Buildings in the financial, commercial district of Pudong, Shanghai, China. Asia needs to deepen its financial sector, says Lagarde (photo: LatitudeStock/Corbis)
ASIAN FINANCE
During the day-long gathering on the future of Asian finance, Christine Lagarde said deeper financial systems could provide a shield against volatility, and also provide opportunities for consumers and business.
“What we are talking about is financial deepening within countries. And that means a shift away from traditional banking practices focused on deposit taking, and commercial lending to corporations,” she said.
Lagarde’s visit, which also included meetings with top Indonesian officials, coincided with the launch of a book, published by the IMF on the outlook for the financial sector in the region.
The state of Asia’s financial system
Asia’s financial systems range from low-income economies where few have access to financial services, to some of the world’s most advanced global hubs. A model based on conservative banking has served the region well, underpinning growth and stability, but progress in developing stock and bond markets has been slow.
Asia learned important lessons from the 1997-98 Asian financial crisis, which helped cushion the blow of the global financial crisis. But rapid credit growth, and household and corporate leverage mean resilience may be weaker during a future crisis.
The region’s stock markets are large, but in many countries, stronger regulation could enhance their role as a reliable source of financing for companies. Bond markets have grown rapidly in recent years, and encouraging more institutional investors will help recycle Asia’s large pool of savings into long-term investments.
Financial sector growth likely to slow
As countries get richer, their financial sectors also grow, but the pace slows over time. As Asia catches up with rich economies, the pace of growth of its financial sector is likely to slow. Aging will also be a drag on some of the region’s economies, but younger countries, such as India and Indonesia should benefit from a demographic dividend.
Today, Asia’s financial systems are relatively conservative and simple, and international linkages are small. But the complexity of these systems, and global integration will grow in coming years, presenting new challenges for regulators and supervisors.
This is particularly true in Hong Kong and Singapore, Asia’s financial hubs. Ensuring that these cities continue to support Asia’s financial development in a stable way will require stepping up cooperation among supervisors.
Better integration, deeper financial markets
Many Asian countries are aging quickly, but others are not, a combination that could work in the region’s favor. Better integration, and deeper financial markets can help the savings of Asia’s older countries finance investments in infrastructure and education in the region’s younger countries.
This kind of integration is particularly important in Southeast Asia, where financial connections have lagged trade linkages. So far, integration has been prudent and gradual, supporting growth while working to minimize domestic vulnerabilities and risks.
But breaking down barriers to financial flows in Southeast Asia could help accelerate growth. In addition, a more financially integrated region could be less dependent on exports, and rely more on domestic investment and consumption.
Growing capital flows could increase volatility
Capital flows into and among Asian economies are already large, and expected to grow further. Asia’s good investment prospects and market size have led to strong inflows. But deepening financial integration, Japan’s monetary easing, and capital account liberalization in China will lead to even more growth.
While this will help support growth and create jobs, it could also mean more volatility. Asia is a world leader in macroprudential policies aimed at containing financial risk. Building on these strengths will be key to managing new flows.
Asia has also been part of the global effort to overhaul bank regulations. Banking supervision is robust, but some banks are too big to fail, and many public-owned banks are inefficient. Shadow banking is also growing rapidly. Keeping up with financial innovation while maintaining Asia’s strong capital and liquidity frameworks will be key challenges for the region.
A bright outlook
More than many regions, Asia has learned from the past. After the Asian financial crisis, banks built up capital, and regulators tightened the rules on finance. Asia’s conservative banks have underwritten the highest growth in the world, while maintaining financial stability.
Looking forward, Asia stands to gain from many key trends. Aging in some countries can help underwrite investment in others. Large stock markets can be used to diversify companies’ sources of finance, and rapidly growing bond markets can fund long-term projects. As financial integration catches up to trade integration, the region’s savers and consumers will both benefit.
Taking advantage of these trends will require bold steps in reform. Supervision must stay ahead of innovation, and the region’s strong track record of maintaining financial stability will have to be maintained. But if those goals are achieved, Asia’s economic growth can continue to lead the world.
