An investigation into the use of mergers as a solution for the Asian banking sector crisis

Abstract

The study examines the effect of bank mergers on bankruptcy risk in an environment characterized by a plunging local currency and sinking asset prices. The 1997-1998 Asian economic crisis saw the creation of such an environment and threatened the survival of banks in many Asian countries. Local bank regulators encouraged or even forced ailing banks to merge as a way to reduce bank failure risk. Casting doubt on the wisdom of such policies, this study shows that merging two banks weakened by the Asian economic crisis or merging one weak bank into a healthier one in many cases would result in a bank even more likely to fail than both the predecessor banks. Moreover, due to exchange rate uncertainty, merging two banks with debts denominated in different foreign currencies appears to be particularly dangerous. The bank created in such a merger is likely to have much higher risk of failing than the predecessor banks. © 2002 Board of Trustees of the University of Illinois. All rights reserved.