It has long been acknowledged that politics and regulatory capture can play an important role in dealing with financial institutions' distress. The East Asia financial crisis meant a large number of distressed and closed intermediaries in an environment with many links between government, supervisors, politicians and financial institutions. This makes for a good event for studying how such connections affect the resolution of financial institutions' distress. We investigate the occurrence of

more »

... tress and closure decisions for 186 banks and 97 nonbank financial institutions from Indonesia, Korea, Malaysia, the Philippines and Thailand. We find that 42 percent of the institutions experienced distress after July 1997. By July 1999, 13 percent of all institutions in existence in July 1997 had been closed. Using 1996 financial data, we find that traditional, CAMEL-type variablesloan loss reserves to capital, loan growth, net interest income to total income, return on assets, and loans to borrowingshelp predict subsequent distress and closure. None of the foreign controlled institutions was closed and the degree of foreign portfolio ownership lowered an institution's probability of distress. "Connections"with industrial groups or influential familiesincreased the probability of distress, suggesting that supervisors had granted selective prior forbearance from prudential regulations. Connections made closure more, not less likely, however, suggesting that the closure processes themselves were transparent. Larger institutions were more likely distressed, but less likely closed, while (smaller) nonbank financial institutions were more likely closed, suggesting a "Too Big To Fail" policy. These policies, together with the fact that resolution processes were late and not necessarily comprehensive, may have added to the overall uncertainty and loss of confidence in the East Asian countries, aggravating the financial crisis.