1. Introduction: Four Puzzles

There are four factors involved in the current financial crisis in Asia that have caused surprise. This chapter suggests that an understanding of the role of derivative contracts in facilitating the financial flows to Asia may provide a key to understanding them.

The Latin American debt crisis of 1982 was thought to have been aggravated by the dominance of syndicated lending by commercial banks. Developing-country borrowers were thus encouraged to increase their reliance on non-bank lending, in particular private direct investment flows. The dominance of direct investment flows to a number of Asian countries was used as an example of the greater stability of such lending. Yet, the Asian crisis appears to have been precipitated by the reversal of short-term private bank lending which had come to dominate capital flows to the region.

Second, the flows of capital to Asia have been used as an example of the benefits of free international capital markets in directing resources to the most productive uses. Yet, in the aftermath of the crisis, it appears that total returns on equity investments in Asia have in fact been lower than in most other regions throughout the 1990s.

Third, it appears that in a number of Asian countries the majority of international lending was between foreign and domestic banks. It has been suggested that the major cause of the crisis is unsafe lending practices by the Asian banks, permitted by inadequate national prudential supervision.