Beijing, 27 May 2010
Financial Reforms in Post Crisis Recovery: Implications for Asia
Ladies and gentlemen,
Good afternoon, Xia Wu Hao!
It is my great pleasure to participate in this China Finance Summit organised by the 13th China Beijing International High-Tech Expo. The theme of this Summit on “Financial Reconstruction and Economic Development” is indeed appropriate as economies around the world, including China, continue to recover from the recent global financial crisis. Having this Summit now and here in Beijing makes this event even more special as we all know China is leading the world out of the current global recession.
Despite Asia’s remarkable contribution to the on-going recovery, sustaining the post-crisis recovery will not be easy. This is because the global economy is still fragile. Across the globe, risks remain considerable as evident by the recent debt crisis in Europe. Unemployment, especially in advanced economies, is rising while in emerging markets, risks from the resurgence of capital flows have started to surface again.
As you all know, the failure of the global financial markets is a major factor that caused the crisis. One important lesson drawn from this crisis is that financial sector reforms should now be pursued more aggressively than before. In particular, reforms are needed on pushing ahead with financial regulation and supervision. Efforts at addressing systemic risks and cross-border risk management issues are also crucial if progress in the financial sector is to be achieved.
Again this backdrop, I would like to focus my remarks on three topics: (1) financial reforms and implications to restoring growth and financial stability in Asia; (2) challenges of strengthening financial integration among ASEAN and the Plus Three countries of China, Japan, and Korea (ASEAN+3); and (3) financial sector development and the challenges of sustaining the recovery.
Financial Reforms and Implications to Post-Crisis Growth in Asia
Reforms are needed because the global financial markets still need repair. Although progress has been made since last year in formulating proposals to fix the financial sector, significant market strains remain. In this highly integrated world where financial globalisation is very much in place, the challenge now is to make sure that the same problems created during the recent crisis will not be repeated again. In a post-crisis era, the financial sector must transform itself and must not return to the financial system of yesterday.
Over the last decade our region is fortunate to have implemented critical financial sector reforms that have increased our resilience to external shocks. This was proven last year in the way our financial markets have responded well to the crisis. When the crisis broke out, Asia’s banks and companies have already maintained adequate capital, ensured proper underwriting standards, and followed sound risk management. For example, the NPL ratio of commercial banks in China fell to 1.8% in mid-2009 from 17.9% at end-2003. China is also one of the first countries in Asia to adopt the new bank capital standards under Basel II in 2007. By end 2008, almost all banks in China have achieved the minimum capital adequacy ratio of 8% mandated by the Bank for International Settlements.
As a result of strong fundamentals, the region’s banks and financial institutions continued to perform their intermediation role even during the crisis. China’s banking business model – which relies on deposits and income as key sources of revenues for banks – exemplifies the less risky behaviour of Asian banks. Compared to other regions, credit in Asia has not slumped as much.
While our regional financial systems are less affected by the crisis, it is still in the best interest of Asia to participate in reforms of global financial system. This is because reforms being implemented on the global stage will have consequences for the region. Due to financial globalisation, the strength of regional financial systems to intermediate, allocate capital, and facilitate innovation will very much depend on the overall soundness of global financial system.
There are two priority areas where reforms can make significant impact on the global financial system. One is on the regulation and supervision of financial sector. Already, we have seen how lapses in this area can create serious problems in the world economy. To address this concern, there is a need to make regulation and supervision better and smarter. At the global level, various options are now being explored including the possibility of introducing financial sector taxes. At the institutional level, combining macro prudential framework with sound supervision of individual financial firms is also a priority. This implies widening the boundary for supervisory oversight to include all systemically important institutions.
Second priority is to strengthen crisis resolution mechanism. This can be done by instituting special resolution mechanisms for banks to ensure an orderly winding of assets with a credible threat of loss for unsecured creditors. At the same time, they reduce moral hazard by making the threat of failure or loss more credible. I believe these mechanisms are also crucial to impose market discipline in the financial markets around the world.
So what are the implications of these financial reforms to Asia including China?
As earlier mentioned, Asia is not at the epicentre of the crisis. Yet its increasing integration with the world financial markets renders countries in the region equally vulnerable to global market strains. Thus, one important implication is for Asia to continuously maintain a strong regulatory and supervisory regime going forward. With the possibility of new risks emerging, Asia should try to leverage on the global priorities for reforms that are now underway. These include renewed efforts to strengthen risk assessment capacities; adhere to higher regulatory norms and standards; and adopt coherent approach for cross-border crisis management.
The current crisis also demonstrates that a strong financial sector development is crucial to any sustained economic recovery. In the absence of strong financial markets, countries are likely to be prone to crises. Similarly, with well-functioning financial markets, the options for higher growth and stability will be greater. For example, the development of robust financial markets will be critical for making the best use of the region’s significant savings in support of domestic demand.
In the case of China, with its tremendous contribution to post-crisis recovery, developing its financial markets will be crucial to support domestic growth. Through deep financial markets and other financial investment opportunities, there will be better allocation of capital toward relatively efficient private enterprises. Similarly, developing financial markets can provide additional saving vehicles that raise household income, thus increasing private consumption.
Prospects of Financial Integration in a Post-Crisis World
Let me now turn to the second issue that I want to discuss. That is, the role of financial integration in
the post-crisis world, particularly in strengthening financial stability in East Asia.
The need to manage external shocks and policy spill over in an era of increased financial globalisation is another important lesson drawn from the current crisis. Some critics have argued that the recent crisis has been caused by financial integration. While there is some truth about it, I would like to believe that the transmission of shocks in today’s interdependent world cannot be avoided. In my view, financial integration is a natural progression of that global interdependence. In the case of the recent crisis, it is the failure of financial supervision and regulation that has triggered the crisis and not financial integration per se.
In fact, I would like to view financial integration as vital to post-crisis recovery. Through financial integration, countries in the region can take advantage of additional savings generated by financial flows, thus adding to investment. Integration allows greater diversification, leading to deeper and complete markets and thereby increased resilience to external shocks.
Although financial integration in East Asia is still limited, I believe that this increased cooperation among countries in ASEAN, China, Japan, and South Korea has helped boost market confidence in the region, and keep the region credible in the eyes of the investors during the recent crisis. Two important initiatives have contributed to this “confidence-building and confidence-enhancing” in East Asia.
First is the US$120 billion Chiang Mai Initiative Multilateralisation (CMIM) facility that plays an important role in providing financial insurance at the regional level. Launched last March, the CMIM is the most concrete proof of regional cooperation among the ASEAN+3 countries. Under the CMIM, countries have pledged their reserves to provide crisis-resolution insurance-like facility that offers liquidity support on very short notice. The activation of CMIM shows how this can be useful in creating confidence in the availability of dollar liquidity in the region. By pooling reserves and risks, this regional financing arrangement can help mitigate external shocks that hit an individual economy.
To support the CMIM, efforts are underway to establish a regional surveillance office among ASEAN+3 countries in Singapore by early next year. This surveillance body is supposed to conduct regional economic monitoring in ASEAN+3 countries to facilitate prompt activation of the CMIM. During non-crisis period, it will be responsible for undertaking comprehensive macroeconomic assessment of the region and identifying emerging vulnerabilities through rigorous country consultations and conduct of early warning systems. In time of crisis, the regional surveillance unit will assume a more crucial role in supporting the collective decision-making process prior to any disbursement of funds as well as in monitoring the use and impact of the funds post-disbursement.
Another major ASEAN+3 initiative that can support post-crisis recovery in the region is the Credit Guarantee and Investment Facility (CGIF) under the Asian Bond Markets Initiative (ABMI). This US$700 million trust fund will be used to provide guarantee to bonds issued by Asian companies, thus facilitating corporate bond issuance and reducing funding costs. Operational details of this facility are currently being discussed. CGIF is expected to be operational by end-December this year.
Looking ahead, the increased financial integration among ASEAN+3 countries can serve as an important link in facilitating the pace of economic recovery in the region. Such efforts can help lower the risk of a future financial crisis through initiatives such as the CMIM and CGIF. The ASEAN+3 countries have also agreed to explore the next stage of their financial integration.
Financial Development and the Challenges of Sustaining Growth and Recovery
Finally, in line with the theme of this Summit on “Financial Reconstruction and Economic Development”, I would like to talk about the links between financial development and the challenges of sustaining growth and recovery in the region.
In theory, financial sector development is desired for two reasons. First well-developed financial markets may facilitate financial flows that moderate the boom-bust cycles in the economy. Second greater financial flows may lead to efficient allocation of capital to competing investments, thereby promoting economic growth.
The evidence is clear on the benefits of integrating the financial markets. For example, financial integration serves as a catalyst for financial sector development, by encouraging competition that enhances intermediation and forces financial institutions to adhere to international best practices and norms. Financial integration also facilitates transfer of technology, efficient risk-management techniques, and policy discipline that signals a country’s commitment to sound policies. Taken together, all of these will lead to increase efficiency of output, and consequently higher growth for the economy.
Against this broad agreement on the role of financial markets in economic development, an immediate challenge for the region, including China, is to ensure that the financial sector contributes to strong economic growth. In this regard, I see four important policy challenges in sustaining the recovery in which the financial sector can play a crucial role.
First, Asia must be ready to participate actively in global rebalancing. In the case of some Asian countries with large external surpluses, the domestic demand must be strengthened to rebalance their economy by increasing private consumption and investment. By rekindling private demand, new sources of growth can be created, thus restoring strong growth in the region.
One way to address this is through better financial intermediation. By having well-developed financial markets, new savings instruments can be created that allow individuals to increase their incomes and consumption. For corporations, access to deeper capital markets may free up corporate savings, thus enabling corporations to invest more in domestic industries.
In China, for example, the government is taking steps to boost consumption through measures that improve the efficiency of bank intermediation. Banks are diversifying their activities to encourage consumer credit. As at end 2008, consumer spending accounts for 12.4% of GDP, and continues to be the fastest growing segment of bank lending. To enhance household access to small loans, the China Banking Regulatory Commission (CBRC) announced a pilot program in 2009 to allow the establishment of non-bank consumer finance companies.
Second, policy makers should continue to manage well the various risks in the economy. Given the dynamism of the markets, risks cannot be avoided. Thus, the best way to prevent boom-bust cycles that can undermine macroeconomic growth and stability is for countries to always remain cognizant of these risks. For example, policy makers must be ready to address financial sector risks and reduce the likelihood of systemic risks. Toward this end, the scope of financial regulation needs to be further widened. Closer cooperation is also crucial to pool macro-financial expertise and address emerging risks and vulnerabilities in the financial sector.
Third, measures to strengthen policy coordination and surveillance must play a central part in the region’s medium-term growth strategy. This requires sharing
information among countries and providing advice to each other regarding the monitoring of economic risks. As we all know, surveillance and policy coordination at regional levels can help reduce the risk of future crises and promote regional dynamism. Consequently, this will help ensure the stability of growth.
Thus, the establishment of regional surveillance in ASEAN+3 early next year, is a step in right direction. Surveillance may improve policy discipline and signals a country’s commitment to sound policies. It also implies that without an effective monitoring of economic risks and policy vulnerabilities, the current recovery cannot be sustained. In this regard, China’s active participation in regional surveillance under the ASEAN+3 Process is encouraging because without a strong China, global rebalancing might be difficult to achieve, in my view.
Finally, to support growth and recovery, deeper reforms in the region must continue. These include the critical financial reforms. In addition, we need reforms that improve institutional frameworks, streamline regulations, and rationalise government policies so that “behind-the-border” barriers are minimized. More important, Asia including China should seek to spur growth by promoting productivity growth. This means substantial investments in education, infrastructure and other technological advancements to realise the output potential of each economy. At a regional level, this means more open and freer financial, goods and labour markets as well as liberal trade and exchange rate system as in the case of ASEAN’s determined goal of establishing an ASEAN Economic Community by 2015.
In closing, I would like to reflect on three important challenges as Asia including China moves toward a post-crisis recovery.
One, Asia should remain committed to financial sector reforms. These include priorities related to strengthening regulatory and supervisory regime, and crisis resolution mechanisms. In addition, there is a need to focus on other critical financial sector policies on corporate governance among others.
Two, as Asia leads the recovery and to sustain economic growth, there is a need for a resilient financial system that will restore financial intermediation and allocate capital efficiently. So far, the financial integration is a step in right direction but more efforts are still needed to ensure that economic growth is well secured.
Three, for China and Asia as a whole, the post-crisis recovery presents an opportunity to contribute to the re-shaping of the global financial system. In as much as the market stresses and risks in global financial markets remain elevated, the challenge is for Asia to remain flexible to change particularly in building a new financial architecture. Moreover, having learned the hard lessons from the Asian crisis and global financial crisis, the pursuit of economic growth and stability should always be the priority of the region.
I wish this China Finance Summit every success.