Many Asian economies see these proposals, including the so-called Dodd-Frank Act in the US, as efforts to address the weaknesses and flaws in the financial systems in the US and Europe, with limited relevance to their own financial systems.
However, Asia has an important stake in the global economy and should not be a bystander in the broader reform of the global financial system. While the immediate cause of the recent crisis may be attributed to the weaknesses of the financial system in the West, its deeper causes can be traced to the systemic risks in the global economy related to the large and persistent macroeconomic imbalances in the global economy, the size and volatility of capital flows, the flexibility of exchange rates, the inadequacy of the regulatory regimes and the architecture and governance of the international financial system.
Asian governments are very mindful of how dangerous the risks can be from their experience of the Asia financial crisis, and have therefore been struggling to manage those risks. As Asian economies are amongst the most open in the world, they are not well placed to insulate themselves from global shocks and developments. Asia’s ability to avoid the worst excesses of the recent crisis is no guarantee of similar fortune in the future.
Many in Asia believe that their relative success in managing the crisis is due to a more cautious approach to financial liberalisation, despite urging from the IMF and the West to do otherwise. Some see the recent crisis as a ‘Western’, rather than a ‘global’ one, caused by excessive financial liberalisation in Europe and the US. They see the Dodd-Frank Act as marking a move by the West towards the more conservative regulatory approach of Asia.
Asia is also looking to play a more active role in reforming the international financial system, having emerged from the recent financial crisis as a much more important player. While many of the reforms on governance structure and regulatory regimes are headed in the right direction, they do not go far enough in addressing the concerns of Asian countries.
Asian economies are facing very different policy challenges today from those confronting the West. While the US and the European economies are still struggling to get back on a more robust growth path, and fiscal stimulus and monetary easing remain a central part of their macroeconomic policies, many Asian economies (except Japan) have recovered so rapidly that they are now facing the potential risk of overheating.
The key concerns are: the need for financial and regulatory integration, the management of capital flows and greater Asian participation in international forums.
Asian economies have long lagged behind the West in the pace of financial innovation and integration. As a result, Asia was often criticised for being backward in financial products and inefficient in cross-border financial intermediation. Ironically, such ‘backwardness’ and ‘inefficiency’ turned out to be a big strength in the recent crisis as it limited the contagion effect in the region.
But Asia is heterogeneous. On one extreme are countries like Japan, Hong Kong and Singapore whose advanced economies have fairly sophisticated economic and financial systems. On the other are countries like Laos, Cambodia, Myanmar and Mongolia, which are among the least developed economies in the world. The majority of the Asian countries are medium-income emerging markets economies. As a result, many of the problems that helped bring down the financial system in the West in the recent crisis such as the securitisation of subprime loans and its repackaging into complex financial products, or the establishment of off-balance sheet vehicles to avoid regulation, are hardly relevant to most Asian economies.
Even in the more developed Asian economies the capital markets are not as ‘advanced’ and ‘liberalised’ as those in the US and UK. The challenges that Asian nations face are therefore quite different. Each country should choose a an appropriate regulatory regime but should not automatically follow those prescribed for the advanced Western economies. A major challenge for Asia is to develop a financial superstructure that is able to integrate the diverse financial systems across the region so that they complement and support each other, despite the different levels of economic and financial development, and help raise the efficiency of capital flows for the whole region.
Such a financial superstructure would, for instance, channel excess savings from the surplus countries to the deficit countries in the region. It would also facilitate the provision of advanced financial services from the more advanced economies to the less developed ones. In addition, it should intermediate the flow of funds not only within the region but also between the region and the rest of the world.
With such a regional financial superstructure, there should be a hierarchy of regulatory regimes corresponding to the range of financial systems in the region. The structure would recognise that it is not necessary for the majority of Asian countries to adopt the regulatory changes currently being proposed in the US and Europe. However, over time, as financial systems develop and become more advanced, the regulatory regimes could converge.
A key concern among financial regulators in Asia relates to the risks posed by speculative capital flows and exchange rate volatility to the stability of their economies and financial systems. The cost of insuring against such volatility should be borne equitably by all the countries so that individual countries do not have to resort mainly to building up a huge stock of foreign reserves as self-insurance. In this regard, it is in Asia’s interest to see a greater global consensus on the use of capital controls and other macro prudential measures to mitigate the adverse effects of capital flows on financial stability.
Asia would like to see a regulatory framework for the global financial system that is sufficiently flexible to accommodate a wide range of financial systems. The elevation of the G20 into the premier international forum for managing the global economy and the international financial system marks a good start in this regard. With six members in the grouping, Asia is well represented in the G20. The grouping could provide the platform for Asia to push for major reforms of the IMF and other major international organisations, to make sure that their policies are aligned with Asia’s interests.
The IMF Executive Board has just approved a significant increase in the quota share of the emerging markets economy in response to the recommendation of the G20 Finance Ministers’ Meeting. The expansion of the Financial Stability Forum and its re-establishment as the Financial Stability Board (FSB) has given Asia a bigger say in providing oversight over the global financial system. There have also been efforts to expand the BIS and other international standard-setting bodies to include more countries from Asia and other regions.
Asia should play a more active role to ensure that these bodies take into account the economic circumstances of the Asian countries in setting the international standards for the various regulatory frameworks.
Hoe Ee Khor is Council Member of Economic Society of Singapore and former Assistant MD of MAS. Kim Song Tan Associate Professor of Economics at the Singapore Management University.