Governments also can reduce corporate vulnerability by...

Governments also can reduce corporate vulnerability by increasing the share of corporate financing provided by nonbank capital markets through measures to enhance financial market infrastructure. The extension of corporate financing from banks, which usually dominate in early stages of development, to nonbank intermediaries reduces corporate sector vulnerability by extending trading to a wider class of borrowers and improving risk bearing. The development of nonbank capital markets is accelerated by government policies that build financial infrastructure such as accounting standards, judicial and legal systems, and other institutional nuts and bolts such as clearing, settlements and payment systems (Caprio et at., 1994). In addition, the removal of impediments, such as regulations that restrict the development of derivative markets, can increase the role of nonbank capital markets.

III. CONTRACTION PHASE

The contraction phase is marked by a severe recession triggered by a cutoff of capital inflows following an external shock or an adverse shift in expectations regarding a vulnerable corporate sector. The capital inflow cutoff leads to a sharp fall in the exchange rate. The depreciation is amplified into a systemic crisis encompassing banks and the real sector via corporate sector balance sheet channels. Formulation of expansionary monetary and fiscal policies in this setting is complicated by the lack of reliable balance sheet data, which often leads to underestimation of the contractionary impulse. Monetary policy can be further complicated by the conflicting goals of limiting the recession and stabilizing the exchange rate.

A. Crisis Dynamics Corporate crisis dynamics are usually triggered by a sudden reversal of capital inflows related to external events or a downward shift in the expected performance of the economy (Table 3). The magnitude of these reversals in recent years reflects not only the increase in capital inflows during the 1990s, but also their concentration in the private sector of a relatively small number of countries and short term maturities. The exceptions to this pattern for the nine countries studied here are Hungary and Poland, as these crises followed from their history of central planning. The sudden reversal of inflows can be sparked by a worsening of domestic prospects, or by external events such as an increase in world interest rates or developments in other emerging markets.

The evidence for domestic credit as the trigger is mixed (Table 4), Sharp drops in domestic credit preceded the crises of Mexico in the early 1980s and Hungary, in contrast to the Chilean crisis. In East Asia the credit cycle did indeed turn downward prior to the crises, but the magnitude and timing of the declines seem to imply that domestic credit shocks on their own did not initiate the corporate crisis dynamics, and, rather, may have followed the onset of the crisis.