It's a salvage operation extending from Jakarta's Jalan Sudriman financial strip to the concrete canyons of Tokyo's Ohtemachi banking quarter. The goal: to move almost $1 trillion in bad loans off the books of the regions' banks and create a smaller and sounder bank sector that can start lending again. The cost: easily in the hundreds of billions of dollars. The chance of success: probably not better than 50-50 given the enormity of the problem, the weakening state of Asia's economies, and the likelihood of political backlash. The cost of failure: huge, since the banking crisis is starving Asia of essential credit.
Policymakers should have tackled the bank mess months or even years ago. Yet financial technocrats are finally starting to talk a serious game across the region--in Japan, South Korea, Thailand, Indonesia, and Malaysia. While the details may vary, all five have or will set up rough versions of the U.S. Resolution Trust Corp. that played a critical role in ending the savings and loan crisis of the 1980's. The RTC conducted audits, shut down thrifts, and sold off their loans and underlying collateral as repackaged securities or via public auctions, usually at discounts to their face value. None of the Asian workouts will probably match the RTC in ruthlessness. But if they can tackle the worst problems, it will be a giant step forward.
Most important, of course, is the "Total Plan" announced by Japan to fix the country's banks. The plan would shake up failed institutions, remove managers, and even close some banks' doors. And in Seoul, where authorities shut down five smaller lenders on June 29, the government will impose mergers on the major commercial banks if need be. Out of 19 major banks, "I think three to five leading banks will emerge through various deals," figures Lee Young Keun, a member of the Financial Supervisory Commission that reports to South Korean President Kim Dae Jung.
FAVORED DEADBEATS. Accountability and shotgun mergers? You wouldn't have heard such talk a year ago. Now, Japan, Korea, and the Tigers of Southeast Asia are under intense pressure by the markets to clean up the mess left by reckless lending to overextended real estate developers, coddled state-run enterprises, and politically favored corporate deadbeats. If they don't clean up the banks, fresh capital may not flow into the region for years to come.
The Japanese plan gives a good idea of what these workout vehicles are like. A new Financial Supervisory Agency, staffed mostly by former MOF officials, will conduct audits of banks' books and have the power to close problem banks and appoint financial receivers. At banks earmarked for shutdown, regulators will transfer deposits and loans to one of several new "bridge banks" funded by state-owned Heisei Financial Rehabilitation Corp. The bridge banks will keep credit flowing to sound borrowers but cut off unsound customers and force them into bankruptcy. The bridge bank will look for merger partners for up to five years before shutting down failed bank operations for good.
That's the theory. The rub is that any real cleanup would have to cut off new loans to the overextended construction and real estate companies that bankroll Prime Minister Ryutaro Hashimoto's ruling Liberal Democratic Party. So politics may enter into the decision on which banks get a lifeline. A tough plan will also throw thousands of bank employees out into the streets. ING Barings Ltd. analyst James Fiorillo figures seven major banks--including Nippon Credit Bank, Yasuda Trust & Banking, and Daiwa Bank--could be candidates for such restructuring. The burning question is whether the government has the will to flush out the bad debts and pull the trigger on chronically ill banks.
Resistance is already forming elsewhere in the region. In Seoul, after authorities shut down the five smaller banks and transferred $9.6 billion in problem loans to the Korea Asset Management Corp., laid-off bank employees rebelled. They sabotaged computer systems and cut off power supplies to branches to disrupt the transfer. The government held firm--but there's no telling how fierce resistance will be at the next round of closings involving bigger banks. Yet the advantages of honestly executed workouts are huge. In Japan, shutting down some of the big banks could begin to restore confidence. More momentum will come if Hashimoto can overhaul Japan's archaic bankruptcy laws in an upcoming session of parliament. That would make it easier for banks to mark down and sell off their loan portfolios and real estate to international investors.
Such sell-offs will be crucial. Although the common assumption is that the banks can only sell their problem loans for a third of their face value, that may be too low. In Thailand, ground zero of the regional crisis, public auctions of autos and auto loans have fetched 50% to 60% of their book value, thanks to bids by companies like GE Capital Services Inc., which has snapped up $500 million worth. Most thought these assets would fetch only 40% of book value. Some property-backed loans, to be sold off later this month, may recoup half their value, too, reckons Salomon Smith Barney Vice-President James Mitchell. "The foreigners are ready to buy."
Of course, some loans are so deep underwater they won't fetch any bids at all and will have to be written off. Writing off the wretched stuff will require a lot of public money. Korea Asset Management has already burned through half of its $18.5 billion in capital to cover write-offs at the five banks it closed. Yet those banks make up a paltry 7% of combined assets of Seoul's big commercial banks, so the workout fund will obviously need fresh capital to complete its task.
Nor are all the workout plans as tough as they could be. Malaysia will launch a gentler version of the RTC to take on problem loans, work out repayment plans with debts, and broker mergers. Yet it has also slashed reserve requirements to prevent outright failures. In China, home to $200 billion in dud loans, a workout vehicle isn't even on the table. Instead, Beijing is shutting down poorly managed local bank branches, nudging loan-classification standards closer to international levels, and training bankers to assess risk.
Yet as the Asian crisis grinds on, global investors can easily avoid the countries that keep propping up their sickest banks. Sloppy lending triggered the meltdown. Fixing the banks, credibly and quickly, is the best way out.