The Asian Financial Crisis, Papers of Financial Market

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Team Members

Nguyen Thi Huyen Linh (^) Bui Huong Giang Nguyen Tri Dung

Table of Content

• I. Introduction
• II. Background of the crisis
• III. Domestic and international stakeholders failed in the case
• IV. Ethical failures in the case
• V. Principles violated in the case
• VI. Conclusion and Recommendations
• Appendix
• Reference

We conduct PEST analysis to examine the Political, Economic, Social, and Technological environment leading up to the Asian Financial Crisis. This framework highlights the external factors that contributed to vulnerabilities in the region's economies.

P

Political factors

E

Economical factors

S

Social factors

T

Technological factors Governments in the affected countries had underdeveloped financial oversight systems. Regulatory agencies lacked the authority and resources to monitor and manage capital flows effectively. Close ties between governments and large corporations created moral hazard. Reckless borrowing and investments by private firms. Fixed exchange rates, making exports less competitive and increasing foreign debt burdens. Massive short-term foreign capital inflows created asset bubbles and made economies highly vulnerable to sudden outflows. Corporations and banks borrowed heavily in foreign currencies to finance growth Export-driven growth strategies left economies vulnerable to global market fluctuations Burgeoning middle class with rising expectations of prosperity fueled domestic consumption and speculative investments. Increased demand for infrastructure, which was often financed through unsustainable borrowing. Relationships between political elites and business leaders led to favoritism, lack of accountability, and inefficient allocation of resources. While financial markets grew rapidly, technological advancements in financial systems and risk management lagged. Advances in communication technologies increased the speed and volume of cross-border capital flows, investor sentiment could change rapidly, leading to sudden capital flight.

Conclusion: Before the crisis, the region's economic and political environment was characterized

by rapid growth. During the late 1980s and early 1990s, many Southeast Asian countries, including Thailand, Singapore, Malaysia, Indonesia, and South Korea, achieved massive economic growth of an 8% to 12% increase in their gross domestic product (GDP). The achievement was known as the “Asian economic miracle.” However, a significant risk was embedded in the achievement.

2. Trigger Events

The immediate trigger of the Asian Financial Crisis was the collapse of the Thai baht. On July 2, 1997, the Thai government abandoned its fixed exchange rate system, allowing the baht to float freely against the U.S. dollar. The decision to float the baht marked a critical turning point. It eroded confidence in fixed exchange rate regimes across the region, leading to capital flight from neighboring countries. As investors withdrew their funds, stock markets plummeted, banking systems collapsed, and regional currencies—such as the Indonesian rupiah, Malaysian ringgit, and South Korean won— also came under speculative attack.

3. What caused the crisis

1. Structural weaknesses in domestic economies: Asian economies faced structural weaknesses that made them vulnerable to the crisis, including excessive foreign-denominated debt, speculative asset bubbles, weak corporate governance, and banking sector vulnerabilities. Crony capitalism fostered inefficiencies, with firms pursuing risky projects under the assumption of government backing. 2. Fixed exchange rate regimes: Many Asian economies maintained fixed or semi-fixed exchange rate regimes, pegging their currencies to the U.S. dollar. While this provided initial stability, it became unsustainable as the U.S. dollar appreciated in the mid-1990s. The strong dollar reduced the competitiveness of Asian exports, strained foreign reserves, and exposed economies to speculative attacks on their currencies. 3. Overreliance on short-term capital inflows: During the 1990s, Asian economies attracted massive short-term capital inflows, particularly in the form of portfolio investments. These funds

IV. Ethical failures in the case

Overview

The Asian Financial Crisis (AFC) had profound economic and social impacts, particularly in countries like Thailand, Indonesia, South Korea, Malaysia, and the Philippines. During the crisis, a variety of ethical issues emerged across many sectors, ranging from crony capitalism to moral hazard:

1. Crony capitalism: “Crony capitalism” refers to a system in which businesses thrive primarily due to their close relationships with political elites and government officials, rather than through fair competition or market forces. During the AFC, crony capitalism was a significant factor that contributed to the severity of the crisis in several affected countries. The concentration of economic power among a small group of politically connected businessmen led to misallocation of investments, declining investment returns, and increasing financial fragility. Government intervention in market operations is a major component of this, which included giving away privatizations to the political leadership's friends and family, creating monopoly rights, directing government credit toward political allies, and providing bailouts for politically-linked businesses. Moreover, they often neglected pursuing policies that were in the best interest of the broader economy, which created conflict of interest and prolonged the crisis in many countries. Additionally, lawmakers were often compromised, since they were politically connected to the very entities they were supposed to regulate. For example, in Indonesia, the members of President Suharto’s family played a pivotal role in controlling large sectors of the economy, including banking, infrastructure, and mining. Businesses with political ties were also overly leveraged and took on excessive debt in several countries. Governments were compelled to decide whether to bail out these companies (sometimes with public money) or allowing the collapse to trigger even deeper recessions. For instance, in South Korea, the powerful conglomerates known as Chaebols (Samsung, Hyundai, and Daewoo) had

strong ties with political leaders, they are offered loans from state-owned banks, in exchange for political support or benefits.

2. Lack of transparency in banking system & corporate governance: Another issue is the lack of transparency in the operations and the soundness of banking system as a result of inadequate regulations. Additionally, there were parallel weaknesses in the non-bank corporate sector during the AFC:  Weak regulations & corporate governance: Banking systems were either badly or inadequately regulated in many of the impacted nations. It was simpler for banks and corporations to take on excessive risks when financial institutions functioned without strict regulation. Regulators were often lacked the capacity to supervise financial markets effectively. Furthermore, there was a lack of effective corporate governance and oversight. In South Korea & Indonesia, business leaders had close ties to political elites, leading to cronyism, where financial institutions were used to fund politically connected businesses that lacked accountability and made it difficult for investors to understand the true risk profiles.  Inadequate Disclosure of Financial Information: In the impacted nations, numerous banks and businesses failed to reveal their actual financial status. Due to this lack of transparency, both local & foreign investors were given inaccurate or partial information regarding the financial standing of important institutions. Off-balance-sheet financing was frequently employed by financial organizations to conceal their risks and liabilities and give the appearance of stability.  Unhedged Foreign Currency Exposure Many banks and businesses in Southeast Asia took on significant foreign currency-denominated debt, but they did not hedge against the risk of currency depreciation. Due to their undisclosed unhedged foreign debts, several companies and financial institutions experienced unexpected liquidity issues as the Thai baht and other currencies started to fall in the middle of 1997. 3. Moral Hazard:

currency overvaluation, and the growing dependence on short-term borrowing were written off as negative anomalies rather than warning signs of a crisis.  Selective Information gathering: Governments and financial institutions tended to overlook the increasing risks connected to weak financial systems, such as inadequate risk management procedures and poor corporate governance, in favor of concentrating on the positive indicators, such as robust GDP growth and investment capital inflows. Consequently, they chose ignore negative information, reinforcing their belief that investments in Asia were still sound, which ultimately led to the domino collapse.

3. Sunk Cost Fallacy: Sunk cost fallacy refers to the tendency to pursue a project after making an investment of time, money, or effort, regardless of the circumstances or prospects for the future, out of a desire to avoid wasting those earlier investments.  Rescue Operations and Bailouts : Throughout the crisis, a number of governments and central banks kept providing financial assistance to struggling banks and businesses in an attempt to preserve the earlier investments. In many cases, rather than allowing underperforming banks and corporations to fail, governments stepped in to bail them out, using taxpayer money. This fallacy prolonged the crisis and delayed the necessary financial restructuring

VI. Conclusion and Recommendations

1. Ethics lessons learned from the crisis

Regulators tend to focus much of their efforts on preparing to address problems after the crisis. However, it would be much more effective to resolve crises by spending more time on prevention. It’s how we arrive at the lessons learned from the contagion from an ethical research perspective, to prevent similar situations from happening in the future, or at least help reduce the costs and efforts required for recovery after the crisis.  In order to avoid such financial crises coming back, it is of utmost importance to improve transparency and accountability. During the Asian financial crisis, the late disclosure of weaknesses in central banks' international reserves contributed to market panic. If the information had

been released earlier, it could have reduced the excessive inflow of capital. In stable periods, improving data transparency and disclosure can help markets better assess risks and prevent imbalances. This approach also encourages policymakers to address vulnerabilities proactively, fostering a healthier financial environment. In addition, transparency also helps avoid undetected conflicts of interest and fraud, encourages the governance of financial institutions, and reduces risk- taking incentives. Transparency also promotes fair competition regardless of connections since clear processes for licensing, permits, and other regulatory approvals can reduce barriers to entry for new businesses, fostering competition. Government officials and corporate executives must be held accountable for their actions. Transparent government processes allow citizens to monitor the actions of their leaders and hold them accountable. Regular audits of public finances and corporate accounts can uncover irregularities and fraud.  Avoid moral hazard: In the context of the Asian financial crisis, several countries were under crony capitalism which is one of the reasons leading to moral hazard whereas close ties between government officials and business leaders, including bankers, created an implicit guarantee that failing businesses would be bailed out. To deal with the moral hazard problem, one of the biggest challenges is the lack of discipline over risky choices taken by banks. Before banks were protected by government safety nets, economic downturns produced immediate contractions of bank credit supply and cuts in bank dividends, as banks rushed to reassure depositors that any losses from bad loans would not affect their deposits. Safety net protection has removed that important disciplinary check on bank behavior, leading to their recklessness in risk management. Therefore, it is crucial to implement strict regulations and supervision of financial institutions to ensure compliance with risk management standards.  Building up strong ethical leadership is becoming more and more critical: Whether based on teleological, deontological, or aretaic theories, focusing on the consequences, duties, or virtues, we can build our own set of ethical values that provide us with a solid foundation for our decisions and actions. In the context of the crisis, due to massive flows of capital into the economies, banks and corporations in this period of time borrowed imprudently, and foreign lenders

 Unethical behaviors of stakeholders : Finally, it was still due to unethical behaviors of stakeholders, taking their own interests above others, that created a cycle of risk-taking and moral hazard, ultimately leading to the collapse of the housing market and the broader financial crisis. Regulators, including governments, central banks, the IMF, the World Bank, and the Federal Reserve…, consistently attempt to learn from past crises. However, they tend to focus on external factors, such as economic, financial, political, and institutional issues, while neglecting internal ethical considerations. By not addressing the right issues, they probably will fail to prevent similar situations from recurring. As a result, future crises are likely to arise with even more severe consequences.

Appendix

Graph 1: Corporate debt levels in affected countries during AFC Graph 2: Credit level to private sector in AFC affected countries

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