Non-core bank liabilities and vulnerability to crisis: Implications for Asia

The recent global financial crisis highlights the vulnerability of Asian economies again. Despite structural changes made since the Asian crisis ten years ago, some of Asian countries were severely hit by the recent crisis. This time, Asia is not the origin of the crisis, but it has not been spared the deepest financial crisis ever since the Great Depression in 1929. As the world economy is getting more globally connected, few countries are expected to be immune to global financial conditions. One of the important lessons we learned from the recent global financial crisis is that shocks in the financial sector can have a devastating impact on the real economy. In particular, the active role played by banks in driving financial cycles has been emphasized by Shin (2010), among others. According to this study, fluctuations in the leverage in the banking sector are characterized by fluctuations in the total size of the balance sheet with equity being almost fixed. Since banks’ balance sheet capacity depends on the amount of bank capital and the degree of ‘permitted leverage’, when the economy is in a boom period, as credit risk gets lower, banks can expand lending to fill up spare capacity of balance sheets.