- 14 -

# **d. Resolution of the 1983-87 Banking Crisis 23**

As it has been implicit in the analysis above, to a great extent the weaknesses of Thailand's financial system lay in the 1983-87 crisis and its resolution. In this section we briefly summarize the main features of this crisis, its causes and the way it was resolved.

**_Causes and Scope of the Financial Crisis._** In 1983-87, Thailand experienced a financial crisis that was associated with a slowdown in the economy, globally high interest rates, and fraud and mismanagement on the part of several finance companies and banks. The crisis originated in the finance companies segment of the financial system, which was poorly supervised and had engaged in heavy speculations in shares and real estate and affected institutions that together accounted for 25 percent of total financial system assets. A total of 24 finance companies were subsequently closed, and nine others merged into two new companies. The crisis led the Bank of Thailand to create the Financial Institutions Development Fund (FIDF) in 1985-a separate legal entity under the BoT with a mandate to provide liquidity support to financial institutions. The FI:DF established a special support scheme-the "April 4 Lifeboat Scheme"-which provided soft loans to 13 finance companies and 8 commercial banks in exchange for an equity stake.

**_Treatment of Depositors._** Depositors of commercial banks were largely bailed out, thus creating-reinforcing-expectations of an implicit insurance guarantee for that market segment. Depositors of 25 finance companies that participated in the "life-boatscheme" were also bailed out. The only depositors to suffer any losses (in the form of foregone interest and illiquidity) were the creditors of the 24 finance companies that were closed. Thus, despite the lack of an explicit deposit insurance scheme, the resolution of the mid-80s crisis reinforced the belief that depositors and banks would be bailed out if their investments proved umprofitable.

**_Treatment of Financial Institutions' Shareholders and Management._** Shareholders of insolvent financial institutions did see a (temporary) dilution of their investments, but they were not completely eliminated as shareholders.<sup>2 4</sup> While the chief executive officers of the failed and restructured institutions were removed, senior management was left in place. This allowed the weak banking culture to remain intact, and made the overall rehabilitation of the financial sector more difficult. Moreover, despite the fact that the financial crisis of the mid 1980s was caused by poor risk management and lending practices, relatively low average operating expenses in the afternath of the crisis seerm to suggest that financial institutions invested insufficiently into upgrading the skill base of their staff and their risk management practices.<sup>2 5</sup>

- 23 See for _a_ detailed account of 1983 crisis: Johnston (1991) and Caprio and Klingebiel (1996a & b).

- 24 Existing shareholders had a buyback option at a predetermnined price and under a five-year time horizon.

- 25 While the comparability of cross country data is limited because of differences in accounting conventions regarding the valuation of assets and loan loss provisioning, and interest rate accrual norms and tax regimes differ across countries, with an average of 1.9 percent operating expenses over average assets over 1990-1997,