Thus, the auditor possesses valuable information that the bank has an incentive to acquire and an inferior firm has an incentive to conceal. Depending on the primitives of the economic environment, the bank may optimally choose not to prevent collusion. When the economic environment is bad, knowing the true type of borrower becomes very valuable to the bank, and the bank will optimally deter collusion by paying more to the auditor, leading to a no-collusion equilibrium where the bank invests in the market capital world after meeting with a low-type borrower.
Note that our setup implies that even the output is observable, the bank cannot tell in case it is the result of a bad state or a low type. Because of this asymmetric information, a low-type entrepreneur may be able to bribe an accountant to get his/her loan approved by the bank. After an investigation, the participating auditor submits a report to the bank in which the audited entrepreneur indicates either a high or low type.
In the case of an honest report, the auditor is compensated by a transfer payment from the bank (t) for the audit. The bank can set the amount of the payment to the accountants and the interest to maximize its profit. As long as this expected profit is greater than the reservation value, the bank is willing to grant a loan to the entrepreneur.
Collusion Equilibrium
In summary, we define the collusive-free set as all combinations for a given parameter configuration such that collusion is discouraged and the constraints on the cooperation of the bank and high-quality entrepreneurs are satisfied. In the rest of the paper, we focus mainly on the special case when there is no honest auditor - in this case, banks have the greatest incentive to prevent collusion. In other words, there is no combination that satisfies the constraints on the participation of banks and big business and leaves no room for bribery (i.e.
Note that since it is the highest interest rate that high-end entrepreneurs can afford, the banks' total collusion income cannot exceed this. If the first inequality in (9) is violated so that this maximum revenue cannot even cover the opportunity cost of banks B, then the banks will withdraw from the loan market and the collusive and non-collusive groups will be empty . The second inequality in (9) is less straightforward – it states that the maximum interest rate. a bank's fee is so low that it cannot prevent low-type entrepreneurs.
Moreover, the optimal interest rate should be set as high as possible without deterring high-type entrepreneurs. The next question is, assuming banks are able to prevent collusion, is it in their best interest to do so? When or in the same way, the disutility from putting in a lot of effort is so low that banks can induce high-quality entrepreneurs simply by setting a high enough interest rate.
To find the conditions under which banks optimally choose not to prevent collusion, we can focus on the case when. Proposition 2: If the fundamental parameter configuration is satisfied. then banks will optimally choose not to prevent collusion. Intuitively, this economy will tend to settle into the collusion equilibrium if: (i) B is small so that the cost of banks lending money to low-type entrepreneurs is low, and (ii) π is large so that the possibility of matching with low-type entrepreneurs is low.
On the one hand, as the expected return of low-type entrepreneurs from project implementation becomes higher, they may make a higher offer to bribe auditors for the same R. As a result, it is not clear whether it becomes easier or harder for banks to offer more than low-end entrepreneurs.
Application: A Case Study of the 1997 Korean Financial Crisis
Taken together, these observations have drawn a fairly clear picture as follows: (i) the causes of the 1997 financial crisis in Korea were not purely non-fundamental, although the crisis is likely to be exacerbated by pessimistic expectations and society-wide loss of confidence (see Obs1-Obs3); (ii) financial illiquidity and monetary/fiscal-led breakdown of the fixed exchange rate regime were unlikely to be the main sources of the crisis (see Obs1, Obs4 and Obs7); and (iii) by eliminating alternative hypotheses, it seems reasonable to conclude that excessive lending by financial institutions was most likely to blame for the crisis. To support the latter argument, we must9 examine the financial structure of the Korean economy more thoroughly, to which we now turn. Financial collusion and overlending in Korea can best be illustrated by the following leader.
Korean companies have long engaged in unbridled expansionism, financed by loans, inefficient octopus-like management, and over- and duplication of investment, hastening the economy's structural failure. The unrest in Korea was mainly caused by the continued bankruptcies of Chaebols, who had borrowed heavily from financial institutions to finance their investment projects. First, we note that the market structure of financial institutions is crucial to the vulnerability of Korea's over-indebtedness problem.
In fact, net profits for the 30 largest Chaebols were close to zero, with 13 of them posting negative profits. It may be interesting to highlight a strong correlation between the probability of bankruptcy and financial leverage: financial leverage of the 12 Chaebols statements. To put these figures into perspective, the total amount of loans granted by the EIB in 1997 was more than 10% of the public budget and almost 1% of the GDP of the entire Korean economy.
Even more surprising is that the percentage of loans provided by EIB to three large Chaebols in the state of bankruptcy or insolvency (Daewoo, Halla and Kia) from 15.0% in 1995 to 23.6% in 1996, just before the crisis, rose and then fell back. to approximately the 1995 level (14.4%) at the end of 1997 just after the crisis. In summary, the evidence suggests that in light of the lending relationship between large Chaebols and NBFIs, (i) the over-lending problem in Korea was severe before the crisis; (ii) such excessive loans were provided to finance investment projects with low returns; and, (iii) the absence of an effective supervisory system and the lack of a financial regulation on the ownership of NBFIs by Chaebols encouraged crony capitalism. President Suharto in Indonesia), (ii) poor corporate governance with expropriation by managers (see for example alleged incidents provided by Johnson et al, 2001, for the cases of the Sinar Mas Group in Indonesia, the Hyundai Group in Korea and the Bangkok Bank of Commerce in Thailand), and (iii) financial collusion between lending firms and lending decision makers, which is the focus of this article.
Although the problem was accelerated by the liberalization of the capital account, when financial institutions and companies were allowed to borrow abroad, excessively. Can the theory developed in this paper shed light on discovering the likely causes of the 1997 Korean financial crisis and address the three questions raised above.
Concluding Remarks
With overlending, active liquidity management to restructure the financial sector can be detrimental to short-term macroeconomic performance, as illustrated by the cases of Korea during the Asian financial turmoil. Burnside, Craig, Martin Eichenbaum, and Sergio Rebelo (2001), "Prospective Deficits and the Asian Currency Crisis," Journal of Political Economy. Calomiris, Charles and Gary Gorton (1991), "The Origins of Banking Panics, Models, Facts and Bank Regulation," in Glenn Hubbard (ed.), Financial Markets and Financial Crises, University of Chicago Press, Chicago, IL.
Chang, Roberto and Andres Velasco (2001), “Financial Crises in Emerging Markets: A Canonical Model,” Quarterly Journal of Economics. Corsetti, Giancarlo, Paolo Pesenti and Nouriel Roubini (1998), “The Asian Crisis: A Review of the Empirical Evidence and the Policy Debate”, in P. Agenor (ed.), The Asian Financial Crisis: Causes, Contagion and Consequences, Cambridge University Press, Cambridge; UK, 127-163.
Krugman, Paul (1999a), "Balance Sheet, the Transfer problem, and financial crises," i Peter Isard, Assaf Razin, Andrew K. Krugman, Paul (1999b), "Currency Crises," i Martin Feldstein (red.), International Capital Flows, National Bureau of Economic Research Conference Report Series, University of Chicago Press, Chicago, 421-440. Fremskridt i økonomisk teori: Proceedings of the Sixth World Congress of Econometric Society, Cambridge University Press, Cambridge, Storbritannien, 151-213.
Notes: At the end of June 1999, non-bank-financed enterprises were conducting business of five types: (i) development (Korean Development Bank and Export-Import Bank of Korea), savings (bank trust accounts, mutual savings and financial companies, credit unions, mutual credit facilities, community credit cooperatives and postal savings), (iii) investment (merchant banking companies, securities investment companies and Korea Securities Finance Corporation), (iv) insurance (life insurance companies and postal life insurance companies) ), and (v) other financial institutions (Securities companies, investment advisory companies, credit guarantee funds, non-life insurance companies, leasing companies, venture capital companies and installment credit companies). Hong Kong in particular had a currency board pegged to the US dollar, whereas the Singaporean exchange rate market was heavily controlled at the time. By conducting a comparative study, we want to gain further insight into understanding the nature of the underlying drivers behind the Korean financial crisis.
While Korea is the only economy with significant exchange rate depreciation before Korea and Thailand were the only two to experience significant stock price declines in 1996 (26 and 35% respectively). Using the growth rates of total credit-to-GDP ratios over 1990-96 to measure the extent of the lending boom, we find that all but Taiwan exceeded 10%, with Korea reaching 17% and Thailand 51 %. Furthermore, the moderate figures for ratios of short-term liabilities (to BIS) to total liabilities indicate that illiquidity did not appear to be the main cause of the Asian financial crisis.
Sources: Calculated using data from various editions of International Financial Statistics (IFS, by IMF), Taiwan Statistical Data Book (TSDB, by the Economic Planning and Development Board of ROC), World Development Report (WDR, by World Bank ), and World Economic Outlook (WEO, by IMF), except the real exchange rate which is the inverse of the J.P.
