Home Banking The Asian Renaissance

The Asian Renaissance

by internationalbanker

By Gerren Bethel, Deputy Editor Finance Publishing

With its share of global GDP forecast to grow from 22 percent in 2013 to more than 30 percent in 2023, the emerging Asia region is projected to experience rapid growth over the next decade. Additionally, impressive increases in the size of Asia’s financial sectors are forecast for this period – with the size of global banking-sector assets in the Asian region rising to more than 30 percent from 18 percent over the same period of time.  Further to this, trade both between Asian countries and between Asia and the wider international marketplace has been growing at a rapid pace. However, at this time it appears that financial interconnectedness is lagging. Asian companies have been expanding abroad, and Asian savers are looking for new places to invest their funds.  Asia’s interconnectedness will need to extend in order to meet this changing economic landscape, and furthermore, new risks will arise from these changes and should be addressed head on.  The Asian region had to adapt and learn from the lessons of the 1997 Asian financial crisis. Some of these lessons were not applied outside of the Asian region, leading to a repeat of history with the 2007 financial crisis. The lessons learnt in 1997 meant Asia was better able to weather the storm of the 2007 financial crisis; however, there are now a whole new set of risks and challenges on the horizon in this post-global-crisis climate.

The industrious and emerging economic regions across Asia have developed substantial, sophisticated financial sectors; however, in today’s economic climate, they are facing new and evolving challenges.  Sustaining the impressive level of growth experienced over the region will hinge on the ability of the financial sector to develop and innovate amongst other significant infrastructure hurdles. Connectivity between business communities and financial services is a key concern as well as the internal management abilities of financial-services firms to conduct new financial processes efficiently whilst managing the risks that come as part of meeting new demands.   Asia’s banking sector will be central to a significant period of change for the region – which many industry participants are beginning to refer to as an “Asian Renaissance”. Banks and financial firms will help facilitate investment, integration and inclusion across Asia, crucially driving this renaissance forward. Continual development and provision of creative new approaches will be vital to developing ensured resilience to both international and domestic shocks – all the while meeting the evolving demands arising from demographic changes across Asia.  Additionally, it is critically important to ensure that this process is developed around maintaining and strengthening financial- system stability as well as economic sustainability. This should be placed as a primary concern as the Asian economies continue to grow. 

The key to navigating the future will be to take heed of the lessons learnt from the past. This will help guide the Asian region through their renaissance period in a sustainable manner.  The Asian markets have faced pivotal crossroad periods in the past, and how the tools and powers of change are harnessed moving forward is central to consistent development.  The Asian region went through a period of major change following the 1997/1998 Asian financial crisis. Prior to this, the most significant period of change came through the emergence of the Asian Dragon Nations (Hong Kong, Singapore, South Korea and Taiwan), which experienced dramatic economic growth and significant rises in living standards over more than a decade. The most prominent difference for the Asian region, however, when compared to Western developed economies, has been the fact that growth through this period was boosted dominantly by bank servicing and finance.  Substantial capital flows, mostly sourced from external bank borrowings, were drawn into emerging Asia during this growth period to the point that the total amount of international bank lending in 1997 to the Asian region totalled US $840 billion. The majority of this external financial flow was of short-term structure and was US-dollar denominated – what the financial community in general would deem very risky as the flows involved currency and duration mismatches.  These risks were ignored as optimism spread about the booming Asian market performance prior to the bubble bursting and subsequent financial shock in 1997. The Asian crisis that followed meant that many had a hefty price to pay for ignoring these risks. The key to the Asian renaissance will be a realistic assessment and efficient management of the risks on the horizon. Complacent optimism will not be satisfactory in building a stable foundation for further development.

Since the 1997 Asian financial crisis, numerous structural reforms have been implemented across the Asian region, and these economies have now re-emerged as stronger and more resilient than at pre-crisis levels.  Asia has garnered increasing amounts of international attention and is increasingly becoming a favourite and popular destination of choice for international capital flows. This time the structure of banking services and finance in Asia has adapted, and although external bank borrowings are still somewhat significant, the key to financing has been significantly from bond borrowings.  For example, over the past three years, approximately 80% of bond issuance in major Asian economies has been domestic-currency denominated.  The importance of this is that the risk- management and mismatch challenges of the past boom period have been addressed and mitigated to a certain degree.  Further to this, the term of the newly issued bonds is much longer, and consequently much more stable – the average length was 6.3 years in 2013 – and this makes significant progress in mitigating maturity mismatches and short-term roll-over risks for borrowers and lenders and the wider economy at large.

Although these changes indicate positive changes for the region, there are still many more challenges to face in the near future.  Complacency still remains a major risk for both short- and long-term stability. In the short term, on a global landscape, the region will have to contend with the role of the Fed’s policy. As is true with all nations across the globe, the impact of US policy can be wide and deep-reaching within international economies. How the Asian region responds to US interest-rate changes and tapering policy will be a key concern for financial and business-industry participants as they remain uncertain as to when and to what extent the carry trade will run out of favour.  Following the collapse of Lehman Brothers, the carry trade has aided capital flows for the last five years across Asia, and US tapering combined with potential interest rate hikes on the horizon are threatening this flow as these changes will result in substantial outflows of funds from the region. This drop in liquidity will have a wide impact for Asia and may lead to falls in growth.  A re-pricing of assets, factoring in new interest rate levels, will be challenging over the next few years. Over the longer term, capital-market structural reforms, designed to meet the changing economic landscape, will be the biggest challenge. The key concern for all involved parties, policy-makers and banking participants, is infrastructure financing. There is a huge need for investment in Asian infrastructure over the next decade – the amount of infrastructure funding required across Asia has been estimated recently in February 2014 by the Hong Kong Monetary Authority to be approximately US $750 billion a year. 

On the upside, Asia has in fact accumulated sizeable savings that may be put towards meeting this huge infrastructure-investment need. However, although there are more than enough saving funds to meet the need, the flow of capital from where it is saved to where it is needed is proving a burdensome challenge. In reality, a massive part of these savings is channelled through banking and financial channels to advanced global-capital markets and then part of these savings flow back through to Asia. This has created an unhelpful and ineffective pattern. Firstly, the implementation of Basel III has meant that banks no longer find it attractive to lend to long-term infrastructure projects due to the increased capital charges required to hold these types of assets on their balance sheets.  In particular, many European banks, historically active in Asian infrastructural financing over the last decade, have been forced to reduce their exposures in this area due to the changes in regulation and are planning to do so increasingly in the future in meeting more stringent regulatory requirements. This means numerous Asian infrastructural projects are finding it difficult to secure the finances necessary to drive projects forward. On a similar note, fund managers and bankers are also noting that although they have an ample supply of funds and are looking for global-investment opportunities, they have found that lending or investing in Asia’s infrastructure has been hampered by a shortage of so-called “bankable” projects. Issues involving legal, governance and political risks have meant that few of these projects are deemed adequately “bankable”, and this has created a gap between available capital and a funding need when it comes to Asian infrastructure. Narrowing this gap will be vital to continued growth for Asia – without the development of Asian infrastructure and financial markets, the potential for future growth will be impaired significantly.

Numerous other positive changes were made to the Asian financial sector following the Asian crisis that began from the attack on the Thai baht back in 1997. The Asian banking and regulatory authorities made a number of changes that helped the region even through the global financial crisis and has put the Asian region in a position to develop further through a blossoming renaissance period should the relevant supervisory parties take necessary actions. Following the Asian crisis, the subsequent broad range of economic and financial-sector reforms created a favourable platform from which the region may now build upon.  One of these changes was the head-on management of poor financial-asset and financial-institution quality. While failed financial institutions were shut down, the remaining viable banks were recapitalized and their nonperforming poor-quality assets were either removed altogether or sold to restore profitability to the banking sector.  The Western economic environment has been slower to carry out this same process in the wake of the global financial crisis, and subsequently the Western banking system is lagging that of Asia when it comes to banking stability, viability and repairs – creating more demand and interest for the Asian financial sector. Additionally, after the Asian financial crisis, authorities were quick and efficient in repairing regulatory and supervisory gaps in the operating frameworks. New and improved laws, institutions and requirements were introduced and effectively incorporated in order to close these gaps. By taking a comprehensive proactive approach to banking services, regulation and supervision, more effective risk-management policies and procedures have been built into the financial system. Corporate governance has become a priority in the majority of Asian companies, and an approach of disclosure and democratic processes have taken increasing roles in these major institutions. This has led to more effective business and economic activity. Tougher penalties for unethical banking practices have been put in place alongside an expansion of supervisory powers to conduct regular and thorough regulatory examinations.  A further positive change in the Asian economy over the past decade has been a substantial investment in the modern-market infrastructure. This was driven forward with the purpose of ensuring that the financial and banking sectors were able to cope with the rapidly evolving demands of the region.  Additionally, authorities in many Asian countries have implemented measures to encourage the development of local-currency bond markets – reducing mismatches of currency and duration risks from sources of funding and underpinning a more stable investment environment.

Perhaps the change implemented in the Asian region that most significantly sets it apart from the international economy has been that of macro-prudential policy. Asian authorities put in place, well ahead of the rest of the world, macro-prudential policies designed specifically to ensure financial stability for the region. This so-titled macro-prudential policy entails a broader approach to risk management. Asian authorities are tasked with responding to emerging systemic risks by deploying a variety of changes and instruments, such as placing restrictions on loan-to-value and debt-to-income ratios, limits on currency and maturity mismatches, and adjustments in risk weights to contain excessive financial imbalances. This direct and far-reaching approach to risk management has created a stable foundation for economic activity across the region – especially when compared to Western regions, which are also lagging in this type of reform.

It is clear from the fallout of the global financial crisis that the Asian economies and financial systems are much healthier than those of many advanced economies, Western or otherwise.

Numerous factors have contributed to this health and are now set to push the Asian region into their next renaissance phase of growth. The leverage in the Asian region has been restrained to much more sensible and manageable levels when compared to many Western and advanced economies globally. The Asian region has ensured that it is not reliant on wholesale sources of funding – and even in countries where wholesale funding has grown to significant size, effective measures have been taken to constrain it with a firm view of effective risk-management in mind, such as in Korea and New Zealand. Furthermore, the Asian banking system was properly capitalized with high-quality capital prior to the global crisis, especially when compared to the rest of the global economy.  As an example, for Europe in 2008, Tier 1 capital was 8.3 percent of risk-weighted assets whilst the ratio was 10.7 percent within advanced Asian economies, and additionally in the ASEAN region, the ratio was 11.5 percent over the same period. These disparities have persisted and indicate a strong position for the Asian economic region going forward.

Tightly monitored and upheld regulatory restrictions have also meant that the exposure of Asian banks and financial institutions to poor-quality assets, such as subprime loans and structured-credit products, has been kept to a minimum. This has kept the Asian banks’ balance sheets healthy and stable. The presence of these instruments in Western banking systems has created instability in those systems and again reinforced the strengthening position of the Asian economic region when it comes to investment and banking activity. Asian regulatory and supervisory authorities have taken significant steps to reduce macroeconomic and external imbalances since the time of the Asian financial crisis, and this has created a stable basis for robust and rapid economic expansion. The steps taken by the authorities led to lower inflation and more sustainable current accounts for these countries in addition to lowered external debts. Changes have been put in place within the exchange-rate mechanisms such that the regimes have become increasingly resilient and credible – further encouraging stability and economic activity in the region. In particular, a number of Asian countries allowed their currencies to depreciate during the global crisis, which allowed a cushioning of the damage stemming from capital outflows through that period – allowing these economies to weather the crisis much better than other economies across the globe.

By enacting an approach fully and firmly of thorough and clear policy change, the Asian region has been able to establish itself as a leader in growth and stability internationally. The changes implemented since the time of the Asian financial crisis have continued to help drive Asia forward today. From mid-2013, many countries have utilised the buffers they built up in good economic times and deployed a strategy mix of exchange-rate depreciation, external reserves and higher interest rates to face the tightening of global financial conditions following the Fed’s announcement of tapering of asset purchases. Individual countries’ circumstances have also contributed to the challenges faced. For example, countries such as Indonesia and India have large macroeconomic imbalances and have had difficulty in managing these through the recovery. However, decisive and vitally responsive action of the authorities across the region has led to a relatively calm and stable reaction from Asian financial markets – bolstering confidence worldwide of the Asian economy’s ability to manage challenges on the horizon, both expected and unexpected.

Although the above factors point to a promising and stable footing for further growth across the Asian region, there are a number of key challenges on the horizon that must be dealt with effectively. Firstly, there is the significant and growing concern of the shadow-banking industry. It is currently insufficiently regulated, and if left to grow further, is likely to get out of control and pose risks to the wider economy – leading to large build-ups in systemic risk. Rapid economic growth has led to rapid growth in demand for shadow-banking services as regulatory and infrastructural change in the formal-banking sector has lagged the pace of wider innovation. This makes risk-assessment more difficult and therefore harder to tackle directly. The proper frameworks will need to be put in place to address these risks and bring them to light to be managed effectively. Part of this concern is an issue of interconnectivity. Connecting and directing shadow-banking transactions into the mainstream and regulated financial system will create a more integrated and interconnected system – removing systemic-risk build-up. 

Furthermore, the financial systems across the Asian region are becoming more and more complex, and new regulations need to be developed to meet these complexities. Although integration within the Asian region has been effective, integration with the wider international economy is less up to speed.  Asian financial institutions are also increasing their activity and presence in frontier markets, such as Africa. This will lead Asia’s financial systems to more closely resemble Europe’s, where addressing cross-country exposure risks is an important and integral element of financial supervision. The concern of “too big to fail”, as experienced across Europe and the US, is also a concern for the Asian region – whereby governments would not allow major financial institutions to fail leading to an inefficient economic system.  Although the global response to this particular type of risk – such as capital charges under Basel III – are being adopted across the globe by many national authorities, Asian authorities need to devise their own additional measures to mitigate these risks.  Global banks have continued to grow in complexity and size despite the regulatory changes. Supervisors must be prepared to expand their operational perimeters to include new types of financial services and firms, and to intervene in businesses that they may perceive pose systemic risks to the economy.

In tackling these risks, the IMF has been working with national authorities globally to improve the ability of regulators to supervise and enforce regulations, whilst limiting systemic risks through macro-prudential measures. In particular, further efforts are required at national levels to ensure authorities have the appropriate tools, and cross-border cooperation, when dealing with increased amounts of geographic and economic interconnectedness and integration.  Asian regulators should act to institute regulations that can guide the financial system towards minimizing risks associated with highly interconnected banks that have become too big to fail. While capital charges for banks with high systemic risks can aid in this, other measures are needed to ensure Asian banks remain manageable in size. With Asia’s financial sector expected to grow more rapidly than other regions, Asia has more space to address these challenges early, and should guide this rapid growth in ways that encourage the development of banks and financial firms operating with less systemic risk.

The impressive growth of the Asian region sets it apart from the rest of the world – currently leading economic growth by a wide margin. The expansion of the Asian financial services and banking sector is forecast to continue to grow at an impressive rate also.  By applying the lessons learnt from the Asian and global financial crises, this period of growth and expansion may be managed and incorporated into a sustainable and successful growth narrative. A new global regulatory perspective and approach will help drive future prospects.  Going forward, a close eye will need to be kept on certain growing risks that will be particular to the region – especially those stemming from rapid growth.  One example is that of credit-to-deposit ratios. Prior to the global financial crisis, credit-to-deposit ratios were much worse in Europe than Asia. However, as demand for Asian borrowing has grown – from substantial growth and investment in the region – credit-to-deposit ratios have now worsened in Asia whilst staying the same in Europe. Additionally, by addressing and closing regulatory and supervisory gaps, the challenges and risks of regulating cross-border financial activity can be mitigated and lead to a smoother flow of funding, project fulfilment and success across Asia.  Improved financial integration will feed future sustainable growth. The wider benefits of a broader and deeper application of capital across the economy must be factored into decision-making and risk-management.  Interconnectedness and policy reform will be key for an efficient financial sector over the coming years, and if these tools and challenges can be harnessed for positive and effective change, the Asian region is set to be not only a global leader in growth opportunities but also a global leader in financial stability.


Related Articles

Leave a Comment

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.