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Asia’s Seismic Shift: How Can the Financial Sector Serve Better?

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Asia is set to be the powerhouse for growth in the next decade, just as it was in the last one. The size of its economy is expected to expand more rapidly than the other regions of the world, and its share in the world output is expected to rise from 30 percent to more than 40 percent in the coming decade. The structure of the economy is expected to continue to transform from a narrower manufacturing hub to a group of vibrant, diverse and large markets with a rising middle-class population.

The role of the financial sector is critical in the success of this seismic transformation. Let me explain by focusing on three areas:

  1. Serving the real economy and structural change. With urbanization, growing trade, and rising demand for communications and travel, Asia needs to invest a lot to meet infrastructure needs—road networks need upgrading, and electricity generating capacity and telecommunications infrastructure lag other regions such as Latin America. Asia has a large pool of savings but—despite potential high returns in the region—most of these currently leave the region. And so a critical challenge is to ensure that there are no impediments to the healthy flow of capital across the region so that savers can find the best returns for their investment and infrastructure financing needs can be met. Securing small and medium sized enterprises access to finance would also support investment.
  1. Serving the demographic shift. Efficient financial systems recycle savings to where they are most needed—for example from aging populations who are typically saving for retirement to younger ones who have investment needs. For Asia this is particularly important as China, Korea, and Japan have rapidly aging populations, even more so than the rest of the world. Yet others, for example India and Indonesia, have younger working age populations and large investment needs. A growing middle class will also lead to demands for a greater range of financial services. Increasing access to basic financial services by households and firms can also help promote saving, enable investment by households in health and education, assist the market entry of new firms, help improve employment opportunities and so help to create the conditions to reduce income inequality.
  1. Managing interconnections and integration. As Asia’s financial systems become bigger they are also likely to become more complex and interconnected than they are today. Market development, including shadow banking, and increased complexity can also raise risks with a potential for problems to spread across borders with an impact beyond Asia.  At the same time big changes are being made to the global regulatory environment that are likely to  create a number of challenges for markets and regulators alike, affecting financial flows and the size of banks and shadow banks, as well as prudential ratios and resolution frameworks.

Navigating the transition

Achieving these objectives require careful planning and policy implementation. The good news is that there is rich experience and lessons we can bring from other regions. These experiences suggest a focus on the following areas: 

  • Broaden the investor base. To ensure economic and structural transformation Asia needs a more diversified financial system with deeper and more liquid markets, which will require a broader and more diverse investor base, greater involvement of long term investors.  Supporting social stability and meeting the financial service needs of a growing middle class in the region, including their retirement and real estate planning, requires longer-dated assets and an asset management industry with a longer horizon. Encouraging a long term investor base would also help build up a stable source of finance for infrastructure projects (for example through unlisted funds) and it would require the development of an appropriate back office support infrastructure.  With institutional investors relatively small in most countries, and barriers to investment across borders still high, this will be a long-term process.
  • Build more liquid markets. Local currency bond markets have grown since the Asian financial crisis in the late 1990s and have proved resilient even through recent bouts of financial market turbulence. Even deeper and more liquid bond markets would enhance financial stability, and could reduce the corporate and sovereign risk premia lowering the cost of capital and helping to support economic and structural transformation. A more active role for market makers, development of hedging instruments, including derivatives, and repo and securities lending markets would also help generate turnover and improve liquidity. Improvements in the regulation of securities markets could also enhance the role of equity markets as stable and reliance sources of financing in the future. Other impediments include an embryonic legal and regulatory framework for nonbank financial institutions— shadow banks—and a lack of information provision including pricing transparency. 
  • Enhance regional and global perspectives. Increasingly, a regional perspective will be key to address rising regulatory and supervisory challenges as financial systems deepen and become more integrated and complex.  Possibilities include forming and strengthening supervisory colleges. Looking more widely, the development of the Asian financial system is likely to increase the potential for impact beyond Asia. So regulators and supervisors, while encouraging innovation, will need to ensure they have good cross border cooperation, adequate regulatory powers to act and stay alert to the risks. And the IMF, with its increased focus on interconnections and global impact, can help to identify the risks including any emerging from changes in global regulatory policy.

There are many unknowns, and what we have learned from other regions need to be applied to Asia with care, recognizing many unique characteristics of the region. The IMF is seeking to help policymakers in the region navigate the transition, bringing our cross-country expertise to the table.  We hosted a joint IMF–Hong Kong Monetary Authority conference, The Future of Asia’s Finance, in February 2014, and now plan to publish a book.  We will drill down more deeply into these topics and  give them our continuing attention.