These countries should move forward with financial deregulation, although the central lesson from this experience is that the prudential framework 11 The sine qua non of should advance in step with the opening up of the financial sector. smooth adaptation to large capital flows must be a resilient and robust formal financial sector, with risk-averse conservative banks forming a large stable core.
Such risk-averse institutions would have been reluctant to expose themselves to the sort of exchange rate shocks that have occurred, and so a well-functioning formal financial sector would have borrowed less in foreign currency and would have been more conscious of the credit risk of lending to those who had borrowed extensively overseas.