Keynote Speech 1 by ADB Vice-President for Operations Group 1 Wencai Zhang on 9 December at the International Financial Cooperation Forum—Strengthening Financial Infrastructure: Towards Shared Growth of Financial Markets in Asia in Seoul, Republic of Korea.

Introduction

Vice Chairman Dr. Chan-woo Jeong, Dr. Chang-Hyun Yun, Dr.Changyong Rhee, distinguished guests, ladies and gentlemen,

On behalf of the Asian Development Bank, I am honored to speak with you today on Asia’s economic prospects and financial development, especially its market infrastructure and deepening integration. I want to thank the International Financial Cooperation Forum for this opportunity and the fine preparations for this conference. Let me start with a synopsis of the economic outlook for Asia, before delving into the region’s financial development, infrastructure and integration.

Asia's economic trends and prospects

In simplest terms, developing Asia remains the most rapidly growing region of the world. Recovery in advanced economies has been tentative this year. Economic growth in the G3 slipped during the first half—and we have been getting mixed signals since. Uncertainty remains over Japan’s prospects. And the eurozone economy continues to struggle. Even the better US growth outlook has yet to benefit Asia.

Despite the weak external environment, the region's economies—with few exceptions—have expanded strongly, with domestic—and in many cases regional—demand playing an increasingly important role. ADB's September 2014 forecasts1 projected that growth in developing Asia would pick up—from 6.1% in 2013 to 6.2% this year, rising further to 6.4% in 2015. This largely reflects country dynamics, which are mixed.

Yet, we see some potential challenges down the road that may have an impact on the region’s outlook. First is the possibility of delays in planned domestic reforms; second, weaker recovery in advanced economies, particularly Europe; third, a slowdown in China and several large ASEAN economies; fourth, capital outflows or financial volatility that could result from earlier than expected US monetary tightening; and finally, geopolitical risks. Taken together, these factors underscore why policymakers must follow through with their national agendas for structural reform, while keeping macroeconomic fundamentals strong.

This is most important for the longer term. Asia is in the midst of a transformation that seeks to boost the quality of economic growth—to make growth not only sustained, but also more inclusive and environmentally sound. Strong domestic fundamentals improve the region’s ability to withstand external shocks. And deepening Asian integration will boost growth prospects. Supply chains and production networks are vital to fuel trade, foreign direct investment, and the financial integration needed to better power developing Asia’s real sector growth.

How these processes of structural transformation and deepening integration are managed will help define Asia’s prospects in the coming decades. And this leads me to the critical importance of the region’s financial development and infrastructure.

Asia's financial development and infrastructure

Distinguished participants, ladies and gentlemen,

In this regard, we are challenged by the wide diversity in income levels,financial development, and financial infrastructure. Low income countries should concentrate on building foundations for their banking systems and establishing equity markets. Lower middle income countries tend to have functioning banking systems, but often lack core government bond and equity markets. Upper middle income countries are building nonbank sectors against a well-developed banking system and functioning bond and equity markets—some are trying to develop derivatives markets. One constant is the need to support capacity building, whether in frontier markets or for harmonizing and integrating existing financial markets.

Since the 1990s, Asia’s financial systems have diversified. Nonetheless, they remain highly bank-dominated with relatively shallow capital markets. Shallow capital markets constrain growth prospects, particularly when they are unable to supply sufficient finance for crucial infrastructure. Limited access to finance by small and medium sized enterprises, or SMEs, is also an issue. I want to emphasize that SMEs have grown to become a primary engine for future growth and can deepen value chains in Asia. And this is why we must work hard to deepen the financial system and supply the infrastructure needed to serve SMEs.

Nonperforming loans (NPLs) were a particular problem following the Asian financial crisis. By the end of 2000, the NPL ratio (as a percent of total loans) reached 8.9% here in Korea, 34.4% in Indonesia, 15.4% in Malaysia, and 17.7% in Thailand. Since then, bank capital and loan loss provisions have increased while NPLs have been drastically reduced. For East and Southeast Asia, increased financial strength came through bank consolidation, restructuring, and improvements in the regulatory framework. Asset management companies unclogged the financial sector drainpipe by cleaning bank balance sheets. Since the 1997 Asian financial crisis, the region has clearly enhanced financial stability. All of this helped return the financial system to its primary function of efficiently allocating credit for the real economy and aiding economic recovery. This success can provide lessons for economies currently experiencing financial and economic challenges from NPLs in other parts of the region.

Today, there is little question that these financial reforms and restructuring helped the region withstand the global financial shock in 2008 and 2009. However, developing Asia cannot be complacent. It is true that the Asian banking sector weathered the global crisis better than those of other regions. But this may also reflect the sector’s narrow business scope, underdevelopment outside traditional banking, and lack of financial sophistication and innovation.

As I stressed earlier, we must boost access to financial services—particularly for SMEs and low income households. We have seen innovative ways to support SME finance in many countries. For example, here in Korea, SMEs have been supported by pooling and securitizing privately-placed corporate bonds into publicly marketable securities—collateralized bond obligations, or CBOs. China has been promoting groups of SMEs to collectively issue bonds with credit enhancement from provincial guarantee corporations, which ADB supports. Another important way to support SMEs is through trade financing, particularly for those who need to tap international markets. For example, ADB's Trade Finance Program, or TFP, is designed to close trade finance gaps by providing guarantees and loans at market rates.

My job in ADB is to oversee its South, Central and West Asian programs. Financial development in these subregions differs in some aspects from that in East and Southeast Asia. Let me describe some of the work ADB is doing with our partners in these subregions. In India, ADB provides long-term sovereign loans to the India Infrastructure Finance Company, or IIFC, for on-lending to public-private partnership projects as part of a lending consortium with other commercial banks. This has allowed better risk sharing with commercial banks. In Bangladesh, we are implementing the Capital Market Development Program to strengthen the policy and regulatory framework for Bangladesh’s stock and bond markets, and provide institutional capacity support to Bangladesh Securities and Exchange Commission.

In Central and West Asia, the first pillars of a modern financial system have been put in place over the past 20 years. ADB has supported financial sector development in the region through programs, projects and technical assistance. In Armenia, Kazakhstan and Uzbekistan, ADB has worked with domestic banks supporting micro, small and medium sized enterprise development. We are also helping Uzbekistan and Kazakhstan develop the supervisory and regulatory framework for insurance market development and promote insurance penetration.

In sum, while significant progress has been made, the region’s financial markets generally remain segmented and vulnerable to shocks. After the Asian crisis, countries accumulated large international reserves—managed mostly outside the region rather than being used to finance development inside the region. This forum is a timely reminder of the importance of further strengthening the region’s financial systems and infrastructure to support economic development.

Asia's financial integration

Ladies and gentlemen,

Since the Asian crisis, financial market integration has also deepened. But it still lags real sector integration. For example, intra-Asian equity flows are slightly less than a quarter of the region’s total. In debt markets, intra-Asian investments continue to grow, but the level remains small, about 16%. While both figures are double what they were a decade ago, there’s a long way to go before they reach the levels of intraregional trade and FDI.

I should stress that much of this increased integration has been driven by market forces and the private sector. It is a natural response to the opportunities offered by new technology and better logistics.

Nevertheless, the integration process needs to be well-managed to avoid market failures that can lead to crisis and contagion across economies. Again, this is what the 1997/98 Asian financial crisis taught us. Regional cooperation—with ADB support when appropriate—has also intensified. Let me highlight a few examples.

Since the Asian financial crisis, finance ministers and central bank governors have held regular policy dialogues on how to improve financial stability. Through the ASEAN+3 framework, for example, the $240 billion Chiang Mai Initiative Multilateralization has been launched as a regional financial safety net. And the Asian Bond Markets Initiative, supported by ADB, has encouraged local bond markets to channel Asia’s large savings into productive investment within the region. ASEAN+3 also established a Credit Guarantee and Investment Facility—with support from ADB—to support issuance of local currency corporate bonds by enhancing their creditability. These initiatives continue to deepen cooperation.

Greater cooperation is also needed to ensure that Asia has a stronger voice in setting the standards of international financial regulations such as Basel III. A strong, more united Asian voice can better enunciate the region’s concerns in working out compromises.

This helps explain why deeper regional financial cooperation and integration are needed to support real sector development. They help boost productivity in three ways: first, by channeling savings into infrastructure financing; second, by enhancing financial inclusion—for example, drawing more households and SMEs into the system through increased financial services and more appropriate products; and third, by further developing regional contingent financing mechanisms and helping coordinate an Asian view or response to global events or issues.

Conclusion

Distinguished participants, ladies and gentlemen,

To conclude, developing Asian economies are on a steady growth path, one that allows for an increase in the quality of growth rather than just its speed. To support this, it is paramount that policymakers stay on course in their national reform agendas. Given the diversity in income levels across the region, financial market development must be designed to support the real economy and individual country priorities. Yet, as regional and global integration continue to deepen through production networks and supply chains, financial integration must follow suit. The region must create the necessary financial infrastructure to support more efficient and effective resource allocation, particularly to finance physical infrastructure, support SMEs and promote greater financial inclusion in general.

I want to take this opportunity to thank the Korean government for its continued collaboration with ADB. For example, the Korean Financial Services Commission strongly supported the launch of the International Public Asset Management Forum, or IPAF, to enhance knowledge sharing and strengthen Asia’s financial infrastructure. I would especially like to thank Minister Shin for the continued support for financial development initiatives.

I sincerely hope we all have very productive and fruitful sessions today for Asia’s economic and financial development.

Thank you.

1 More recent data suggest these projections may be subject to some revisions in our forthcoming December Asian Development Outlook Supplement. However, the revisions are not likely to change the big picture.

Speaker