In the words of Alan Greenspan, “what turns otherwise seemingly minor imbalances into a crisis is an actual or anticipated disruption to the liquidity or solvency of the banking system”. When banks are already weak, for example because of a high level of non-performing loans, an external shock such as an attack on the currency will further damage confidence in the banking system. Banks will lose domestic deposits and will find themselves unable to rollover short-term external borrowing. The resultant capital outflows will put further downward pressure on the exchange rate, force up interest rates and drive down asset prices. The customers to whom banks have lent will get into financial difficulties, further weakening the position of the banks. With their capital and liquidity impaired, the banks are in no position to lend, and this leads to the “credit-crunch”, and resultant shrinkage of the real economy that we are seeing in so many countries in the region. The reasons for the banking sector weaknesses are various. Lending excesses drove up asset prices and allowed companies to become over-leveraged. Poor risk management on the part of the banks themselves was compounded by ineffective banking supervision and lack of transparency which provided little scope for market discipline to be exercised until the problems were glaringly obvious. At that point, the market reaction was extreme. Even if supervisors did have the will to tackle banking sector problems in their countries, they were often subject to political interference that stood in the way of prompt corrective action.

Recognizing that inflation targeting is not a panacea, the Monetary Policy Committee has supplemented the framework with a regular monitoring and assessment of seven key areas of financial imbalances, where buildup may threaten the macroeconomy and price stability. These seven areas are the country’s external position, the real estate sector, bank credit, household and corporate financial positions, the financial market, and the fiscal position of the Government. Ladies and Gentlemen, despite all these reform efforts and the stronger foundation the Thai economy now has, we have to remain vigilant. Today, the change of pace in the global economic environment is simply unprecedented. Some of these changes, if left unchecked, may have significant implications on a country. While the new global dynamics represents an opportunity for a country like Thailand to leap forward, it also entails increasing risk of economic instability. The evolving complexity of the global economy means that conventional thinking and approaches to deal with economic problems may, at times, need to be adapted. The 1997 crisis highlighted this point. Back then, the conventional wisdom for a crisis-ridden country is to adopt restrictive monetary and fiscal policies. As we all now know, overtightened stance aggravated the already fragile situation and created many unnecessary pains. Only when the crisis contagion spread to several countries was it evident that such measure was a wrong medicine for Asia, which ultimately led to the abandonment of some of these measures. Today we are faced with the major problems of global imbalances and large and volatile capital flows.