Press Briefing for East Asia Financial Flagship Launch with Homi Kharas Chief Economist, East Asia Pacific Singapore, September 14, 2006 P R O C E E D I N G S MR. AL-ARIEF: Good afternoon. Thank you for coming to the launch of what we call the East Asia Financial Sector Flagship which we have titled, “The Road to Robust Markets.” This is actually the first report that tries to comprehensively capture the state of play in the East Asia financial market and to try to provide a road map toward a more robust financial market in the Region. Let me just give a brief introduction of the two distinguished panel members here. Homi Kharas is the Chief Economist for the East Asia and Pacific Region of the World Bank. He has been at the Bank for 26 years now, so he started at the Bank when he was two-and-a-half. Next to him is Swati Ghosh, who is principal author of the report. I’ll give the floor to you, Homi. Go ahead. MR. KHARAS: Thanks, Mohamad, and good afternoon to all of you. It gives me a great deal of pleasure to welcome you to this press conference and talk about “East Asian Finance: The Road to a Robust Markets.” This is one of the reports that the East Asia Region is launching here in Singapore, and the key author of this report is Swati Ghosh on my right here. I hope that you will have a chance to take a look at the report. I think it has a collection of data which is unparalleled to allow us to have really a picture, a snapshot, of where the Region is today. So, we did this report with the aim of contributing to the policy dialogue that is underway in the Region about the agenda for financial sector development, and we were very fortunate that in doing this work, we benefited from a very broad-based engagement of other institutions in the Region, and there are six of our partners that I would like to mention here–the Asian Institute of International Financial Law at Hong Kong University; Cagamas Berhad from Malaysia; the Hong Kong Mortgage Corporation; the Korea Institute of Finance; the Rating Agency of Malaysia; and the Securities Commission in Malaysia. All of them collaborated on this work, did specific background papers, and all of these are included in the CD that is attached to the back cover of the report along with all of the data that we collected. We think that this is a very timely moment for release of a report on East Asian finances, because the Region has undergone a fairly remarkable transformation over the last decade. I think that the Region has addressed and has emerged much more resilient from the debilitating crisis of 1997, and what we have seen is that banks have been recapitalized, and now, reported capital adequacy ratios are in the range of 13 to 19 percent across the Region, with the exception of China. We see that nonperforming loans are now down to single-digit levels, and we see that the corporate sector has de-leveraged and improved their performance, and median debt-to-equity ratios of the corporate sector now range from a low of 40 percent in Malaysia to 68 percent of Indonesia, figures which are substantially lower than the very high corporate leverage that was prevalent before the crisis. But while we see that banks may be sounder and might have developed more prudent approaches to managing risks, they have also reduced their lending to the corporate sector in some countries like Indonesia, Philippines and Thailand. So a key issue for the Region is how to balance access to credit, particularly to companies which are not investment-grade, like small and medium enterprises, with the risks that this entails. The Region has now accumulated US$1.6 trillion in foreign exchange reserves, and US$9.6 trillion equivalent in domestic financial sector assets, and these domestic assets amount to almost one-quarter of that of U.S. financial markets and half that of Japan. They have been built through the resumption of large capital inflows and a substantial amount of owned savings in East Asia, and this is really reshaping the financial landscape in the Region and provides an opportunity for deepening and extending the reach of the financial sector. Many of you might have heard Alan Greenspan after the crisis remarking that East Asia had “no spare tire” in the financial sector. I think if I had to paraphrase the message of this report, it would be to say that East Asia now does have a spare tire, but it is still not a full-sized spare tire. And what the report does is try to lay out the policy agenda that would allow the Region to take the financial sector to the next level and develop that full-sized spare tire. With that, let me now turn to Swati Ghosh to give a brief overview of the main findings and recommendations of the report. Thank you. MS. GHOSH: Thank you. We have already circulated a PowerPoint presentation which provides brief summary of the main findings of the report, so let me just highlight a few key points. Mr. Kharas mentioned the significant developments that are changing the context in which the countries in the Region are operating–namely, the accumulation of financial assets. The issue therefore is no longer the quantity of savings–there is plenty of liquidity in the system-–but on how these savings should be allocated given the changing demand for financial intermediation. With rising per capita incomes, the financial sector is facing growing demands from consumers for credit cards, mortgage finance, car purchase, et cetera. At the same time, businesses in the Region are looking for a broader range of services, including investment banking services, and with the deepening of intra-regional trade, firms that are operating cross-border require cross-border financial services such as trade financing, mergers and acquisitions. The report argues that a vibrant East Asian financial sector will need to have at least three key characteristics. First, it will need to be highly diversified in its ability to cater to the needs of increasingly complex and sophisticated economies; second, it will need to provide financial services efficiently; and third, it will need to be robust, to withstand a variety of shocks in a fast-changing globalizing world economy. A central pillar to achieving such a vibrant and robust financial sector is the further development of securities markets, particularly of corporate bond markets. Although securities markets have grown by 300 percent over the last nine years, they only amount to US$4.3 trillion, or about 40 percent of total domestic financial assets. In particular, given the per capita incomes in the Region and the depth of financial sector assets overall, the Region lags behind in the relative importance of the bonds markets.
To further develop the securities markets, the report stresses the need to foster liquidity. An illiquid market cannot be efficient, and there is a two-way interaction between liquidity and efficiency in the secondary markets and the size of the primary markets. In the report, we develop a measure of efficiency that captures transaction costs and the quality of information disclosure. Based on this measure, Korea, Hong Kong, Singapore and Malaysia have the most efficiency equity markets in the Region, but they do not score well in global terms. Among a sample of 124 economies, Korea falls in the third-highest quartile, and the others in the median. The remaining economies covered in the report–namely, Indonesia, Thailand, the Philippines and China–fall in the bottom quartile in terms of efficiency. Limited liquidity and efficiency, as measured by turnover ratios and bid-ask spreads, is an even greater issue in the bond markets for most countries, particularly for countries such as Indonesia and the Philippines. The report points to three factors that affect liquidity in the securities markets. The first is the availability of information to price securities accurately; second, transaction costs; and third, the size and heterogeneity of the investor base. To enhance efficiency, each of these elements will need to be addressed. Information to price securities accurately is clearly affected by corporate governance and the degree and quality of information disclosure. Countries in the Region have made considerable progress in strengthening the legal and regulatory framework with respect to corporate governance and information disclosure, and also in strengthening accounting and auditing standards, but focus is now needed on implementation and enforcement. To reduce transaction costs, which I mentioned also affects liquidity, the development of complementary or supporting infrastructure such as redo markets, margin trading, and derivatives can be very important. If developed within an appropriate framework, these financial instruments and mechanisms also allow market participants to manage and transfer risks to those who are better able and willing to bear them, and hence, they help advance the development of robust financial systems overall. But the report notes the potential danger with the use of such instruments from inappropriate risk transfers to institutions with weak risk management capacity and to more weakly-regulated segments of the financial sector. In particular, there is a danger that risks are being shifted from well-managed private banks to public banks, and from banks to non-bank financial institutions which may be less stringently regulated. This calls for proactive measures by regulators and supervisors to monitor and contain these risks as these instruments are developed and introduced. Finally, developing a broad and more diversified investor base is key. The participation of investors with different risk appetites and risk preferences contributes to greater trading and liquidity and to more efficient markets. This will require further developing the domestic institutional investor base–that is, pension funds, insurance and mutual funds–as well as fostering greater regional financial integration.
The regional financial cooperation measures that have been undertaken under the EMEAC, such as the Asian Bond Fund Initiative, and under ASEAN+3 and APEC, are providing an impetus to financial integration and to deepening and diversifying the financial markets. They are doing so by identifying the impediments to cross-border investments and by facilitating issuance by the private sector. Together with measures to develop the domestic institutional investor base, these initiatives should help promote deeper and more diversified financial markets. Thank you. MR. AL-ARIEF: Thank you, Homi and Swati. I’ll open it up for questions and answers, but before that, I’d like to make sure that you all have in your press kit the overview of the report itself as well as the full report, as well as our release and a couple of other materials. Are there any questions? Yes, sir. QUESTION: The Asian Development Bank has done a lot of work in this area as has the ASEAN+3 group and EMEAP and SOLANUC [ph.]. How much essentially further is your work taking what has already been done–I mean, it has been recorded many times that Asia’s bond markets are underdeveloped. What essentially are you saying that is new here that hasn’t already appeared in the literature that has appeared so far? MR. AL-ARIEF: Do you want to take that, Swati? MS. GHOSH: If I may answer that, actually, the report looks at all the key financial segments–banking, equity markets, bond markets, derivatives, securitization–systematically. I think what we have done here, the focus has been on what is needed at the domestic level and how the regional initiatives and what is needed at the domestic level can work together to foster integration and deeper and more diversified markets. So the focus, actually, of most of the report is on the domestic measures. The initiatives that you have mentioned are of course regional, the regional initiatives, which are very important in identifying the impediments and in facilitating issuance, but we need, for example, the domestic institutional investor base, the retail investor base, to be able to make those cross-border investments. There is also quite a lot to be done at the domestic level to make those markets more efficient so that people are interested in investment cross-border. QUESTION: Okay, but what do you intend to do to help improve the situation, and do you intend to give more help to these countries in developing domestic markets through technical assistance or what; I mean, we know the problems are there, but I mean how much further are you able to help in the actual fostering of the development of these markets, or are you simply saying “these are the problems” and leaving it at that? MS. GHOSH: No, actually the report does have specific policy measures, and I think I’ll let Mr. Homi answer the package that we could potentially put together for countries at the domestic level, and that would include technical assistance. But I think the first step is that you identify how all the different segments fit together and what is needed to foster more efficient markets, and the policy measures that would help deepen the markets. Individual segments also the linkage is across the market segments. Then it is a question of a combination of policy advice, technical assistance and the like. MR. KHARAS: I think that in doing this report, we’ve been talking quite closely with various groups, and there are some extremely specific proposals. There was an analysis done of whether institutional entities like regional credit rating agencies would be a viable proposition or not. I think the jury is still out on that, but there is a lot of work on the pros and cons that has been done. It remains to be seen whether that is something that will be taken up at the regional level. I think we have been able to put together a great deal of detail country by country in a way that is necessary if one wants to advance certainly any of the measures at a country level, as well as to understand why it is that things that happen at the regional level do or do not gain traction in individual country markets. So the devil is really in the details, and I hope that as you go through this report, you’ll get a better indication of where the differences between countries lie and why it is that countries such as Malaysia or Korea have actually been able to develop their bond markets quite well whereas other countries have not, and what those other countries can do in order to bring themselves up to the same kind of level. I think we bring to the table global comparisons. Swati mentioned that even though the volume of equity markets, for example, is quite comparable with that in the rest of the world, the efficiency of these markets is really not, and there is a lot that can be done to improve efficiency, and as you improve efficiency of equity markets, that will also have implications for the ability to develop bond markets.
So I think at the end of the day, this is about what countries can do, and our argument is that a great deal of what needs to be done needs to be done at the national, at the country, level, but that that can also be spurred by regional initiatives, and it’s putting those two things together which is really going to make a difference in the Region. And yes, we are ready to offer technical assistance in trying to make that happen. MR. AL-ARIEF: Anybody else? Yes? QUESTION: I’m from China, and I want to ask one question. What do you think about China’s reformation in banking and the financial sector; does it benefit the world financial sector? MR. KHARAS: Thank you. China is somewhat different from the other countries in the Region, because in China, the issues are not so much issues of a restructuring of the banking system which had a crisis; it is really the development of a modern banking system. China has gone down a specific path just now of inviting in international investors and strategic investors into their banking system. I think we see a lot of good things happening in China’s efforts to try to develop a modern banking industry, but as yet the banking sector in China still lags behind the transformation that it needs to be on a par with banking sectors in other countries in East Asia. China’s banking sector of course is extremely large, and their financial sector is also large. China has made very good progress in some aspects such as housing finance, where already housing finance is something like 15 percent of GDP, quite good penetration. China is also making progress with consumer finance, which is one of the new issues in the Region. So there are some strengths there but also some weaknesses. QUESTION: I’m from Vietnam, and I have a question for you. I don’t know, but do you have any assessment on Vietnam’s banking sector? You say that Vietnam is on banking reform, and frankly, it is not as good as expected. So what is the assessment on, for example, the debt-loan rate of Vietnam’s banking system, and what is the document that Vietnam should do as it joins the WTO, because it has to open up the banking area for the foreigners. Thank you. MS. GHOSH: We actually don’t cover Vietnam in the report. MR. KHARAS: Let me, though, just give you a couple of thoughts on Vietnam. Of course, Vietnam is just starting with the road map to banking system reform and modernization, including the reform and modernization of the State Bank of Vietnam. That will be a very important step forward. Vietnam has already made commitments to open up its financial sector under the bilateral agreement that it entered into with the United States a couple of years ago, and I think that as it moves towards negotiations on WTO entry, they will include further liberalization of the financial system. That will surely be a very good thing for Vietnam, because one of the things that the Asian crisis demonstrated is that as countries liberalize and open up, their financial sectors can be vulnerable and that that can set back the pace of opening up. So one way I think that the report shows very clearly is what some of the advantages are to countries by having foreign participation in their banking sectors. Those are usually associated with good practices. They are usually associated with lower transaction costs, better transparency, many of the characteristics that we describe as being the necessary characteristics for robust financial markets. MR. AL-ARIEF: There is a question in the back; yes? QUESTION: There is an assessment that East Asia securities markets are relatively stable compared with those of the other regions, and the sampling of 124 economies worldwide shows that Singapore falls in the highest quartile, Hong Kong and Malaysia in the second quartile. If you could help me paint a picture of what factors will enable a country to fall within the first quartile and within the second quartile; that’s number one. And is there a comparative ranking to your previous study? Has the ranking changed? MS. GHOSH: No. These are actually indicators that we have recently developed at the World Bank, so there is no comparative time series on that. The stability index, actually, the one that we show in the graph, is a composite indicator, and it is a composite indicator that measures volatility and the skewness of returns, the extent to which markets are more likely to deliver large negative returns. This is from the literature on efficiencies and stability of equity markets that has been developed. We have, actually in the CD in the back, we have this data. We also have the components that go into this composite indicator. MR. KHARAS: You might want to mention what base that is in. MS. GHOSH: It’s in the report. If you have a copy of the report, it’s on page 108. QUESTION: I just wanted to go back on to the East Asian Financial Crisis. From what you have said today, that region is not in a very solid position in terms of field reserve and the reforms that have been taking place in the banking system. Conceivably, though, I’m just wondering what can you see out there that could place this region in a vulnerable position? It has also been suggested that while China is looking very strong at the moment, at post-Olympics there could be emerging problems. And this would again relate back to China’s banking system, which is perhaps not on par or--as you said earlier on-- needs a little bit more work to be done. Can you comment on this please? Thank you. MR. KHARAS: I think it’s fair to say that the report really is about risk and the kinds of risks that inevitably exist in any integrated economy. What the report suggests is that private banks, which are relatively well managed, which have good risk management practices, have really taken on board many of the risks that face the region. And they have shifted their risks through a variety of techniques, including cutting back on lending to riskier customers. The place where it’s less clear how these risks are being managed are in public banks. And there’s also quite clearly been a shifting of risk from the banking system to the non-bank financial institutions through the use of derivatives and other kinds of instruments. Now these non-bank financial institutions are less stringently regulated and it’s very difficult to know whether they have properly understood and priced the risks that they are now taking on. And indeed, in the region there have been episodes where non-bank financial institutions have run into trouble. So that’s another of the big unknowns. And what we do in the report is talk a little bit about the size of trading in derivatives, especially exchange rate derivatives and interest rate derivatives. And of course, these are very complex instruments and the degree of risk that they pose is quite difficult to measure. And so those are some of the newer and less well understood risks, I think, in the region. In terms of your other question, of course there are real economy risks, whether it’s from a slowdown in China or a slowdown in global markets or oil prices or interest rates. But those are the kinds of real economy risks. The whole idea of the financial sector is to spread those risks across a range of players who can best take them on. And we think that what’s happening in the region is, indeed, that those risks are being spread out across a larger number of players. So I’m less worried about the ability of the region’s banks to manage risks and more about the unknowns that we think still lurk out there. QUESTION: I just want to ask about what’s your command or what’s your view on money trade authority of Singapore that rescind the issue of draft notices on requesting foreign banks-- the branches of foreign banks based in Singapore to maintain a minimum amount of assets in Singapore? Do you think it’s overly prudent measures or is it necessary? Thank you. MR. KHARAS: Sorry, neither of us seem to have seen that draft notice, so it’s very difficult to comment on it. QUESTION: Can I do a follow up question? Is that a common practice in countries in this region, to require foreign banks--the branches of foreign banks based in the particular market to maintain a minimum amount of assets? Or how is the practice in other parts of the world? MS. GHOSH: I have to say I haven’t looked into that, so I wouldn’t necessarily like to make a generalized statement on it. But countries do have--occasionally have minimum requirements. Now whether these differ for foreign bank branches or not, I think that’s the issue that you’re asking. I actually haven’t surveyed that. MR. KHARAS: I mean most banks have net foreign exchange exposure limits. So to the extent that they’re taking deposits in Singapore dollars, they need to be holding assets in Singapore dollars. And I think it’s quite common practice across the region to manage individual banks’ net forex exposure on a daily basis. So I’m not sure whether that’s the issue at hand or not. MS. GHOSH: I don’t have the draft notice so I don’t know if it’s like capital requirements or what. QUESTION: Could you just provide a bit more detail on the technical assistance that the World Bank plans to give to financial as well as non-financial institutions to master especially the newer risks, such as currency derivatives? MR. KHARAS: Well, for example, in Indonesia, where they’ve just issued a new policy package on the financial sector, we’re offering some assistance on non-bank financial institutions and some assistance on restructuring of the insurance industry. In China there are issues with brokerage houses. In the Philippines there are issues with pre-needs financing. In some banks there are pension funds where we have some technical assistance programs. So there are a variety of different programs across each country. But with a report like this, what we would really like to do is, by putting some more issues on the table, is to encourage countries to think hard about what they’re priorities might be and then to discuss, whether it’s with us or with the Asian Development Bank or whomever, what their own needs and priorities are. And those really differ country by country. QUESTION: May I just follow up on the earlier question again? You talk about the lending by the non-banking sector institutions. Do we have an idea of the size of lending out there, either collectively or even regionally? MS. GHOSH: Yes, we’ve got the institutions--but not lending by non-bank financial institutions. We’ve got the size of the assets of pension funds and mutual funds and insurance. MR. KHARAS: It’s about US$1.5 trillion equivalent is with institutional investors. MS. GHOSH: The asset base of the institution. MR. KHARAS: That’s their asset base. And they’re typically investing in government bonds and other kinds of assets. QUESTION: The table on page XII, Roman numerals that is, shows that in a number of countries, the equity market capitalization as a percentage of GDP is considerably higher than the bonds outstanding as a percentage of GDP. That would be unusual, presumably, in developed economies. But does it suggest that companies in this part of the world generally are over-reliant on equity finance? Or is it compensated for by the fact that bank assets or also a very hefty chunk of total corporate financing? Are you with me? Roman XII. It’s got a table of equity market capitalization. And those percentages as a percentage of GDP are quite considerably higher, in some cases, than bonds outstanding. So that seems to indicate an over-reliance on equity. Because I imagine in developed economies the ratios are different. But does it indicate that or doesn’t it? QUESTION: Actually, I would say it may be an indicator the bond markets are not as developed. MR. KHARAS: Yes. And in particular there’s really only a market for quite highly rated corporate bonds, AA or above. And the real issue in the reason is that less well-rated corporates have not been able to tap bond markets. QUESTION: You mentioned that consolidation has taken place in the banking sectors in Hong Kong and Singapore, and the plan has been driven by competitive pressures arising from deregulation and technological advances. Do you think that this consolidation will be a future trend for the financial system in this region? MS. GHOSH: In fact, there’s been quite a lot of consolidation in the region already. In Hong Kong and Singapore it’s been driven by the competitive pressures, as elsewhere, as in the U.S. and parts of Europe. In the remaining East Asian countries it’s been government-led consolidation after the crisis. So I think it depends--actually, most of the countries that we look at already have quite large banking sectors now as a result of the government-led consolidation. So I’m not sure how much more consolidation will take place just from competitive forces. In the report we have a table, in the banking chapter, that looks at the median size of assets and deposits now in the banks across the region. And some of them are quite large. Some countries have quite large banking systems already, I mean quite a lot of consolidation already, of the banks. There’s another finding that we have in the report, which is that although there’s been a lot of consolidation, the banks in the region don’t seem to be reaping the benefits of the consolidation in terms of scale economies and scope economies yet. This could be a learning process because it takes some time. It could also be because so far the consolidation has been mostly government-led in most of the crisis affected, formerly crisis affected, countries. So that competitive--allowing a competitive environment will enable banks to respond more, sort of taking consolidation further depending on whether that is profitable for their business. So there could be more consolidation, to answer your question, in the future as the environment is made more competitive for the banks. MR. AL-ARIEF: Thank you very much for coming. Thank you. [Whereupon, at 4:39 p.m., the press briefing was concluded.] |
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