The difficulties encountered in Asia and the rest of the world during the latter part of 2001—economic slowdown, fallout from the largest US bankruptcy in history, and continuing reverberation from Sept 11—raise questions about how far Asia has come since the last major economic crisis in 1997-1998, particularly with regard to restructuring and strengthening of the region's financial sector.

The short answer is: pretty far, but there are plenty of risks and hard work ahead.

Since 1997-98, there has been a good amount of change and improvement across Asia's financial sector. Non-performing loans (NPLs), for example, have come down from their 1998 peaks of 50-60 per cent in Thailand, Indonesia and Korea to around 20 per cent, while in Singapore NPLs are now down into the single digits.

Capital adequacy is generally up across the region and some of the worst banking debacles (remember Bangkok Bank of Commerce!) have largely been addressed.

In many markets, steps have also been taken to improve regulatory reporting, oversight and infrastructure for dealing with bad loans and financial failures going forward.

It is easy to forget that back in 1997 institutions such as Ibra and the AMC in Indonesia, Danamodal and Danaharta in Malaysia and the FRA, FIDC and AMC in Thailand didn't yet exist.

At the same time, the financial sector in Asia is again facing some very tough conditions. With the exception of China, every economy in the region has been experiencing a downturn that, by most measures, is worse than 1997-98.

Singapore, for example, has just gone through the worst quarterly setback in economic growth since its founding in 1965.

As their customers' problems have increased, banks in the region have again started to see NPLs turn upward, although not yet at the dramatic pace of several years ago (Japan and China are currently facing the largest absolute amount of NPLs).

And while initiatives have been taken to re-engineer branches, upgrade management, and strengthen business processes in areas such as credit risk management and customer service, there is unfortunately still much inherent inefficiency and weakness that has not yet been adequately dealt with.

Sept 11, of course, is also having an impact, in ways that are still not fully understood due to the sheer magnitude of losses involved.

Claims on the insurance industry, for example, are expected to total somewhere between US $45 billion and US$60 billion—more than the next five largest insurance disasters in history combined (all of which were natural rather than man-made).

Fortunately, it appears that the burden will be shared widely among industry participants, with no single insurer or reinsurer facing more than US$800 million-US$850 million in losses (still a lot!).

While some ripple effects will be felt in Asia, the brunt of losses will be borne by institutions in Europe and the US. If global insurance is able to pull through the aftermath of Sept 11 reasonably intact, it will be an amazing testimony to the robustness of the industry.

The recent Enron collapse is also sending tremors throughout the world's financial community. While the circumstances leading to Enron's demise are unique and unlikely to set off a broader wave of bankruptcies, the fact that the list of Enron creditors is 54 pages long suggests that losses will be widely felt among financial institutions around the world, including Asia.

In short, while the financial sector in Asia has generally strengthened since 1997-98, it is facing a period of unusual stress and is likely to encounter significant challenges well into 2002.

For institutions that do find themselves facing serious difficulties, there are three—and really only three—paths forward.

The first is to dig out of the difficulties through self-restructuring. This can be painful, as it typically involves significant cost-cutting, staff reductions and some degree of business redefinition. But there are successful examples of institutions that have followed this path.

DBS-Thai Danu Bank, for example, closed a third of its branches, pared staff proportionately, and introduced major changes throughout its business processes a year ago in the most extensive restructuring in Thai banking history. As a result, the bank was able to return to profitability from the brink of NPL-driven failure during the second half of 2001.

The second path for institutions in difficulty is to find a partner, one that brings capital, management know-how, or other helpful capabilities or assets.

Korea First Bank is a good example of how this path can pay off. In 1998, Korea First experienced a loss of close to S$1 billion before the Korean authorities opened the door for partners/investors.

After capital injections by the government, Newbridge Capital acquired a 51 per cent stake in the bank, brought in new management and undertook a massive turnaround programme that could lead to profits for 2001 of over S$350 million.

Mergers are another method of partnering that can bring advantages of greater scale and potential for operating and cost efficiencies.

This has been the most followed path in the region over the past few years, even by institutions that have not had their backs to the wall.

The amount of overall consolidation that has occurred in Asia since 1997-98 is really quite remarkable: from seven to three banks in Singapore; 31 to 10 banking groups in Malaysia; 15 to 13 banks and 95 to 21 finance companies in Thailand; 238 to 142 banks in Indonesia; and so on, with a next wave of consolidation likely in China.

Of course, to merge is one thing. To get the full value out of a merger is another, and so far there are few if any examples of bank mergers in Asia where full merger synergies have been realised. This is due to the crush and distraction of integration activity, which in turn makes determined, strategic follow-through aimed at capturing the full potential of combined capabilities difficult.

Finding an appropriate partner, of course, is easier from a position of strength than weakness, which is why for some institutions in trouble there is only a third path available—takeover by the government.

The precedents for government takeovers of failing financial institutions are found mostly in the US and Europe, but in recent years this path has become common in Asia as well.

Today in Japan, Korea, Thailand, Malaysia, China and elsewhere in the region, governments still own banks—at enormous cost to the public—that they are trying to figure out what to do with.

While there have been a few instances of governments successfully merging, restructuring or divesting failing institutions (if the sale of Bank Central Asia in Indonesia is completed in a timely manner, it could serve as an example of success), these are exceptions rather than the rule.

There is still a great deal of learning and improvement possible in the approaches of governments across the region in dealing with financial institutions once they get into, and even before they get into, serious difficulty.

In conclusion, the financial sector in Asia gets an overall grade of B for the changes and improvements made since 1997-98, in terms of strengthening capital adequacy, reducing NPLs, consolidation, and aspects of regulatory upgrading.

But the sector will have to work even harder to get the grade up to an A, and is going through a tough exam period that is likely to extend well into 2002. Study hard, learn well, be disciplined, and position for future success!