The Asian Financial Crisis 1997: A Turning Point

BY Aysha Abdulla/ November 9, 2025
DESIGNED BY Riddhi Jain

In the face of crisis, chaos, and depression, it is important not only to look back but also forward, towards the future of a nation that one has envisioned to bring about true change.

The 1990s marked an era of extraordinary expansion across South-East and East Asia. Many economies in the region grew at rates exceeding 5 per cent annually for several years, lifting millions out of poverty, driving industrialisation, and advancing market liberalisation (Mishkin, 1999).

It was observed that following market liberalisation, countries in the South-East and East Asian region, including Thailand, South Korea, Malaysia, Indonesia, Philippines quickly garnered large capital inflows in foreign currency as these inflows, as investments in the banks of these emerging market countries earn high yields in comparison to but the economies suffered due to asymmetric information and excessive risk-taking in the markets. Transfer of funds via the financial system were hampered due to asymmetric information among stakeholders where no two parties had the same information, giving way to selection problems and moral hazard. Excessive risk-taking though is believed to be a product of lack of experience amongst the bank management in the area of risk management and stagnant growth of managerial capital and its absence is reflected in lack of screening and monitoring of newly approved loans. This affected the current balances of the countries and in the years that followed Thailand, South Korea, and Indonesia, which were the most impacted by the financial crisis, underwent rigorous economic reconstruction (Mishkin, 1999).

Furthermore, the implicit safety net provided by the government exacerbated the problem of moral hazard as depositors and foreign lenders believed that likely government bailouts would protect their interests. As a result of this unchecked capital growth, there was a lending boom in the East Asian economies, as is the pattern in most emerging economies in case of capital growth, resulting in excessive risk-taking on the banks' part. Between 1993 to 1996 capital inflows amounted to around 50 to 100 billion USD annually (Mishkin, 1999).

illustraion via pinterest by the new york times.jpg

Illustration by The New York Times via Pinterest

However, all of this quickly changed in July of 1997, after the Thai Baht was unpegged against the US Dollar, initiating the domino effect which went on to result in one of the biggest financial crises after World War II.

While it was argued that the crisis was caused by market panic, many scholars discuss the deficiencies in the administrative and financial structures of East Asian economies at the time upon which the onus of market liberalisation, globalisation and industrial growth was (Chomsisengphet & Kandil, 2007).Every component of the financial system began to unravel as the currency sharply depreciated. As the loans were denominated in foreign currency and the assets owned by institutions were denominated in domestic currency, depreciation caused the real value of the loans to sky-rocket while the value of assets owned by firms remained the same. Since households and firms were unable to pay off their debt the banks were being squeezed on both asset and liability front, causing the net worth of the bank to decline (Mishkin, 1999).

At the time, international financial institutions including the International Monetary Fund (IMF), the World Bank and the Asian Development Bank (ADB) played the significant role of international lender of last resort to aid the affected countries on the condition that the countries would have to implement the austerity program, similar to what was implemented in Mexico only two years ago. The IMF in this situation did not consider the effect this could have on the entire region and the austerity measures were highly criticised (Mishkin, 1999). Jang-Sun Ship, along with Ha-Joon Chang in Economic reform after the financial crisis: a critical assessment of institutional transition costs in South Korea, presents an alternative perspective on the 1997 Asian Financial crisis, one where IMF’s measures are heavily discussed and criticised. With a focus on Thailand and South Korea, looking into the economic conditions prior to the crisis and the financial reconstruction of the economic structure in these two countries is essential to grasp the extent of dismay, hope and vigor in these economies during the crisis the years that followed (Shin & Chang, 2005).

The Thai Capital Flight and Crisis

Thailand enjoyed the spurt of international capital inflow in the 1990s but behind the smokescreen of profitability enabled by the credit boom, the country's financial system channels were suffocating in the process of transferring funds from savers to borrowers, regulations were optional, lack of information in the banking sector resulted in untimely discipling of wayward banks, current account deficits were widening and real exchange rate was appreciating (Yoshihiro, 2001). At the time, the supervisory and regulatory authorities did not possess the independence required to fulfill the prudential norms either, the overall lack of transparency and lax regulation added to the overburdened system (Charoenseang & Manakit, 2002).

Whilst participating in cross-currency trade, the illusory stable nominal exchange rate prompted domestic banks and Non-Banking Financial Institutions (NBFIs) to borrow from foreign countries and lend in the domestic markets at relatively higher interest rates. The pegged nominal exchange rate eventually lost credibility and coincided with external factors like a cyclical downturn in world trade and appreciation of the US Dollar against the yen, this supported by the weaknesses in the Thai financial institutions balance sheets, worsened the credibility of the currency peg (Yoshihiro, 2001). Additionally, these short-term foreign borrowings were unhedged, under the impression that the pegged exchange rate eliminated risks of borrowing in USD or other currencies (Charoenseang & Manakit, 2002). To put it simply, financial institutions under the impression that a pegged exchange rate would restrict the rise in interest rates or fall in real value of assets due to the absence of exchange rate fluctuations, did not undertake any counterbalancing agreements in case of inflation or exchange rate fluctuations to cushion the impact of these events. Consequently, when the currency was unpegged, rapid devaluation in the currency led to rise in the real value of interest rates and fall in the real value of domestic assets.

Mismatch in the maturity period of borrowed funds and loaned out funds further created a divide in the time period of loaning the money and receiving payment on these loans. Short-term foreign borrowings were utilised to finance long-term projects. Furthermore, the quality of loan portfolios for both banks and financial institutions were undesirable, with increased credit availability post-liberalisation, the credit trickled into risky sectors like real estate and securities market participants to name a few. Lack of prudential norms meant that the banking sector was over exposed to particular sectors (Yoshihiro, 2001; Charoenseang & Manakit, 2002).

Financial institutions' asset portfolios were deteriorating due to fall in local asset prices and since the Bank of Thailand had to support illiquid and insolvent financial institutions, it was forced to use domestic interest rates to defend the peg (Yoshihiro, 2001).

Market perception changed as the stakeholders soon became aware of the weak asset qualities and excessive short-term foreign borrowings. This caused capital flight and the foreign exchange reserves were being exhausted as the authorities attempted to defend the Baht in the foreign exchange markets.

Eventually, on July 2nd 1997, the authorities let the Thai Baht float in the markets (Charoenseang & Manakit, 2002).

Later in the year, banking and finance companies were forced to take the initiative of cleaning up their own and their borrowed balance sheets. In the interim, between June and August 1997, 58 finance companies were shut down (Charoenseang & Manakit, 2002).

The IMF agreed on a 17.1 billion USD assistance package with the Government of Thailand at the end of August 1997 and the ADB had also committed 1.8 billion USD to this package. The IMF-led assistance package emphasised measures to halt asset hemorrhaging, strengthen fiscal balances, implement a new framework for monetary policy, and structurally reforming the corporate sector. However, the programme underestimated the structural difficulties, extreme fiscal targets were finalised for an economy that had experienced deflationary shocks and the regional shock waves were not anticipated (Yoshihiro, 2001).

A sharp increase in the interest rate resulted in shrunken real incomes, increased non-performing loans and simultaneously the banks’ capital was depleted. In response, distressed banks denied loans to creditworthy borrowers as well and some had to liquidate assets for extremely low prices in depressed markets (Yoshihiro, 2001).

In response, the Thai government set up the Financial Restructuring Authority (FRA) in October 1997, to review the rehabilitation of the 58 suspended finance companies and it was decided that out of the 58, 56 would be permanently shut down and their assets would undergo the liquidation process. Additionally, the Asset Management Corporation (AMC) was established as a buyer of last resort to prevent sale of assets at very low prices, undermining the collateral value. Assets bought by AMC were managed for resale later (Charoenseang & Manakit, 2002). As banks individually attempted to reach their capital adequacy goals, lack of coordination manifested as a credit crunch in the market (Yoshihiro, 2001).

By the end of the year, the real GDP witnessed negative growth of 0.4 per cent for the first time in over a decade, and the traditionally surplus budget went into deficit. On the brighter side, import compression helped in quick strengthening of the balance of payments position. In February 1998, the IMF allowed fiscal easing, but a contractionary monetary policy was maintained alongside certain credit easing schemes for exporters (Yoshihiro, 2001).

By mid-1998, the reason for the long overdue process of cleaning up of balance sheets was determined to be the adjusting of wrong valuations in the balance sheets. Hence, in August 1998, the government announced efforts to recapitalise private banks. First, the overall capital adequacy ratio was established at 8.5 per cent for banks and 8 per cent for financial institutions. For Tier 1 banks, however, it would be lowered from

illustraion via pinterest by liam mcliamson.jpg

Illustration by Liam Mcliamson via pinterest

unknown illustration via pinterest 1.jpg

Unkown Illustration via Pinterest

6 per cent to 4.5 per cent and Tier 2 ratio was increased from 2.5 per cent to 4.25 per cent. Participating banks had to immediately meet the threshold at the receipt of capital injection.

Second, the government set aside 300 billion BHT for two Tier 1 and Tier 2 capital support schemes. Tier-1 banks' condition for participation was that they adopt Loan Classification Provisioning (LCP) aimed at strengthening banks capital bases combining both LCP and private sector-led capitalisation. Similarly, Tier-2 banks balance sheet issues were tackled by the government injecting non-tradable government bonds for bank debentures for a maximum of 2 per cent risk weighted assets. Tier-1 capital support facility was aimed at encouraging the entry of private capital and Tier-2 capital support facility was focused on providing financial resources and incentives to accelerate corporate debt restructuring.

Third, banks were permitted to establish AMCs of their own with the goal of banks being able to focus on the good bank and future lending, while the bad assets could be transferred to AMCs, thus improving the balance sheet and asset quality. Fourth, the banks which were unable to recapitalise were intervened by the government. Through this process some banks were consolidated and others, including some financial institutions, had to be shut down (Charoenseang & Manakit, 2002).

In the same year the Government of Thailand, established Corporate Debt Restructuring Advisory Committee (CDRAC) constituting the Governor of the Bank of Thailand, and the members represented both chairpersons of debtors and creditors associations, namely the Thai Bankers Association, the Foreign Banks Association, the Association of Finance Companies, the Federation of Thai Industries and the Board of Trade Thailand. This framework for corporate restructuring was called “Bangkok Approach”.

More than 50% of the national loans at that time were extended to small and medium-sized enterprises (SMEs), posing a hurdle in the process of corporate debt restructuring. Although CDRAC could not target debtors that were not financial institutions, by the end of 2000, 6,329 cases with debt worth 1.1 trillion BHT had been recovered out of 12,000 debtors and by April 2002, 10,109 cases were facilitated (Charoenseang & Manakit, 2002). At the time, the South Korean economy also suffered during the Asian Financial Crisis due to deficiencies in its financial structure and concentration of industrial expansion in the hands of few.

The South Korean Conundrum

Similar to Thailand, the South Korean economy also suffered at the hands of rising current account deficit, a pegged exchange rate policy, and Korean conglomerates reliance on short-term foreign debt. Relying on the pegged exchange rate to prevent volatility and failing to anticipate the sudden flight of foreign capital, many South Korean businesses and financial institutions had taken up short-term loans from foreign creditors. By December 1997, the foreign exchange reserve dwindled from approximately 30 billion USD to almost 4 billion USD, and on 4th December 1997, the rescue fund amount agreed upon was 55 billion USD jointly contributed by IMF,the World Bank and ADB contributing 21 billion USD and 14 billion USD respectively. The South Korean government also received funds from individual governments amounting to 20 billion USD. Until then, in October 1997, the number of unemployed individuals had jumped to 452,000 and the number further increased to 1,378,000 in 1998 (Kyung-Min, 2023).

Similar to the South-East Asian countries undergoing the crisis, South Korea was also obliged to implement the austerity policies, financial and corporate restructuring plans, pursue trade liberalisation, enhance labour market and exchange rate flexibility, and provide leeway to foreign investors in domestic markets (Kyung-Min, 2023).

The history of economic liberalisation in South Korea is different from that of Thailand. In the 1980s, the authoritarian government in an effort towards economic liberalisation deregulated the bank entry barriers, privatised banks, reduced policy loans and liberalised interest rates. This deregulation and privatisation of banks led to the growth in number of banks from 7 in 1985 to 13 in 1992. At the same time, various other NBFCs also shot up, and the country then housed 12 investment banks, 1 investment trust and 57 mutual credit firms.

In the early 1990s, the government failed to perform two roles: one as an investment coordinator in the country and the other as a planner of the economy. The government relaxed control on foreign borrowing and failed to supervise the borrowings adequately. The merchant banks in the country that had by 1996 increased to 15, excessively borrowed foreign funds on short-term maturity and lent them on the basis of long-term maturity, causing a mismatch in the maturity period of loans. Around the same time, the planning ministry was merged with the finance ministry to create the Ministry of Finance and Economy.

To conceptualise the South Korean economy at the time, it was dominated by family-owned business conglomerates, otherwise also known as chaebols, which enjoyed a comfortable relationship with the government, largely because they were perceived as ‘too big to fail’ (Lim, 2010).

illustraion via pinterest by lagartha.jpg

Illustration by Lagartha via pinterest

The IMF programme in South Korea had 3 goals, macroeconomic retrenchment, market opening, and structural reform. First, both high interest rates and a tight budgetary policy were implemented as an effort towards retrenchment. Additionally, in the agreed upon contract IMF demanded the government to reverse the liquidity injection before the bailout, and as a result, money market rates were raised to 30 per cent.

Second, all trade subsidies were abolished, import barriers were removed, the upper limit for foreigners’ shareholding was eliminated, the bond market was fully opened, and commercial lending was further liberalised. Third, the Financial Supervisory Commission was launched for comprehensive supervision of financial institutions by applying the Bank for International Settlements capital adequacy ratio (BIS Ratio). The chaebols were heavily scrutinised for their unaccounted over expansion and had to reduce their debt-to-equity ratio from 400 per cent at the end of 1997 to less than 200 per cent two years later (Shin & Chang, 2005).

Soon in 1999, however, after 6.7 per cent negative growth in 1998, the GDP growth rate shot back to 10.9 per cent for the year 1999. While the IMF and the Korean government attribute this growth heavily to the IMF aid, South Korean economists Jang Sup Shin and Ha Joon Chang, argue otherwise. They argue that the bounce back experienced in the South Korean economy was a Keynesian recovery, resulting from all time low inter-bank call market rates in the history of the nation, which was lowered to 6.6 per cent in December 1998, and the government injecting 64 trillion KRW (equivalent to 50 billion USD) of public funds into recapitalisation of financial institutions. The drastic fall in imports in 1997 and 1998 resulted in an improved balance of payments.

The economists also specify that the aggressive Keynesian policy worked because of the global economic environment as well. The global economy was recovering from the financial crisis, the aftershocks in Brazil and Russia and the Long Term Capital Management (LTCM), a New York- based hedge fund led the G7 countries to lower their interest and expand their monetary supply (Shin & Chang, 2005).

In the spring of 1998, between January and April, a movement emerged in South Korea. A nationwide campaign encouraged citizens to donate and sell gold, in order to help in increasing the gold reserves of the country. While there was criticism towards this campaign and allegations of corporates committing tax evasion, throughout the campaign, 227 metric tonnes of gold worth 2 billion USD was collected from 3.51 million participants (Kyung-Min, 2023).

The era of the Asian Financial Crisis was one of great turmoil and depression for the ASEAN region and East Asian countries. It brought to the surface deep seated issues in the administrative and financial structures of the nations involved and exposed the cosy relationship between the politicians of a country and business conglomerates in the country. It is a critical study of developing economies unfamiliarity with the global markets and inefficiency in decision making but it also explores the faults in the Anglo-American model of reforms that was implemented furthering the extent of damage in the region. The financial structure in the affected countries was challenged by this crisis. While the issues of corruption, concentration of economic resources and indebtedness persists in many countries, the crisis forced the financial structure in these countries to adapt to global standards.

Keywords

Asian Financial Crisis, Market Liberalisation, Capital Inflows, Currency Devaluation, Moral Hazard, Financial Restructuring, IMF Austerity Measures, Thai Baht, South Korea, Economic Recovery, Structural Reform, Globalisation, Public Recapitalisation, Economic Resilience

References

Charoenseang, J., & Manakit, P. (2002). Financial Crisis and Restructuring in Thailand. Journal of Asian Economics, 13(5), 597–613. https://doi.org/10.1016/s1049-0078(02)00175-6
Chomsisengphet, S., & Kandil, M. (2007). Towards Understanding the Asian Crisis and Its Aftermath. Journal of the Asia Pacific Economy, 12(4), 452–484. https://doi.org/10.1080/13547860701594095
Kyung-Min, N. (2023, September 13). From Miracle to Debacle: Painful IMF Days of 1997-1998. The Korea Herald. https://www.koreaherald.com/article/3212370
Lim, H. (2010). The Transformation of the Developmental State and Economic Reform in Korea. Journal of Contemporary Asia, 40(2), 188–210. https://doi.org/10.1080/00472331003597547
Mishkin, F. S. (1999). Lessons From the Asian Crisis. Journal of International Money and Finance, 18(4), 709–723. https://doi.org/10.1016/s0261-5606(99)00020-0
Shin, J., & Chang, H. (2005). Economic Reform After the Financial Crisis: A Critical Assessment of Institutional Transition and Transition Costs in South Korea. Review of International Political Economy, 12(3), 409–433. https://doi.org/10.1080/09692290500170742
Yoshihiro, I. (2001). Whither Thailand. In Asian Financial crises Origins, implications and solutions. International Monetary Fund. https://doi.org/10.5089/9781451965476.071

DISCOVER MORE STORIES

Reimagining Rural Development: How Grameen Bank Transformed Bangladesh

NOVEMBER 03

BY ANNAPOORNA MARIAM FATHIMA

Military Tensions And stock Market Violatility: The Bull Maket Dilemma

OCTOBER 07

BY HARSHITA DUBEY

unknown (3)_edited_edited_edited_edited_edited_edited.jpg

Is the Auction System Flawed for Small Holder Centric Markets

SEPTEMBER 07

BY SNEHA DEKA