Macroeconomic and Financial Stability in Asia Emerging Markets

This conference, jointly sponsored by ADBI and Bank Negara Malaysia (BNM), was attended by high-level policymakers from Asia and the United States senior officials from international institutions such as the IMF, and top academics. The conference featured papers and presentations on frameworks for promoting macroeconomic and financial stability in Asian emerging markets.

The conference participants were welcomed by Sukudhew Singh, assistant governor of BNM, who emphasized the importance of the conference topics for Malaysia and other Asian economies. He noted that the key challenge was to frame the questions correctly before jumping to answers. In his remarks, ADBI Dean Masahiro Kawai reviewed the lessons to be learnt from the global financial crisis in developing robust policy frameworks and emphasized the importance of macroprudential regulation. Eswar Prasad of Cornell University and the Brookings Institution also provided brief introductory remarks drawing out the connections among the different topics to be addressed at the conference.

Session I: Macro-Prudential Regulation for Emerging Markets

Shyamala Gopinath of the Reserve Bank of India (RBI) presented a paper titled, "Macro-prudential Approach to Regulation-Scope and Issues," which provided an overview of the RBI's approach to macro prudential regulation and systemic risk management and reviewed lessons drawn from the Indian experience. The paper emphasizes the need for harmonization of monetary policy and prudential objectives, which may not be possible if banking supervision is separated from central banks. It also notes that supervisors need to have the necessary independence and flexibility to act in a timely manner on the basis of available information.

Kyungsoo Kim of the Bank of Korea's Institute of Monetary and Economic Research presented a paper titled, "Interest Rate-Oriented Monetary Policy Framework and Financial Procyclicality." This paper shows that the current interest rate-oriented monetary policy framework in Korea, if combined with sophisticated interbank transactions, can foster financial procyclicality since the central bank's high-powered money can be used as a funding source for financial intermediaries.

Reza Siregar of the South East Asian Central Banks Research and Training Centre discussed key points from his paper titled "Macro-Prudential Approaches to Banking Regulation: Perspectives of Selected Asian Central Banks." New lessons, challenges, and debates have emerged from the recent subprime crisis. While the macro orientation of regulatory policies is in fact not new-it has always been among the classic toolkits of central banks in ensuring financial stability-the current explicit articulation and specification of such tools as a global standard is new.

Chia Der Jiun of the Monetary Authority of Singapore offered perspectives on how macroprudential and microprudential perspectives can both be embedded into the prudential policy framework. Chia points out that delinking macroprudential objectives from dedicated tools would permit a wider set of tools to be used, allowing fiscal and administrative tools to be used for macroprudential and financial stability objectives, and creating space for a more targeted response to specific macroprudential risks.

In the discussion period following the presentations, Bandid Nijathaworn of the Bank of Thailand and Sukhudew Singh asked what tools were used by RBI to handle the balance between macro and prudential policies in ensuring financial stability. Andrew Sheng of the China Banking Regulatory Commission noted the failure of existing analytical models in helping to understand how to cope with systemic risks.

Session II: Macroeconomic Frameworks to Support Financial Stability

Masahiro Kawai presented a paper titled, "Managing Capital Flows in Asia: Experience, Challenges, and Policy Implications." The paper describes trends in capital flows in emerging and developing economies, with a focus on emerging Asia. The paper also analyzes the impact of capital flows on key macroeconomic variables, and discusses the policy challenges and measures needed to manage the surge in capital flows that Asia is likely to experience in the postcrisis period once markets settle down and shed their fear of risk.

Charles Collyns of the US Treasury noted that sound macroeconomic policies and robust policy responses had helped shield the region from the worst of the financial crisis. Asia had been effective in controlling unchecked credit growth and potential asset bubbles. He argued that strong regulatory standards and fiscal policy were better suited than capital controls to dealing with surges in capital inflows. He emphasized the importance of regional cooperation and the need to develop sound financial safety nets at the global level.

Kiyohiko Nishimura of the Bank of Japan presented his paper titled, "Macroprudential Lessons from the Financial Crisis: A Practitioner's Perspective," which provides a stylized account of the financial imbalance buildup in the late 1980s in Japan from a macroprudential perspective. He draws lessons in comparing the similarity of the recent US experience to Japan in the 1980s. Nishimura points out that it may be desirable to develop and operationalize early warning indicators to detect the sign of financial imbalance buildups and to rein them in as early as possible, before it becomes more costly to do so.

Former RBI Governor Y.V. Reddy offered his perspectives on the links between the monetary policy framework and financial stability, the use of macroeconomic, financial, and regulatory policies for financial stability, and the relationship between capital account management and financial stability. Reddy believes that the scope for judgment and more discretion for monetary authorities are essential in emerging market economies, particularly in view of the enormous structural changes that many of them are undergoing.

In the discussion, Singh asked if financial development was a double-edged sword as better-developed equity and debt markets could encourage more inflows. Prasad asked if providing greater discretion in monetary policy rather than having a well-specified anchor could reduce the effectiveness of monetary policy. Sheng noted that speculators had been creating turmoil in financial markets and noted the lack of tools in Asia to cope with inflows resulted in fueling inflation or asset bubbles.

Luncheon Keynote

Dato' Muhammad Ibrahim, Deputy Governor of Bank Negara Malaysia, in the keynote address said that Asia had become greatly integrated into the global economy and that this had brought enormous benefits but also two key challenges. First, is the need to balance domestic and external considerations (such as the impact on capital inflows) in determining monetary policy actions. Second, is the need to continue developing financial markets despite the global financial turmoil, and to maintain the strength and soundness of financial markets. He said that the pragmatism of Asian policymakers had served the region well but cautioned that the development of tighter global standards on bank capital and liquidity could have unintended negative consequences for the region. He called for greater trade and financial integration among Asian countries and greater regional cooperation to improve stability and harness the growth potential of the region.

Session III: Financial Deepening and Regional Financial Integration

Raymond Atje of the Center for Strategic and International Studies, Indonesia presented a paper titled, "Financial Deepening and Financial Integration in East Asia: What Have We Learned?" which covers lessons learned from the 1997-1998 and seeks to explain why the more recent financial turmoil has had a mild impact on financial systems in East Asia. While the exact nature of the link between financial development and growth remains unclear, it is clear that a sound and sophisticated financial system promotes the efficiency of investment and, hence, economic growth and that a poorly functioning financial system can inhibit economic growth.

Mangal Goswami of the IMF presented a paper titled, "Perspectives on Financial Development: A Framework and its Application to Domestic Capital Markets in EM Asia." According to Goswami, the priorities for developing bond markets in the region include foreign investor participation and access, widened domestic investor base, an improved infrastructure to reduce systemic risk, intensified regional initiatives, allowing foreign issuers to local markets, a legal framework for public and private securities issuance, pricing, and valuation services, meaningful disclosure, accounting and investor protection, enabling funding and hedging markets, and securitization with safeguards to ensure adequate prudential standards, supervisory oversight, and disclosure.

Naoyuki Yoshino of Keio University, discussed SME financing and the construction of an SME database in order to reduce information asymmetry in his paper "The Development of SME Credit Information Database to promote SME Lending." Developing such a database could have implications for financial stability and might also help direct more credit to the SME sector by allowing banks to undertake better risk assessment.

Sukudhew Singh discussed the imperatives of broadening financial inclusion and the experience of Malaysia in this regard. He said that the objective of financial deepening is to reduce imbalances in the economy and promote sustainable development. The poor need a variety of financial services but there is a lack of delivery channels for such services.

During the discussion, Reddy said that the definition of financial inclusion must be broadened to cover deposit and insurance functions, rather than just provision of credit. He argued that the importance of corporate bond market development had been over-emphasized and that it was not essential for infrastructure financing in India. Prasad asked if there was any tension between broadening financial inclusion and ensuring financial stability. Nijathaworn asked what are the most important factors driving local banks in Malaysia to improve financial access.

Panel Discussion: Regional and International Coordination of Regulatory Practices

Aditya Narain of the IMF discussed the need to improve supervision of individual institutions, called for a greater emphasis on financial regulations that reflect the systemic nature of financial risks, and noted the role that macroeconomic policies play in financial stability. Bandid Nijathaworn said that stronger regulatory coordination was needed in the region. Initiatives being undertaken under Basel III are useful but the adoption and implementation of new frameworks and regulations could pose difficult challenges. Given the complexity of the proposed reforms, he said that it is essential for Asia to play a greater role in shaping global policies, noting that the discussions were currently being dominated by the advanced industrial economies. Kiyohiko Nishimura argued that the financial innovations of the past quarter century have blurred the dividing line between banks and non-bank financial institutions. These developments have made it possible to shift risk back and forth between the banking system and capital markets. It has become difficult to locate exactly where ultimate risk lies, and the banking system has often found itself vulnerable to the volatility of capital markets.

Andrew Sheng discussed the regulatory reforms being developed at the international level and how these affect Asia. The current crisis has exposed many weaknesses in the existing financial architecture, including the fragmentation of regulatory jurisdiction at the national and institutional levels. What is required is a system-wide and global view of market behavior. Sheng cautioned that global imbalances were a first-order problem and now posed a greater danger to global stability than weak financial regulation.

Following the panelists' remarks, Dato' Ooi agreed with Sheng that the Asian traits of humility and reserve had not served the region well in international forums. Kawai asked how Asia should deal with systemically important financial institutions (SIFIs). Kim followed up by asking how to identify SIFIs, especially in the context of their cross-border operations. Prasad asked for specific examples where Asia might have been disadvantaged by the outcomes of deliberations at international forums such as the G-20 and the Financial Stability Board.