Speech

Opening Remarks by Takatoshi Kato
Deputy Managing Director
International Monetary Fund
At the APEC Finance and Development Program 2004 Annual Forum
Sanya, Hainan Province, P.R. China
November 28, 2004

It is my great pleasure to attend this APEC forum, and to have the opportunity to address such an eminent gathering. We meet today in a city known in ancient times as the "remotest cape of the earth". But in our times, Hainan Island sits right in the middle of one of the most inter-connected regions of the world, and hence finds itself very much at the center of the earth. Thus our location provides a stimulating backdrop to our forum today, with its emphasis on increasing regional cooperation on financial sector issues.

The focus of today's forum—on how to enhance the efficiency and stability of financial system reform—is entirely appropriate, given the critical role played by strong financial systems in enabling growth and reducing vulnerability to crisis. As the APEC economies make progress towards meeting the Bogor Goals of free and open trade and investment by 2010/2020, they will need to ensure that greater openness does not lead to greater instability. Further progress to strengthen financial institutions and regulatory and supervisory frameworks, as well as enhance regional cooperation in these areas, is therefore warranted. And these reforms not only are sound from a policy point of view, but also make sense from a business perspective, as evidenced by the support expressed in the APEC Business Advisory Council's recommendations to APEC Economic Leaders.

Considerable efforts have been made since the crisis in the late 1990s to rebuild Asia's financial sectors and increase their resilience to shocks. As a result, the financial condition of banks in the region has improved considerably. Capital positions have been rebuilt, with average capital adequacy ratios now around 8 percent in emerging Asia, and headline nonperforming loan ratios have fallen quite dramatically, to about 10 percent. The quality of supervisory and regulatory institutions has also been strengthened, in some countries through the creation of new agencies dedicated to overseeing financial sector stability, and in all countries through upgrading of relevant capacities.

There have also been significant reforms to strengthen corporate governance. Most Asian jurisdictions have substantially revamped their laws, regulations, and other formal corporate-governance norms, so that in many cases, Asian rules now reflect international best practices for corporate-governance systems. Asian regimes have also made considerable progress in converging with international standards and practices for accounting, audit, and non-financial disclosure.

As a complement to national efforts to strengthen the domestic financial markets, various regional initiatives have been launched to promote greater financial stability. Under APEC auspices, initiatives are underway to strengthen corporate governance, support freer and more stable capital flows, and develop securitization and credit-guarantee markets. APEC is also playing an important role in capacity-building, for example through regional seminars on credit risk analysis for bank supervisors, and supervision of market intermediaries and enforcement for securities regulators. It is through such events that practitioners are able to learn from best practices, and also exchange ideas about how to handle common problems.

On-going efforts to deepen capital markets, notably through the development of domestic and regional bond markets, will also enhance financial sector stability. More extensive bond markets can lessen the vulnerability to crisis by diversifying sources of financing and by reducing maturity and exchange rate mismatches. Bond market development may also contribute to improved corporate governance and transparency, which will help reduce the risks of financial crises. The launch of the Asian Bond Fund, and subsequent developments on this initiative, provides an opportunity for participating countries to create the institutional and regulatory framework needed for regional financial integration.

While these steps bode well for further strengthening of regional financial systems, the reform agenda remains unfinished. In the banking sector, more progress is needed to improve risk assessment capabilities. This is likely to occur as banking systems prepare for the implementation of the Basel II capital accord, which is designed to promote sound risk management practices. But implementation of Basel II will require an increase in the capacities and resources of regulatory agencies. Increased cooperation between regional regulators, relevant multilateral and regional agencies, and private financial groups will also be helpful in this regard. Turning to corporate governance issues, further efforts are needed to promote convergence and early adoption of international accounting standards, which will increase corporate sector transparency and also support investment flows both within the region and from further afield.

The IMF recognizes the importance of supporting institutional reforms and capacity building in this area. Extensive technical assistance on a wide variety of financial sector issues has been provided to emerging member nations of APEC, most frequently through the expert staff in our Monetary and Financial Systems Department. The IMF-Singapore Training Institute is also active in this area of capacity building, most recently by hosting a workshop on consolidated bank supervision in October. And our International Capital Markets department has worked with many countries in support of their efforts to strengthen market infrastructure and develop deeper and broader capital markets.

The fact that private capital flows remain large and volatile lends additional weight to the call to press ahead with the financial sector reform agenda. The Asian experience of the late 1990s underscored all too clearly the vulnerability of emerging market economies to volatile capital flows, which, if not handled properly, can result in significant economic dislocations. As was the case in the run-up to the Asian crisis, the region has once again become the recipient of large capital inflows. Of course, this is a testament to the favorable outlook for the region, and in this regard is to be welcomed. But given the high costs that reversals of capital flows can exact, greater resilience to such reversals is needed. In this connection, more attention is needed to improve the monitoring, reporting and disclosure standards for capital flows.

The current favorable economic backdrop presents an opportune moment to press ahead with, and even to accelerate, reforms to financial systems. While many of these reforms may appear less urgent now that the APEC economies are once again doing so well, it is precisely at this time, when the implementation of reforms is somewhat easier, that they should be pushed all the harder. Key elements of strong "market economy fundamentals" include a sound and well-supervised banking system that limits credit to unprofitable borrowers, a corporate governance structure that ensures effective oversight of actions of corporate management, and a legal and judicial system that facilitates corporate restructuring, including through effective bankruptcy procedures. Japan's experience in the late 80s and the decade of the 90s vividly attests to how costly the failure to put in place these market economy fundamentals can be to the health of the macro economy. Japan's experience also shows that structural reform remains a necessary condition for sustaining dynamic economic growth even at—or perhaps especially at—the most advanced economy level.

Thank you for your kind attention. I look forward to the presentations that our expert speakers will be making today, and to engaging with all of you on the important policy issues and reforms that they will address.