and the Resolution of Financial Distress: Evidence from Malaysia and Thailand

Abstract

The Asian Financial Crisis brought about widespread financial distress in both the corporate and banking sectors. Therefore, the efficiency of asset resolution policy would determine, in large part, the impact of the crisis on the economy as well as speed of economic recovery. Using a two- tier hierarchical framework which comprises of a regulator, banks and firms, we examine how hidden information and moral hazard affect agents' behaviour and thus, the regulator's policy choice. We show that banks' tendency to rollover defaulted loans encourage firms' manager to dissipate assets. Therefore, if the regulator anticipates that banks are likely to rollover defaulted loans than invoking bankruptcy, the regulator, under certain conditions, should opt for a centralised approach. We complement our theoretical model with empirical study and show that Malaysia, which opted for a centralised approach had larger improvement in real bank credit growth, NPL ratio and corporate performance as compared to Thailand, which opted for a decentralised approach till 2001.