More Work Needed to Create Robust East Asian Financial Markets

September 14, 2006

Singapore, September 14, 2006 - A new World Bank report, “The Road to Robust East Asian Financial Markets”, released here today argues that East Asia needs and is well positioned to enhance its financial systems to meet the growing and increasingly sophisticated demand for financial intermediation in the region.

“East Asia’s financial system has witnessed a remarkable transformation over the past decade in two important respects,” said Dr Homi Kharas, the World Bank’s Chief Economist for East Asia and the Pacific. “The region has emerged more resilient from the debilitating crisis of 1997. It has also accumulated US$1.6 trillion in foreign exchange reserves and US$ 9.6 trillion in financial sector assets at the end of last year. These assets reflect not only the resumption of large capital inflows but also the region’s own savings which amount to almost a quarter of that of the US financial markets and half that of Japan. These developments have reshaped the financial landscape in the region that now provides an opportunity for deepening and extending the reach of the financial sector.”

The report examines the agenda if the financial sector is to fulfill its role. It argues that the demands for financial intermediation in the region are changing. In the past, the financial sector focused largely on the needs of the corporate sector. But as per capita incomes rise, the sector will face growing demands from consumers. At the same time, businesses in the region are looking for a broader range of services, including investment banking services. And with the deepening of intra-regional trade, firms will require cross-border financial services.

A vibrant East Asian financial sector, according to the report, should have at least three characteristics:

  • highly diversified in its ability to cater to the needs of increasingly complex and sophisticated economies
  • able to provide financial services efficiently
  • robust enough to withstand a variety of shocks in a fast changing globalizing world economy.

“A key challenge is the further development of securities markets, particularly bond markets,” said Swati Ghosh, lead author of the report. “Deep and efficient securities markets will make an important contribution to meeting more sophisticated needs and to improving the resiliency of the financial sector.”

The report notes that although securities markets have grown by 300 percent in the last nine years, the banking sector, with US$5.5 trillion in assets, still dominates East Asia’s financial sector. The region’s institutional investor base of US$1.5 trillion is large, but has considerable potential for future growth given the large pool of savings in commercial banks.

To further develop the securities markets the report stresses the need for greater liquidity and efficiency. It says that the efficiency and liquidity of markets is affected by the availability of information to price securities accurately, by high transactions costs, and by the limited size and heterogeneity of the investor base.   To enhance efficiency, the report notes, policy makers will need to address each of these elements.

The report also notes that the emergence of initiatives for regional financial cooperation is providing an impetus for deepening and diversifying financial markets by identifying impediments to cross-border investments, providing greater liquidity, and facilitating issuance by private sector participants. But the experiences with implementing the Asian Bond Funds Initiative shows that measures also need to be taken at the domestic level. Regional financial integration can significantly enlarge the gains from domestic policy measures and make the development of domestic financial markets more viable.

The agenda to strengthen securities markets and a more robust financial system overall will require concerted efforts on three fronts:

Strengthening implementation of corporate governance and information disclosure is extremely important to enable investors to price securities accurately. Countries in the region have made considerable progress in strengthening the legal and regulatory framework around corporate governance and disclosure requirements and in strengthening accounting and auditing standards but greater focus on implementation and enforcement are needed.

Developing complementary or supporting infrastructure such as repo markets, margin trading and derivatives. If developed within an appropriate framework, these can be important means of reducing transactions costs. It also allows market participants to manage and transfer risks to those better able and willing to bear them and so helps advance the development of robust financial systems overall. The report also notes the potential danger of inappropriate risk transfers—through the use of such instruments--to institutions with weaker risk management capacity and to more weakly regulated segments of the financial markets. This is especially the case for transfers from private banks to public banks and from banks to non-bank financial institutions. Proactive measures by regulators are needed to monitor and contain these risks.

Developing a broader and more diversified investor base. The participation of investors with different preferences and appetites contributes to greater trading and liquidity and more efficient markets. This will require further developing the domestic institutional investor base—pension funds, insurance and mutual funds—as well as fostering greater regional financial integration.