Perhaps the most serious aftershock of Asia's 1997–98 financial crisis has been a growing burden of bad debt that threatens the region's banks and national economies. Private estimates suggest that nonperforming loans now total a staggering $2 trillion—equivalent to almost 30 percent of the region's GDP. Yet governments have yet to recognize the full extent of the problem: their own reports peg the amount at a fraction of that level (Exhibit 1).1
With so many bank assets failing to produce income, profits are suffering mightily. In fact, many banks would be insolvent if their balance sheets reflected the true value of their loan portfolios. Since Asian governments explicitly or implicitly protect depositors, the debts could well become yet another liability for taxpayers, who have already paid out $370 billion to mop up the 1997–98 mess.2
Worse still, bad debt is dampening economic growth: capital that could be used productively is tied up in defaulted borrowers—thus dragging down national productivity—and insolvent companies continue to operate rather than face liquidation. Moreover, as the nonperforming loans of banks have mounted, they have turned risk averse, preferring to invest in government securities and foreign markets instead of stepping up lending to...