The coronavirus disease (COVID-19) pandemic has battered, bent, and reshaped many things in its wake. Asia's financial system has not been spared either. The pandemic has exposed its structural weaknesses. The good thing is that the shortcomings spotlighted are an opportunity for all to step up efforts to collectively tackle them. This call to action applies to members of ASEAN+3—the Association of Southeast Asian Nations' (ASEAN) 10 members plus the People’s Republic of China (PRC), Japan, and the Republic of Korea.

Here are some areas of concern, which are drawn from a forthcoming ADB book entitled “Redefining Strategic Routes to Financial Resilience in ASEAN+3”:

Banking risks

Although banks were generally in good shape when the pandemic hit, growing nonperforming loans could give rise to financial distress as policy support winds down. As the region continues to grapple with the pandemic and its ripple effects, the deteriorating credit quality of nonfinancial borrowers poses a clear and present danger to financial stability.

The region also remains vulnerable to the concentration of cross-border borrowing from some large regional and global banks. Regional regulatory cooperation should be strengthened to guard against region-wide slow-burn contagion. Greater sophistication in the international financing activities of regional firms can also obscure the sources of increased external vulnerability.

US dollar dependence

The continued dominance of the United States (US) dollar as an invoicing and reserve currency and in external financing presents significant challenges to the regional economies as exchange rate flexibility has limited capacity to insulate many of its economies from external shocks.

While some regional economies (particularly the PRC, Japan, and Thailand) have taken important steps to internationalize their respective currencies, they have not made significant headway. There are, however, some signs that regional (own and partner) currencies are increasingly being used for trade among ASEAN+3 economies and with the European Union. Policy actions could help nudge this trend forward.

While reducing the region’s US dollar dependence must remain an objective for the medium to long term, the immediate aim should be to develop a region-specific integrated policy framework that promotes macro-financial stabilization in a US-dollar-dominated financial system.

Fintech challenges and opportunities

The COVID-19 pandemic has accelerated the shift towards fintech activities. Fintech can offer significant benefits in terms of greater efficiency, transparency, convenience, and enhancing financial inclusion. That said, there is a need to balance the benefits of financial innovation with possible costs involving financial stability, consumer protection, cybersecurity, privacy and data protection, and measures to tackle money laundering and terrorism financing.

These areas require greater international cooperation in the development of legal, regulatory, and supervisory frameworks, monitoring capital flows, harmonizing of standards, and better sharing of data. Regulators also need to recalibrate their policy frameworks to better deal with specific types of systemic and contagion risks arising from the interconnected activities of Big Tech firms across multiple sectors in various jurisdictions.

Funding sustainable infrastructure

The region, still in the grip of a long-drawn pandemic, faces a significant financing gap for infrastructure investment, especially if climate mitigation and adaptation needs are factored in.

Mobilization of private finance for funding renewable energy and low-carbon infrastructure remains an acute challenge in the region. Despite the recent surge in interest in green bonds, concerns persist about greenwashing and the lack of generally accepted standards about what constitutes environmental, social, and governance investment.

Regional cooperation could help develop standards and other measures to facilitate the development of green finance. More could also be done for greater regional consistency on carbon taxes.

Financial sustainability of pensions

The rapid population aging in many ASEAN+3 economies has major implications for the management of public and private pension systems. This is particularly acute in the PRC, Japan, the Republic of Korea, Singapore, and Thailand, where old age dependency ratios are rising sharply.

Despite the scale of pension coverage and sustainability as an issue, there appears to have been little discussion about it at the regional level. This is concerning from the perspectives of social welfare and macroeconomics as unsustainable pensions and rising contingent retirement liabilities might spark a fiscal crisis in one country with effects that spill over to neighbors.

On a positive note, pension funds with large assets under management are a potential source of demand that could facilitate the development of local currency bonds.

Moving forward

In view of the high degree of economic and financial interconnectedness in the region and the potential spillover impact, clearly more could be done by ASEAN+3 to strengthen regional financial cooperation.

There are many things the grouping can work on, including developing regional capital markets for long-term finance, strengthening cross-border market infrastructure, improving regulatory cooperation, and tackling emerging issues such as financing climate change mitigation and the rapid rise of fintech and big tech firms in finance. Management of cross-border risks and enhancement of crisis surveillance forms a substantial part of this effort.

A clear long-term vision is essential too for navigating the path of regional financial cooperation to achieve substantial results along agreed milestones of necessary reforms.

This article was first published in The Straits Times.

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