Challenges and Opportunities in Developing More Competitive and Innovative Financial Sector in Asia

Keynote Speech by ADB President Takehiko Nakao at the Asia Securities Industry & Financial Markets Association Annual Conference 2013, Developing Asia's Capital Markets, Hong Kong, China

as drafted

Introduction

Your Excellency K C Chan, Secretary for Financial Services and the Treasury of Hong Kong SAR, Mr. Charles Li, Chief Executive of Hong Kong Exchanges and Clearing Limited, distinguished guests, ladies and gentlemen.

I am honored to be here this morning, and would like to thank ASIFMA for inviting me to address our region's top experts on finance and capital markets.

I would like to use my time today to speak on five important issues: first, the increasing role of emerging market economies globally; second, what the international regulatory reform after the Global Financial Crisis means for Asia's financial system; third, the need for more competitive and innovative finance for the region; fourth, the importance of further developing the region's capital markets; and finally, what ADB is doing to promote financial sector development in Asia.

The increasing role of emerging economies globally

After 5 uncertain and volatile years, the outlook for advanced economies—Europe, Japan, and the US—has started looking better, even if the recovery remains fragile. The US economy shows signs of picking up; the eurozone appears to be turning the corner; and Japan is responding to "Abenomics".

Developing Asia saw market turbulence after Chairman Bernanke's remarks in May about tapering quantitative easing. But in our judgment, emerging Asia today is much better placed than during the 1997/98 Asian financial crisis to ward off stress. Macroeconomic policies are far more sound, financial systems are stronger, ample foreign reserves provide buffers, and regional safety nets like the Chiang Mai Initiative and expanding swap arrangements offer financial resilience.

ADB's latest forecast for developing Asia shows economic growth declining marginally from 6.1% in 2012 to 6.0% this year, then slightly rising to 6.2% in 2014. Despite risks and uncertainties, this is still relatively stable, robust growth.

Beyond the short-term, I believe the global economy is continuing an important structural transformation, particularly through the growing role of emerging economies. Between 1990 and 2012, emerging economies in the world grew far faster than the global average. Their share of world GDP nearly doubled—from 20% to 38%, according to IMF data. More importantly, emerging markets' share of annual world GDP growth jumped from about 20% in the early 1990s to more than two-thirds today. And developing Asia made a major contribution. It is quite remarkable.

ADB's client countries are now predominantly middle income countries. Five of ADB's 45 developing member economies, including Hong Kong, China, have already attained high income status. Thirty-three are now classified as middle income. Only seven remain ranked as low income—and they are all showing healthy growth rates.

So while ADB continues to help our poorer member countries, we must also focus on ensuring our majority middle income members address their challenges appropriately, and escape the "middle income trap". These countries need to make efforts on many fronts including building good infrastructure, investing in human capital, enhancing governance, and promoting innovative technologies. Making the needed investments requires mobilizing financial resources in an efficient manner. Developing sound and active financial systems and markets is essential to that end.

Implications of the Global Financial Crisis for Asia

Here I would like to touch upon implications of the global financial crisis and subsequent regulatory reforms for Asia. The 2008/09 Global Financial Crisis was different from past crises in its origin and complexity. It started from global financial centers. From subprime to Lehman Brothers' to Europe's sovereign debt, it is clear that the global financial system needs serious reform.

In Asia, the crisis and subsequent international regulatory reforms had a lot of implications for financial systems, especially the banking sector—the core of the financial activity in the region. While highly diverse across countries, Asian finance remains dominated by banks. Without a doubt, banks offer most essential financial services and naturally form a core of the financial sector, especially in developing economies.

In response to the Global Financial Crisis, it was agreed to strengthen rules regarding the banking sector in terms of capital adequacy, liquidity risk management, and systemically important financial institutions, or SIFIs.

Many middle income Asian countries have already adopted Basel III rules to enhance financial stability in their markets. In addition to Asian members of Basel Committee, that is, the People's Republic of China; Hong Kong, China; India; Indonesia; Japan; Republic of Korea; and Singapore; other emerging countries such as Malaysia, the Philippines, and Thailand have already adopted Basel III. Not doing so could attract regulatory arbitrage and encourage the migration of risky financial activities to Asia.

The good news is that most Asian banks are in good shape now and even already appear to meet Basel III standards thanks to adequate capital, liquidity and provisioning, and relatively modest levels of nonperforming loans. Indeed, Asian banks are filling the gaps created by deleveraging European banks.

Toward a more competitive, innovative, and inclusive financial sector

At the same time, Asian developing countries cannot be complacent about their financial systems. For developed financial markets, it is natural that reforms focused on enhancing stability in the markets, but for developing countries, promotion of more competitive, innovative, and inclusive financial sector should be also pursued.

It is true that the Asian banking sector weathered the crisis better and remains more stable. But it may also reflect a lack of sophistication and innovation, the narrower scope of their business, and underdevelopment of financial players outside traditional banking.

Let me discuss specific areas which developing Asia should promote.

First, about repos and securitization. Global efforts to enhance financial stability are now rightly dealing with interconnectedness—for example, bank exposures to shadow banks via repos and securitization. Yet, in many Asian middle income countries, the markets for repos and derivatives are underdeveloped or even nonexistent. Although the danger of moral hazard in the originate-and-distribute model must be addressed, the region should explore the benefits of securitization.

Second, financial inclusion. Developing Asia also needs to provide more inclusive finance to reach unbanked households and small and medium enterprises, or SMEs. The region should aggressively take advantage of technology in enhancing financial access via mobile banking and other innovations.

Third, Asia also needs to ensure that trade finance—relatively short-term and safe finance—will not be compromised by leverage limit imposed by Basel III.

Fourth, Asian middle income countries also need to diversify financial services beyond traditional banking, and to develop such services as leasing and factoring. This would help enhance SMEs' access to reliable finance.

Fifth, frontier economies must focus more on improving banking foundations such as payments systems, interbank money markets, and central bank monetary operations. And they must build a core financial legal framework.

Sixth, we should also promote more competitive and integrated financial markets in Asia. ASEAN is now working on scaling up financial system through the integration of financial services and markets as part of its ASEAN Economic Community agenda.

Finally, about SIFIs. Regional integration of financial systems may lead to the creation of SIFIs operating across national borders. ASEAN members need to set a higher capital requirement for these SIFIs, define roles of national deposit insurance systems, and build arrangements for cross-border resolution of distressed banks.

Need for Developing Capital Markets

Let me turn to related but another set of challenges for Asia. That is to develop active and deep capital markets. It is particularly necessary to mobilize long-term resources to finance infrastructure investments. Though a high saving region, Asia is actually short of instruments that can intermediate long-term savings, as much of Asia's savings is concentrated in short-term bank deposits.

Indeed, many middle income countries in the region have successfully developed equity markets and—more recently— government bond markets. The region's bond markets have grown 15 times in size since the 1997/98 Asian financial crisis. However, until recently this growth has been largely in government bonds.

Asia needs to promote corporate bond markets. It also should expand the markets for structured instruments particularly those financing public private partnerships, or PPPs. Asia's massive infrastructure investment requirements cannot be met by public finance alone.

Under its Asia Bond Markets Initiative, or ABMI, ASEAN+3 established a Credit Guarantee and Investment Facility — designed to support the issuance of local currency corporate bonds by enhancing their creditability. ASEAN+3 is also working on harmonizing corporate bond issuance, streamlining cross-border trade processes and processing, and enhancing cross-border settlement of bond trades.

More recently, the region's corporate bond markets started to grow faster—as banks were faced with acute liquidity contractions and needed to deleverage in wake of the Global Financial Crisis. This has helped the region's corporate bond markets demonstrate their ability to function as a "spare tire" when banks are under stress.

In nurturing corporate bond markets further, the role of pension funds and insurance companies as stable bond investors is crucial. In this regard, I believe the region should turn another major policy challenge into an advantage. Several middle and high income countries in the region face the challenges of an aging population. This will naturally bring about the growth of contractual savings, such as pension funds and insurance companies.

One important technical issue is the need to promote currency swap markets and central counterparties or CCPs for them. Active bond markets should be complemented by efficient and deep currency swap markets, particularly in financing long term infrastructure projects. One challenge is that new global regulatory standards require greater capital for exposures to over-the-counter or OTC derivatives, possibly including currency swaps that are not cleared by a central counterparty, and not reported to a trade repository. Thus, Asian middle income countries will likely need to develop their own CCPs and trade repositories in conjunction with efforts to develop currency swap market.

Finally, I would like to touch upon two issues regarding market stability. One is that Asian banks now hold a significant amount of bonds on their balance sheets—and, therefore, are more exposed to interest rate risk. Monetary authorities will need to monitor this.

The other is that larger and more liquid government bond markets created a new channel for speculation on currency carry trades. Indeed, capital flows are again a policy concern across the region in anticipation of the inevitable tapering of quantitative easing. The region's authorities need to come up with effective macro prudential measures to deal with this new risk.

ADB's role

In most of the areas I just mentioned, ADB is co-working with member countries and regional institutions through its technical assistance. ADB's operations supporting financial sector development comprise about 10% of its lending. Our focus is on (i) foundations for the financial sector such as payment systems, central bank law and banking laws, (ii) financial inclusion, (iii) capital market development for infrastructure finance, (iv) financial stability and integrity, and (v) regional monetary and financial integration. ADB has also increased its trade finance program, partnering with private banks in the region in the wake of the global financial crisis.

In the area of regional monetary and financial integration, ADB has been supporting the integration of capital markets and financial services in ASEAN. ADB is also a strong promoter of the ASEAN+3 Asian Bond Markets Initiative. Recently, ADB developed an Asian Currency Note Programme, under which we issue local currency notes in countries participating in the program.

We are stepping up our knowledge generation and dissemination on issues of financial inclusion, capital markets, contractual savings and financial stability.

I offer my commitment that ADB will continue to work seriously toward developing a more competitive and innovative financial sector to sustain and enhance inclusive and balanced growth in Asia. In this endeavor, dialogue between private sector, partner governments and other stakeholders, such as we have in today's conference, is critical.

Thank you very much.