Financial liberalization and financial fragility : the experiences of Chile and Indonesia compared

The far-reaching liberalization process introduced in Chile after the overthrow of the Allende regime first met with reasonable success, but in the early 1980s a foreign-exchange crisis and a banking crisis appeared to mark the end of the experiment. Liberalization was resumed in 1985 and has not been plagued by serious crises since. The root of the problem seems to have been an exchange rate policy which had to be abandoned, but not before it had led economic actors to make the wrong decisions. The lack of prudential supervision of the financial system did the rest. So far, Indonesia has been following much more cautious exchange rate policies in its liberalization drive. Crises on the scale experienced by Chile are not very likely to occur. The lessons provided by the lack of prudential supervision in Chile do not, however, seem to have been taken to heart, or not sufficiently. Even if the Indonesian banks are unlikely to suffer as much as their Chilean opposite numbers from foreign exchange risks, bad loans, in particular resulting from intra-conglomerate lending, are an increasingly serious prohlem. In dealing with troubled banks the Indonesian authorities have not repeated the mistake of the Chileans to provide a full deposit guarantee. Nonetheless, excellent though the banking rules may look on paper, the implementation leaves much to be desired and Indonesia probably has not yet seen the end of its banking troubles. Apparently, market imperfections are such that effective prudential supervision cannot be dispensed with. Also, it appears that low capital-asset ratios in both banks and their clients, as in Chile in the mid-1970s, call for a cautious course in liberalization.