26 March 2014
Shanghai January 2011

Asia's financial markets

Asia's financial markets are, with a few exceptions, underdeveloped and weakly integrated -- and this is holding back Asia's future development, according to the recent CanadAsia 2013 conference.

Asia's financial markets are underdeveloped and weakly integrated, with a few exceptions like Hong Kong, Japan and Singapore. And this is holding back Asia's future development, according to discussions at the recent CanadAsia 2013 conference, organized by the Asia Pacific Foundation of Canada in Vancouver.

This is perhaps not surprising, argued JC Parrenas from the Bank of Tokyo-Mitsubishi. Most of these markets are young and don't have the scale of the major global markets.

But as they are now, stressed Parrenas, Asia's financial markets are definitely not adequate to support the regions's goals of balanced, innovative, sustainable and innovative growth. More efficient financial markets in Asia could be a transformative factor in the next phase of Asian growth.

Over the past fifty years, Asia's rapid growth was fed mostly by foreign direct investment and exports to America and Europe. That was good, but it was not sustainable, and that era has ended. Asia's growth in the next 50 years will depend more on broad-based domestic consumption, growth of small enterprises, innovation and expansion of physical and social infrastructure.

This kind of growth cannot be supported by existing financial systems in Asia's emerging markets, which continue to rely very heavily on banking systems, including banks which are closely connected with the state. As Songzuo Xiang from the Agricultural Bank of China said China's banks are now among the world's biggest, they have launched IPOs and interest rates have also been liberalized. But China's state owned banks direct much of their lending to state-owned enterprises and local governments, and the quality of a lot of these loans is questionable. At the same time, a large unregulated shadow banking sector has grown up, posing questions for financial stability.

Because many Asia banks cannot by themselves provide the long-term finance needed for infrastructure, bottlenecks are choking Asia's cities with traffic and constraining growth.

In recognition of the enormous infrastructure needs and growth potential of Asia, there is a growing need for financial market development and integration in the region. Asia needs capital markets, particularly long term local currency markets, which are the major sources of funding in advanced economies. This also fits the needs of our ageing population, who need long-term assets to invest their savings in.

The Asian Development Bank Institute's Masahiro Kawai highlighted some of the initiatives launched to develop local currency bond markets in Asia, like the Asian Bond Market Initiative, the Asian Bond Fund, and the Asian Bond Forum. And as he argued, total local bonds outstanding in emerging East Asia are now over 8% of the global bond market against 2% in 1996.

But there is a great need to further develop these markets, argued Parrenas. You need liquidity and a large and diverse issuer and investor base, and especially institutions with long-term horizons like insurance companies and pension funds.

Indeed, despite ample high-yielding investment opportunities being available in the Asia Pacific region, global capital is still drawn to western industrialized countries and to traditional financial centers such as New York and London. And even with massive pools of capital accumulating in Asia, the underdevelopment of capital markets has meant that relatively few of these savings are deployed within the region.

Financial development will come faster if emerging Asian markets become more efficient and attractive to investors, issuers and intermediaries through better legal and regulatory frameworks and improved market infrastructure. If it becomes easier and less costly and less risky for investors and institutions to operate across borders in Asia and treat Asia as an integrated market, which can come about through greater convergence of regulations and practices and connectivity.

The requirements to make this happen are enormous. There is a lot being done - ASEAN, ASEAN+3, EMEAP, SEACEN, IOSCO, APEC, FSB, BIS -- the list goes on. But there is a need for better coordination. There are many gaps, for example, repo markets are lacking, credit reporting systems don't provide sufficient information to financial service providers, flawed perfection systems prevent expansion of secured lending, just to name a few. And there are many new standards and regulations that have been put in place to address problems in Europe and the US, in the wake of the global financial crisis, whose unintended consequences for Asian markets still need to be better understood and dealt with.

Collaboration and coordinated action between the public and private sectors is one way of accelerating this development and this is why the Asia Pacific Economic Cooperation Business Advisory Council (ABAC) decided to propose to the APEC Finance Ministers to establish a regional platform for such collaboration, which is the Asia-Pacific Financial Forum. The APFF will not be there to duplicate what is already being done, but its goal is to promote a better understanding of how to design policy and regulatory frameworks that would enable financial markets to help attain the region's development goals, drawing on perspectives from the ground and the cutting edge of innovation in financial services.

In April 2013, private sector leaders and regulators in the financial services industry from across the Asia-Pacific region met to explore a proposal from the ABAC to establish an ongoing Asia Pacific Financial Forum (APFF) to strengthen and promote financial markets in the region. This provides a basis for an initial two-year work program that ABAC will discuss with Finance Ministers this September in Bali, and it is expected that finance ministers will agree to go ahead with this initiative.

The key component of the APFF is a pool of senior private sector experts from a wide cross section of the financial industry who commit to make themselves available to collaborate with regulators, policy makers and multilateral and standard setting bodies on a manageable number of projects with concrete deliverables that can be achieved within specified time frames.

Another issue on which concerns also expressed is that of the risk of financial instability, as developed countries undertake "quantitative easing".

“While the massive inflow of capital to the region is a welcome news in view of infrastructure deficit in many of the emerging economies of Asia, there is dire need to consolidate the financial market and regulate the global financial services industry,” according to Kawai.

If not managed well with appropriate policy measures, the rapid capital buildup in the region could lead to a financial crisis furthering the income gap among the region’s economies in different phases of development as well as within them. “In order to avert potentially negative impact from overheating capital inflows, it is important to mobilize a combination of appropriate macroeconomic, macroprudential and structural policies in Asia,” stressed Kawai. He did however highlight the progress made on developing regional financial safety nets, through the Chiang Mai Initiative Multilateralized, and AMRO, the ASEAN+3 Macroeconomic Research Office.

"Financial inclusion" -- or access for formal financial services -- is another critical issue for the development of sound, efficient and integrated financial markets in Asia. Only 55% of adults in East Asia have an account with a formal financial institution, and in South Asia the figure drops down to a mere 33%, according to the World Bank.

There are several factors that inhibit the development of a more inclusive financial sector in Asia, as discussed by Parrenas. The large administrative costs of handling small depositors and borrowers means that banks prefer to cater to large clients.

The challenge of improving financial inclusion is enormous, but so are the potential benefits. Much innovation is indeed underway, reports Parrenas, to improve access to financial services by low-income households, and small and medium enterprises. Mobile banking and branchless banking offer great potential. Efforts are also being made to develop credit reporting systems, and also to improve citizens' financial education. A balance must be struck between the ultimate goal of better financial access, the need for innovation to achieve this, while ensuring the right dose of regulation to mitigate systemic risks and protect consumers of financial services.

Finally, is there a possible future for an Asian Currency Unit, in light of the experience the European sovereign debt crisis. Kawai recognized that an ACU was certainly out of the question for the moment in light of Asia's diversity in terms of economic development, political systems and institutions. Further, the euro crisis has highlighted the need for fiscal and banking unions.

But Kawai argued that, over the long term, capital accounts will open up, financial development will strengthen, and financial regulations will harmonize. Economic integration will also deepen, as will financial markets. And finally, over the long term a single Asian currency would be possible.

But as John Maynard Keynes reportedly once said, "in the long run we are all dead".


John West
Executive Director
Asian Century Institute
Tags: asia, financial markets, bond markets, Asian Bond Market Intiative, ABAC, CanadAsia 2013, Asia Pacific Foundation of Canada

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