There has been a significant shift from the Asian crisis era idea that ‘all evil is local’ – crony capitalism and bad policy on a local level being to blame for the crisis – to the notion that ‘all evil is global’. Asia has come back from extreme imbalances to the Golden Mean, and Dr. Goh’s famous quote, which is actually paraphrased Confucius — that financial regulation, like ruling a country, is like frying small fish — it must not be overdone.

In this highly distorted, politically charged and still Western dominated global architecture, Asia must steer a steady ship. There must be no deviation from the long-term goals of social development, social equity and environmental sustainability.

If Asia is to shoulder global responsibilities then Asian mindsets, institutions, knowledge and modus operandi will have to be vastly different from today. But the new approach must overcome five major problems before Asia can even begin to compete with the West in the global financial arena. These are the global financial architecture problem, the moral high ground question, the issue of financial and accounting standards, the Too Big to Fail problem and the need for regional and global cooperation.

Global Financial Architecture

In terms of the global architecture, the dollar and the euro will remain as global reserve currencies within the next two decades at the very minimum. This is because it will be difficult to achieve Asian consensus on what the right currency arrangement is for Asia. Perhaps the right step forward for global architecture is to impose both financial turnover tax and financial services tax, both of which the European Commission has adopted to recommend to its members.

At the regional level, the financial turnover tax on foreign exchange transactions (the Tobin tax) will be a good way to slow down speculation in foreign exchange when the market gets too frothy. Having common levels of such tax would avoid the problem of racing to the bottom in terms of tax arbitrage and would fund some of the costs of resolving financial failure when they do occur. Having a common tax base would also foster institutional arrangements for better regional cooperation.

The Moral High Ground

The second problem is that Western money has reigned supreme because they commanded the moral high ground. That high ground has been shaved a notch or two by this crisis. Let me say that I used to think that we should build Wall Street in Asia. I now think that is exactly what we should not do. I am still a firm believer that finance must be at the service of the real economy, not the other way around. I still believe that finance must look after the interests of the public first and foremost before its own interests. We change these beliefs at our peril.

Financial and Accounting standards

The third issue is the question of regulatory and accounting standards that were shown to be flawed. They are too complicated to be understood by the layman, which is exactly why the current system is too complex, non-transparent and can easily be gamed at the expense of the public. Asia has to go back to basics and challenge these rules and standards at the fundamental level. This will take a lot of research and resources.

The biggest challenge within Asia is not the lack of rules, but effective implementation of the Basel, IOSCO and Insurance Principles. What changes market behaviour is enforcement. We have to identify what bad incentives are driving faulty markets and then fix them, not pretend that we are not guided by theory or we do not have the powers to deal with these problems. It is the public which has paid for such ideological fallacies.

In other words, a strong global network must begin with strong and resilient domestic networks.

Currently, Asia does not have the intellectual firepower and institutions to conduct a strong dialogue with the West. We need more discourse, and institutionalisation of think tanks and research institutions. We need the work of our research institutes to feed the debate that will be ongoing in the coming decades. The intellectual battle for the right finance model will be as important as the battle for market share.

The Too Big to Fail Issue

Fourthly, we must address the issue of Too Big to Fail, or what has really emerged, Too Powerful to Fail, because the largest complex financial institutions have become even more concentrated, connected and powerful than before.

Asia’s solution to this problem is state-ownership, because in the largest countries the commercial banking system has been largely state-owned or guided. This has solved the power problem without solving the innovation problem.

How do we make financial institutions more innovative to help fund and foster growth within Asia?

If we are to deal with the question of Too Big to Fail, we have to deal with leverage, incentives and the political economy of who is bigger, the state or financial institutions that can hold countries to ransom. As I said earlier, this problem cannot be solved with zero interest rates, because low or negative real interest rates are at the heart of the leverage and incentive distortion problem.

Regional and global cooperation

The institutionalisation of Asian regional and global cooperation will be challenging, given that it is a geographically vast, culturally diverse, economically disparate and politically complex region. Nevertheless, there is increasing awareness that many of the problems that Asia and individual economies face cannot be solved by national action alone. The interdependence and interconnectivity are such that there must be greater national, regional and global dialogue and policy research. Given the disparate levels of financial development and understanding of the issues, convergence towards global standards will inevitably take time.

My personal conclusion from this brief survey is that there is unlikely to be a ‘Big Bang’ in Asian financial sector reforms, even as the current financial crisis evolves, until Asian financial sector actors appreciate that the current Wall Street financial model is irretrievably broken. I am not sure that many Asian bankers agree with that view. If we do not find a viable alternative model, we may be paying for quite a lot of the costs of that failure. However, within Asia, there is a gradual realisation that its financial markets must change rapidly in response to fundamental changes in our demographics, consumer behaviour and industrial structure. This analysis is urgent and must be of the highest priority. How these will impact on the global regulatory architecture will be an interactive debate between Asia and the rest of the world.

Andrew Sheng is Adjunct Professor at the University of Malaya and Tsinghua University, Beijing.