March 2002 Insights Issue
#40
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Crisis in Jamaica
Has the cost been excessive?
In recent decades, financial crises have threatened the financial
and monetary systems of many developing countries. But have the crisis
management measures alleviated or intensified the accompanying economic,
social and political upheaval?
Research from the University of Manchester's Institute for Development
Policy and Management looks at Jamaica's recovery from financial crisis
in the mid-1990s. The paper argues that financial crises can be resolved
without excessively impairing the real economy, but only if the problem
is properly diagnosed and if the treatment is appropriate, as determined
by local conditions. It rejects the IMF's standard shock treatment as
a panacea for local financial crises. Instead it uses Jamaica's experience
in responding to its crisis without the IMF's involvement to show that
crisis management programmes are more likely to succeed if they draw on
the national stakeholders' expertise and knowledge.
The Jamaican financial crisis was severe. A downturn in the real estate
and stock markets precipitated illiquidity problems in the overexposed
life insurance industry. Affiliated commercial banks were infected, and
despite Central Bank assistance, panic spread throughout the sector. The
government was initially inclined to follow the standard remedy of closing
distressed institutions. However, after pausing to evaluate the extent
of the problem, fast track legislation and other measures were introduced
to resuscitate the sector.
The Jamaican response to the crisis was unusual, as it disregarded contemporary
multilateral wisdom and fully protected all deposits. This was done to
maintain the public's confidence in the sector and prevent international
capital flight. Instead of closing institutions, the government created
the Financial Sector Adjustment Company (FINSAC) to assist troubled financial
institutions with an injection of capital. In exchange, FINSAC acquired
a combination of equity, board seats and other assets, which facilitated
the much-needed restructuring and subsequent divestment of the sector.
A comparison of the effect of this response with that of the IMF-led
response to the South East Asian crisis is instructive. The Asian meltdown
resulted from financial panic, triggered by the closure of institutions
without arrangements to protect depositors. The ensuing credit crunch,
and contraction in economic activity and social unrest, stand in stark
contrast to the relative calm maintained in the Jamaican financial sector
and wider society.
The paper recognises the high cost of the Jamaican intervention, and
the worrying resultant debt-overhang, but argues that this is less significant
when compared to what would have occurred if the standard IMF prescription
had been adhered to. The Jamaican case study shows that the cure for severe
financial crises will always be painful, but the adjustment costs can
be reduced if an appropriate policy response is adopted. The adoption
of universal panaceas has tended to worsen rather than alleviate crises.
Responses must be appropriate to each financial sector's structure and
history and to the broader social and economic environment.
The study also contributes the following general principles for recovery
to the broader debate about appropriate responses to financial crises:
- During periods of financial panic, governments should adopt an approach
aimed at restoring public confidence. Public resources may have to be
used for bank restructuring and protection of deposits, but should be
complemented by strong incentives against future moral hazard.
- Post-crisis financial restructuring is vital and best carried out
by strong, independent public agencies with political and legal clout
to implement difficult decisions.
- Strengthened prudential regulation and supervision of the financial
sector is crucial, but in periods of crisis, banks should be given appropriate
leniency to meet these regulatory standards.
- Post-crisis policies should focus on the reduction of social hardships
resulting from the linkages between the financial sector and the real
economy.
David Tennant
Department of Economics
University of the West Indies
Jamaica
Davidf_Tennant@hotmail.com
Colin Kirkpatrick
Institute for Development Policy and Management
University of Manchester
Manchester M13 9GH
UK
T +44 (0) 161 275 2800
colin.kirkpatrick@man.ac.uk
See also
'Responding to Financial Crisis: Better off without the IMF? The case
of Jamaica' Finance and Development Research Programme WP #38: IDPM University
of Manchester, by C. Kirkpatrick and D. Tennant, 2002
http://idpm.man.ac.uk/idpm/fdwp38abs.htm
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