Evan's Financial Blog

Speech by Mr Donald L Kohn, Vice Chairman of the Board of Governors of the US Federal Reserve System, at the Federal Reserve Bank of Boston 54th Economic Conference, Chatham, Massachusetts, 23 October 2009.

* * *

I am pleased to participate in the conference discussion of the international dimensions of the recent financial crisis.1 A striking feature of the crisis was its global character. With markets for financial assets increasingly integrated, often by the activities of globally active banks, no country escaped completely unaffected.

The way the problems in the U.S. subprime mortgage market spread illustrated the interconnections. Underwriting standards for U.S. subprime mortgages had weakened at the same time that non-U.S. investors, including many non-U.S. financial institutions, had eagerly invested in the subprime mortgage market by purchasing subprime-backed securities. When house prices leveled out and then began to decline, default rates on subprime mortgages started to rise rapidly. Both U.S. and foreign banks suffered losses, along with other investors.

Many of those losses affected asset-backed commercial paper (ABCP) conduits and similar structures that had invested in subprime-backed securities. Many of these conduits were sponsored by non-U.S. entities. The conduits had funded illiquid long-term assets with short-term liabilities, creating a substantial maturity mismatch. When a few of these conduits began to report subprime-related losses, investors ran from many conduits. The flight was broadly based because investors were uncertain about the incidence of losses and liquidity pressures arising from nontransparent and poorly understood exposures.

Integrated bank funding markets were an important source of contagion. Short-term funding markets in both the United States and Europe were disrupted when conduits drew on bank lines of credit to replace maturing ABCP, and banks turned to dollar-denominated money markets to raise the needed funds. As the financial crisis deepened, banks hoarded liquidity and became concerned about the exposure of their counterparties in the interbank market to losses from subprime mortgages. Spreads between the London interbank offered rate and the overnight index swap rate, a measure of interbank market stress, widened in dollars, euro, sterling, and other currencies.

To be sure, the mispricing of assets and risks was not confined to the U.S. subprime mortgage market. Many credit risk spreads across the globe were at historic lows in the period before the crisis, after several decades of mostly mild, infrequent recessions in the industrial economies. The broad incidence of narrow spreads in part reflected the activities of investors and intermediaries who were facing the same perceived incentives in many different markets. And asset prices – especially real estate prices – were unsustainably high in a number of countries.

Liquidity risk had also been mispriced. Investors had paid insufficient attention to the maturity mismatch present in a number of investment vehicles, including ABCP conduits and money funds. And both investors and intermediaries had assumed that the exceptionally liquid conditions in many markets of the pre-crisis period were a permanent part of the financial landscape. Again, with hindsight, we can see that these vehicles were vulnerable to runs once the crisis hit, and these runs did not stop at national borders.

Moreover, even countries where assets weren’t obviously mispriced felt the effects of the growing dislocations when global banks were forced to deleverage and conserve liquidity. Their pullback from lending was broad-based and eventually affected many emerging market economies. And the adverse feedback loop between world financial markets and the real economy was exacerbated by the greater global integration of markets for goods and services. Trade and industrial output plunged everywhere as consumers and businesses pulled back from spending.

Notably, although financial institutions in some countries seemed to be more resilient to the growing turmoil than in other countries, all were affected to a degree, and no particular type of regulatory or supervisory system proved itself clearly superior to other designs – either in the buildup or the crisis-response phase. Problems afflicted both the fragmented system of the United States and the unified systems of other countries. They cropped up where the central bank was deeply involved in regulation and where it played only a consultative role. And it occurred both in systems that were principles-based and those that had thick rule books. Clearly, the deficiencies in both private behavior and public oversight were widespread, and both needed to be addressed.

The response to the crisis was global

Given the global factors that helped spread the crisis, the response to the crisis needed to be global as well. And many of the responses were indeed global – or at least were quite similar across various jurisdictions. Everyone was reacting to the same types of problems, but the similarities also reflected a high degree of global consultation and collaboration.

We can see this in the actions of many central banks. Beginning in late 2007, central banks generally reacted to funding problems and incipient runs with similar expansions of their liquidity facilities. They lengthened lending maturities, in many cases broadened acceptable collateral, and in several instances initiated new auction techniques for distributing liquidity to overcome the inertia from stigma. Central banks were in constant contact through this period, although they arrived at many of these actions separately.

However, we did explicitly coordinate to address problems in dollar funding markets. The Federal Reserve entered into foreign exchange swaps with a number of other central banks to make dollar funding available to foreign banks in their own countries. By doing so, we reduced the pressure on dollar funding markets here at home.

Governments also reacted similarly when in late 2008 the turmoil deepened and many countries saw a need to provide broad support to their banking systems. The rescue plans in different countries contain similar elements: expanded deposit insurance, guarantees on nondeposit liabilities, and capital injections. Although most countries wound up in a similar place, the process was not well coordinated, with action by one country sometimes forcing responses by others.

Many countries also took measures to deal with financial distress at systemically important firms. Efforts in this area were much messier. The failure of Lehman Brothers highlighted the lack of a framework that would allow for the orderly resolution of a systemically important nonbank financial institution in the United States. Even where formal crisis-management frameworks existed, such as within the European Union, they were not always used in the heat of the crisis. The reality is that the resolution of failing firms is still a national responsibility, even for institutions that operate globally.

Early on in the crisis, authorities recognized that addressing the deficiencies made apparent by the crisis required an international effort. Many of those deficiencies – for example, in bank capital and liquidity requirements and in accounting systems – were embodied in internationally agreed regulations, standards, and codes of conduct. Addressing them would require working through global bodies of national and international standard setters and they would require broad agreement among national authorities. The Financial Stability Forum (now renamed the Financial Stability Board) brought central banks, regulators, and finance ministries together to identify the problems, suggest avenues for addressing those problems, and push for timely solutions.

What remains to be done?

The process of addressing the problems is still at an early stage. Now that the crisis seems to be abating, we can better identify the causes of the crisis and work on finding the best solutions. Deficiencies must be fixed on a global basis to forestall gaps and regulatory arbitrage that could undermine the effectiveness of regulation. And countries need to have confidence that others are implementing tighter standards in a consistent way. But at the same time, regulations must be passed and implemented nationally. On one level, this type of action is simply what is required under existing legal structures. On another level, it reflects the reality that taxpayers in individual countries end up bearing much of the cost when home-country institutions need to be stabilized. I’ll highlight four of the many areas that require international coordination.

First, we need to identify the global risks that can affect local banks. One obvious issue is cross-border exposures, especially when banks in many countries have similar exposures. On a global level, international groups like the Financial Stability Board have an important role to play in looking for these kinds of vulnerabilities. For individual banks that operate across borders, supervisory colleges bring the key supervisors together and can improve the flow of information. These groups can also help raise supervisors’ awareness of the risks that occur when the business plans of local banks evolve and shift to take on more global exposures.

Of course, we shouldn’t expect too much from these exercises. In identifying risks, false positives will be common, and some mispricing of assets is inevitable as people attempt to evaluate the implications of broad economic trends and innovations. But looking in a focused way across markets and institutions may help to identify areas where greater supervisory attention could result in a more resilient system.

A second area that is likely to involve international collaboration is the development of a more macroprudential approach to supervision and regulation. One aspect of such an approach is higher standards for systemically important institutions; another is supervisory and regulatory measures to offset procyclical tendencies of the financial sector. Formulating higher standards for systemically important, globally active institutions will require international coordination to avoid uneven playing fields. And, offsetting procyclical tendencies presents a difficult question: Should authorities aim at damping such tendencies at a global level or at the level of an individual country? If only global risks are addressed, vulnerabilities will persist at the local level; however efforts to address local problems could disadvantage domestic banks relative to those headquartered abroad.

Third, we need to improve our ability to resolve systemically important institutions without generating spillovers that spread systemic risk across firms or across borders. Clearly, each country should have the legal authority to wind down a systemically important institution in an orderly way, taking account of the international dimensions. Beyond this, there is not yet a consensus on exactly what to do, but a range of promising proposals have been suggested to facilitate orderly resolutions. One is for supervisors to press firms to strengthen their ability to quickly provide the information on exposures, funding, and counterparties that would be needed for crisis management. Another would have supervisors recommend changes to simplify the organizational structures of systemically important firms to make it easier to deal with their failure. A related proposal would require firms to maintain a so-called living will, a written contingency plan that provides for an orderly wind-down should severe financial distress lead to failure.

Fourth, we need to address home-host issues that arise in the supervision of cross-border firms. For example, some global banks can expose a host country to a withdrawal of risk-taking caused by problems outside its own borders. This exposure understandably makes host countries uncomfortable with the traditional division of responsibility that restricts a host-country to supervising only the activity of a global bank within its own country. One possible response here would be more information sharing from home to host, to better enable host countries to protect themselves. Another response would be restrictions by host countries on cross-border operations of global banks, perhaps going so far as requiring global banks to operate through separately capitalized subsidiaries. However, this requirement, in addition to imposing costs on the banks, might also impede the ability of the global financial system to channel capital to where it is most likely to enhance productivity and growth.

Conclusion

I’ve touched on only a few of the international aspects of the crisis. We face a difficult set of decisions regarding how best to reform our national regulatory and supervisory frameworks in response to the lessons we have learned. But perhaps chief among the lessons learned from the past two years is that in an integrated global financial system we cannot make those decisions in isolation; we must collaborate internationally if we are to build a more resilient financial system for the future.

source: http://www.bis.org/review/r091028d.pdf

bis, crisis, Donald L Kohn, speech

Speech given by Mr Jaime Caruana, General Manager of the BIS, at the IAIS Annual Conference on “Insurance as a means of socio economic development: financial crisis and the future of insurance markets”, Rio de Janeiro, 22 October 2009.

Abstract

Three key lessons from the global financial crisis are important for both banking and insurance supervisors. First, we need to broaden our focus from the supervision of individual institutions to taking into account system-wide risks. Second, we have to deal with the procyclicality inherent in the financial system. Third, better regulation is not enough if not implemented as intended and in a consistent manner across countries. These three lessons should serve as important signposts for all prudential supervisors, and I am confident that the IAIS will help us to meet these challenges. The BIS and other Basel-based bodies will continue to fully support the IAIS in this endeavour. We have a complex financial system where old boundaries between sectors no longer apply. This puts a premium on closer cooperation among standard setters, supervisors and policymakers.

Full speech

It is a great pleasure for me to address today such a distinguished audience of high-level insurance regulators and supervisors as well as representatives of the worldwide insurance industry. Thank you for inviting me to discuss with you some key lessons of the financial crisis from a BIS perspective that can be of interest for all financial supervisors. We all face important common challenges, even if we must recognise that business models differ across sectors.

Towards a safer destination

The crisis has triggered significant reforms and a number of important debates that will have long-lasting implications. Today I would like to share with you some thoughts on certain aspects of ongoing regulatory reforms. Many efforts are under way in various areas, and much has already been achieved. Allow me to give a few examples. The monitoring of financial markets is being enhanced through the conduct of Early Warning Exercises led by the IMF and the Financial Stability Board (FSB). In early September, the supervisors and central bank Governors of 27 major industrial and emerging economies adopted a comprehensive set of measures to strengthen regulation and supervision of, and risk management in, the banking sector. And today’s conference clearly shows that significant progress is being made in the regulation of the insurance industry.

I will not review all these efforts in detail. The recent reports by the G20, the FSB and various standard setters provide a clear and comprehensive view of what has already been achieved. My main message is that we are facing complex issues and more work is needed to find well balanced solutions.

Let me start with some thoughts about the future and the changes and reforms that are needed. In 2017, 10 years after the beginning of the current crisis, OECD countries will have an average ratio of gross public debt to GDP that will exceed the 2007 level by 30 full percentage points. In some of these countries, this ratio is projected to at least double over the same period. These projections are not based on extreme, stressed scenarios, but on the expectation that these economies will recover and that fiscal consolidation measures will be adopted. In fact, the deterioration in fiscal positions could be much more severe in case of adverse developments. These fiscal figures highlight the magnitude of the policy actions that have been required to address the recent crisis, and therefore the absolute need for changes and reforms looking forward.

The last few months have witnessed improved conditions across a number of financial markets and better than expected macroeconomic news. But some financial markets are still not working properly after their recent unprecedented failure. The message from policymakers is clear: we must sustain the reform impetus and not return to the previous status quo. An enhanced financial regulatory framework will allow for a safer and sounder financial system which is less prone to the kind of leverage (both off- and on-balance sheet) and excessive risk-taking we observed before the crisis. We at the BIS have emphasised that the road to this new, safer destination is narrow, meaning that there are significant risks. Important adjustments and reforms in the real economy will be required. Some features of the business models of financial institutions will have to change. Maintaining the momentum for financial stability reforms, and in particular establishing clear objectives and timetables, is thus critical.

Most debates focus on regulatory reform. But let me emphasise that better regulation alone will not be enough. First, we need a better, structured collective monitoring of how vulnerabilities develop in the financial system and the commitment to address these fragilities. In the official sector, this is what the Early Warning Exercises and the newly established FSB Standing Committee on Assessing Vulnerabilities are all about. A second key area for improvement is better integration of financial stability objectives into our macroeconomic policy frameworks to make sure that they help lean against the build-up of financial excesses in the first place. Third, we must strengthen financial market infrastructure, for instance by promoting trading through central counterparties. Fourth, and perhaps most importantly, implementation is essential.

So, various elements are necessary to ensure a safer financial system. Nevertheless, better regulation is obviously an important part of the solution, and I will now discuss this particular aspect. My view is that the global financial crisis has revealed common lessons for all prudential supervisors, and in particular for banking supervisors and insurance supervisors. Allow me to focus on three key lessons:

1. The need for a system-wide view of risk: we must connect the dots.
2. The need to deal with procyclicality while maintaining adequate risk sensitivity: we must push back against the natural tendency of market participants to understate risk in good times.
3. The need for consistent implementation of regulation: we must not just adopt the right rules, but make them stick.

First lesson – The need for a system-wide view of risk

The global financial crisis has taught us that we need to broaden the focus of prudential supervision, focusing less on single entities and more on how the components of the financial system interact. Our understanding of these interactions proved limited when the crisis occurred – we failed to connect the dots. Because of such interactions, system-wide risk can be much larger than the sum of the risks posed by individual institutions. We must develop a system-wide view of financial risks.

This is referred to as the “cross-sectional” dimension of the macroprudential approach to regulation. This dimension relates to how risk is distributed within the financial system at a given point in time.

Recent developments have highlighted the importance of this cross-sectional dimension: the way systemic risk materialised in the banking sector was without precedent. A “traditional” banking crisis was thought to mainly emerge through a loss of confidence leading to a “run” by retail depositors. In contrast, an unexpected feature of the crisis that started in 2007 was that interbank and wholesale funding markets ceased to operate properly due to a lack of confidence in counterparties. We must understand better how asset deflation, forced selling, leverage, counterparty risk and the real economy interact, reinforcing adverse dynamics.

Prudential tools should be calibrated so as to take into consideration the contribution of individual institutions to system-wide risk, for instance by requiring tighter prudential supervision that could include asking for a “systemic capital charge”. Making this concept operational is not easy: how should we measure system-wide risk and assess the contribution of a single institution to it?

The latest issue of the BIS Quarterly Review, published in September, presents some work that may prove useful in thinking about these issues. ¹ First, there is a potential trade-off between diversification at the level of individual institutions and at the level of the system. By diversifying its portfolio, and hence reducing its own riskiness, an institution could become more similar to others, increasing overall systemic risk. Second, the contribution to systemic risk increases more than proportionately with relative size. Third, for a target level of system-wide risk, capital can be used more “efficiently”, as the increase in the capital of those institutions contributing the most to system-wide risk can be more than compensated for by the reduction that occurs in the smaller ones.

In this context, and in response to a request from the G20, the IMF, the FSB and the BIS have been developing high-level guidelines so that national authorities can better assess the systemic importance of financial institutions, markets and instruments. In a nutshell, it is recommended that the following criteria be considered to identify the systemic importance of an individual component of the financial system: size, ie the volume of financial services the institution provides; substitutability, ie the extent to which the same services can be provided by other components of the system in the event of a failure; and interconnectedness, ie the linkages existing with the other components of the system.

These criteria can help in assessing what systemic importance entails. The capacity of the institutional framework to deal with financial failure is also a key element. In particular, there must be a process to organise the orderly winding-down of financial institutions which are relevant system-wide so that they cannot be considered as “too big too fail”. This will not only lower systemic risk, but will also reduce moral hazard.

I will not discuss in detail to this audience how insurers can pose a systemic risk. Insurance business models are very different from those of the banking sector, and indeed can contribute positively to financial stability. In particular, insurers with a long-term time horizon can help stabilise markets. Life insurers aggregate the long-term savings of individuals, which are then invested in the real economy, supporting stability and capital formation in the economy. Insurers also provide a mechanism for the transfer and pooling of risks into more predictable aggregated exposures. This can enhance the management of risks and reduce overall financial system-wide risk.

However, I would caution against being too confident. The combination of asset deflation, protracted low interest rates, inadequate capital quality of firms and insufficient market and funding liquidity could lead to adverse dynamics. Efforts by the IAIS to better understand how, and to what extent, insurers can be a source of systemic risk must be sustained. In particular, it is essential to develop tools to measure systemic risk that take into consideration the peculiarities of the insurance sector.

It is also vital to understand how insurers can be interconnected with other parts of the financial system, thereby amplifying system-wide risk. The fact that the IAIS is an active member of the FSB will surely help enhance our common understanding of such cross-sectoral interconnections.

Let me conclude my comments on the first lesson for supervisors by underlining a prerequisite. Before we can adequately understand system-wide risks we need to understand group-wide risks. The global financial crisis has shown that this was not the case in the past. In the banking industry, off-balance sheet risks were not well understood. In the insurance industry, the failure of AIG demonstrated that group-wide risk can be driven by a specific, risky business entity. While it is true that the risk emanated from the part of AIG that was outside the purview of insurance supervisors, that should not be of great comfort.

Gaps in regulation need to be closed to ensure that prudential supervisors can assess the risks of a group on a consolidated basis. The Joint Forum is already working on the differentiated nature and scope of regulation that will help identify problematic differences and gaps across sectors. Turning to supervision, one must proactively look through structures, subsidiaries, special purpose vehicles, etc – a task which will require coordinated efforts by supervisors across sectors and jurisdictions. Good accounting and prudential frameworks are also needed for effective supervision of complex groups. The bottom line is that authorities must collectively work to remove impediments to effective group supervision rather than use them as a reason for inaction.

Second lesson – The need to deal with procyclicality

The second key lesson of the crisis for prudential supervisors is the need to deal with procyclicality. This represents the second, or “time”, dimension of the macroprudential approach to regulation, which relates to how system-wide risk evolves over time. This dimension reflects the natural tendency of the financial system to amplify business cycles. System-wide risk can be amplified over time through interactions within the financial system as well as feedback between the financial system and the real economy. Credit extension and leverage, risk perceptions and risk appetite, asset prices and economic activity, all reinforce each other over time with complex, non-linear dynamics. Individuals and firms become overextended in good times, with excessive retrenchment in bad times.

The guiding policy principle must be to build countercyclical capital buffers in good times, when it is easier to do so and can help to restrain risk-taking. In bad times, running down the buffers allows the system to absorb emerging strains more easily, dampening the amplifying mechanisms.

In the banking sector, the Basel Committee on Banking Supervision has been working to translate this policy principle into a concrete proposal that will enhance the existing Basel II framework. Similarly, there is certainly room for the community of insurance supervisors to reflect on how procyclicality effects can arise in the insurance sector and how they can be mitigated. Of course, addressing procyclicality – while maintaining adequate risk sensitivity – is a complex task, and concrete proposals are difficult to design properly. Moreover, these issues are likely to differ significantly between the insurance and the banking sectors, not least because of differences in the respective business models.

Nevertheless, the ongoing work of the Basel Committee has revealed some lessons that can be of interest for insurance supervisors too. One is that it is difficult to find the kind of indicators that can be used for guiding both the build-up of buffers in good times and the release of capital in bad times. The solution is to be pragmatic and cross-check a number of variables, acknowledging that relying on a set of imperfect indicators is better than considering none at all. There are also some principles that have been agreed by the banking supervision community that can be useful for other supervisors, such as the preservation of capital principle: the fact that earnings should not be fully distributed through dividends and payments as long as the capital basis of the firm has not been restored. Another lesson is that the quality of capital matters. The crisis has shown that in times of stress the best-quality capital is in demand, and that markets can overreact if a financial institution is seen as relying excessively on non-core capital.

Third lesson – The need for consistent implementation of regulation

Globalised financial markets and level playing field considerations require an appropriate internationally agreed regulatory framework to be in place. So far, I have limited my comments to how to enhance this regulatory framework. However, implementation matters too. My third key lesson relates to the application of international standards.

The recent crisis has highlighted that many problems derived from the inadequate application of similar prudential regulation rather than inherent weaknesses in regulatory requirements. Indeed, good supervision appears to have played an important role in insulating banks in countries such as Australia and Canada from the global financial turmoil, suggesting that proper, proactive enforcement of regulation at the national level is essential, and that sufficient resources should be devoted to this task. Even sound regulatory frameworks can be undermined by poor implementation and enforcement of the rules.

The implementation of regulation must also be consistent across jurisdictions, and requires full cooperation among national authorities. Severe financial crises of the magnitude of the current one tend to reinforce national bias in policy actions. To some extent, this can be explained by local specificities and the pressures to react rapidly to financial stress. But if this kind of nationalistic orientation goes too far and becomes entrenched, it can hamper cross-border finance, undo some of the benefits of many years of globalisation, impede a level playing field and economic efficiency, and reduce global growth and well-being. So we need both international standards and strong supervision cooperation to properly support national frameworks.

The G20 is playing a key role in achieving such coordination. It has provided strong political impetus for international cooperation, with a clear commitment by G20 members to implement international agreements and standards. This is particularly important because we are dealing with new and complex financial reforms.

The IAIS is also playing an important part in facilitating the establishment of sound insurance regulatory and supervisory systems, especially in emerging markets. This work must continue. I am happy to note that a key milestone is being reached during this IAIS Annual Conference with the launch of insurance content on FSI Connect, the online learning tool and information resource developed by the Financial Stability Institute of the BIS for financial sector supervisors. Just five years after its launch in mid-2004, the reach of FSI Connect is impressive – 8,000 individuals from over 200 organisations and 140 countries around the world access its tutorials regularly. So far, FSI Connect had focused primarily on matters of interest to banking supervisors, and the new initiative launched today will help close the gap with insurance supervisors. You will hear more about the new insurance tutorials later this afternoon, and I would also encourage you to visit the FSI Connect booth during this conference.

Conclusion

Let me conclude. Three key lessons from the global financial crisis are important for both banking and insurance supervisors. First, we need to broaden our focus from the supervision of individual institutions to taking into account system-wide risks. Second, we have to deal with the procyclicality inherent in the financial system. Third, better regulation is not enough if not implemented as intended and in a consistent manner across countries. These three lessons should serve as important signposts for all prudential supervisors, and I am confident that the IAIS will help us to meet these challenges. The BIS and other Basel-based bodies will continue to fully support the IAIS in this endeavour. We have a complex financial system where old boundaries between sectors no longer apply. This puts a premium on closer cooperation among standard setters, supervisors and policymakers.

Thank you for your attention.

---

¹  N Tarashev , C Borio and K Tsatsaronis, “The systemic importance of financial institutions”, BIS Quarterly Review, September 2009.

 

source: http://www.bis.org/speeches/sp091029.htm

bis, finance, reforms

Keynote address by Mr Heng Swee Keat, Managing Director of the Monetary Authority of Singapore, at the Paris Europlace International Financial Forum, Singapore, 26 October 2009.

* * *

Governor Noyer,

Your Excellencies,

Ladies and gentlemen,

Good morning

It gives me great pleasure to join you today at this Paris Europlace International Financial Forum. Let me warmly welcome Governor Noyer and our overseas visitors to Singapore, and welcome Mr Bresson and your team for holding this Forum in Singapore.

Policy challenges ahead

A year ago, the global financial community was grappling with a severe crisis that hit every part of the globe and every sector. We were on the edge of an abyss. The timely and forceful action by authorities, including the use of unconventional monetary policy tools, helped avert the worst. In recent months, the global economy and financial markets are showing signs of stabilization. Though we are yet to see a firm or sustainable rebound in final demand, there is a sense of relief, even optimism.

Now, what’s next? What will be the shape of the recovery, and what policy actions are appropriate? It is difficult enough to make policy judgments in normal cyclical downturns. It is even harder now that this downturn is not a garden variety recession. The impact of a financial crisis emanating from the largest economy in the world that also serves as the world’s economic locomotive and provides the global reserve currency is likely to be pervasive and longer-lasting. There are no easy precedents, and we have to remain alert to new surprises.

Moreover, the key pillars of economic theories that underpin much of our policy thinking are now being vigorously questioned.

We need much more thinking and empirical work on how economies and people behave to draw out the critical lessons from this crisis. But based on what we know, we need to undertake policy changes to build a more stable, sustainable and resilient global economic and financial system. Much of this has to be globally coordinated, given the extensive linkages among economies and the financial system.

In Asia, we face many policy challenges, and I will touch on three of these: managing the recovery, economic restructuring, and the regulation and development of the financial services sector. My main theme is that we must be cognizant that many Asian economies enter this crisis with different starting conditions, and going forward, face different challenges from those in advanced economies. Understanding these differences, and avoiding a one-size-fits-all approach, will be critical to the design of policies appropriate to each country and region.

Managing the economic recovery

First, the economy. The financial crisis hit Asia with unexpected speed and force. From peak to trough, stock prices fell by more than 60% and a group of Asian economies contracted by an average of about 6.2%, not far from the 8.3% fall during the Asian Crisis. Exports fell by over 30%, and intra-Asian exports fell even more sharply, by over 48%. These are far worse than even during the Asian Crisis. There was no de-coupling.

Just as the fall was swift and sharp, the initial rebound has been rapid and strong. One quarter after the trough in the present cycle, Asia’s GDP grew by 9.4% on a quarter-on-quarter basis, more than twice of the 4.3% rise after the Asian Crisis. Exports have also rebounded swiftly, lifted in part by the sharp increase in shipments to China.

While the outlook has improved, the sustainability of the recovery is not clear at this point. With this uncertainty, managing the cyclical recovery of Asian economies presents several challenges. A withdrawal of government stimulus measures too early risks stifling the recovery, while a withdrawal too late could result in inflationary conditions. A series of carefully calibrated actions will be needed.

Moreover, many analysts and fund managers now hold the view that emerging economies, while not de-coupled, will still grow significantly better than advanced economies for some years to come. Hence, there has been a re-rating of assets in emerging economies. Coupled with extremely accommodative monetary conditions globally, we can expect increasing inflow of funds to many emerging economies, including those in Asia, in search of yields. Managing this inflow so that it supports growth, and not drive excessive asset inflation, will be challenging. Policymakers will need a variety of tools.

Economic restructuring in Asia

Beyond the immediate challenges, the second set of issues that Asian policymakers will have to grapple with relates to the re-structuring of their economies. Business-as-usual policy will not work. The world has enjoyed a positive supply-shock with the entry of emerging economies into the global economy. We have had a period of Great Moderation. But this supply shock also creates new competitive dynamics, which will drive changes in the patterns of trade, production and growth in the coming years. The adjustments to these changes will be neither easy nor smooth. As unemployment in some advanced economies mount, the risk of trade and financial protectionism rises. Rapid changes in the real economy will generate greater uncertainty, and potentially greater volatility in financial markets.

Over the next few years, Asia is likely to grow more slowly compared to pre-crisis days, when external demand from advanced economies weakens. To sustain growth, Asian economies with big domestic markets will need to continue with structural reforms to boost domestic demand. Smaller Asian economies will have to re-orientate their economies to respond to new opportunities in these markets. The cross-border production and supply-chain networks, which have been so efficient in raising Asia’s exports to the rest of the world, remains valuable but will have to be increasingly re-orientated towards raising domestic and intra-Asian consumption of final goods and services. Measures to encourage new investments in the corporate sector and in public infrastructure, as well as in education and healthcare, will be necessary for most Asian emerging economies in order to realize their growth potential.

The basic outline of changes is well understood, but crafting the details of these changes, and calibrating the pace of implementation, will need thoughtful work. The build up of domestic demand would probably be a gradual process, as experiences of Japan and Germany suggest that reducing a nation’s export dependence involves major structural changes that evolve over an extended period of time. Nevertheless, I am optimistic that Asia will be able to respond to these challenges, to achieve its longer term growth potential and contribute towards more sustainable global growth.

Financial regulations and development

Let me now turn to the third set of challenges: financial regulations and development. Financial authorities are now working intensely in various fora, such as the Financial Stability Board and Basel Committee, on regulatory reforms and cross-border cooperation. The major themes relate to new capital and liquidity frameworks and linking these to systemic risks; dealing with the moral hazard problem of individual institutions becoming “too big”, or “too connected” to fail; cross-border coordination and resolution regimes; redefining accounting rules and building counter-cyclical buffers to address pro-cyclicality; adherence to global standards and others. In many areas, measures have already been agreed and implemented.

Many of these changes will be relevant to Asia, and we need to abide by global standards. However, following the Asian Crisis, significant financial sector reform has taken place in many parts of Asia. In many economies, the rules have become more conservative. For instance, many jurisdictions here in Asia have strict loan-to-value ratios in mortgage loans and provisioning requirements. There is therefore less need for Asia to have to make drastic changes to meet the new norms.

In fact, Asia’s bigger challenge lies less in having more stringent regulations, but more in development and innovation of financial services to complement its economic development. Saving rates in Asia are high, but these have to be efficiently intermediated to support productive investments. In most parts of Asia, the banking system dominates the intermediation channel.

Developing a stronger second channel through the capital markets, venture funds and private equity to support a range of entrepreneurial activities can raise the efficiency and resilience of the system. This will also provide a wider range of asset classes to meet the investment needs of a rising middle class. Similarly, the insurance and risk management markets will have to be developed further to meet corporate and individual needs. There is already a momentum, with capital markets in China, India and ASEAN economies developing well. In bigger economies, micro-finance, mobile finance and rural finance are also being developed. Cross-border financial activities within Asia are also showing signs of increase. These are positive changes, as the development of a deep and integrated financial system provides a vital support for structural adjustments in the region.

Economic and financial linkages between France and Singapore

Let me now say a few words on how Singapore is responding to these challenges, and how the French business and financial community can collaborate with those in Singapore to promote growth in Asia.

The Singapore government has set up an Economic Strategies Committee to identify policy changes to strengthen Singapore’s value as a vibrant global economic node in the heart of Asia. Singapore’s connectivity enables it to facilitate the flow of goods, services, capital and ideas. The value of Singapore as a stable, trusted hub that respects the rule of law, and its value as a consistent regulatory regime are our core strengths. But these will need to be enhanced with new capabilities in knowledge creation and innovation, as well as the development of deeper talent pool, in order for the business community to seize new opportunities.

The connectivity and ease of doing business is well acknowledged by global businesses. Today, over 26,000 international companies use Singapore as a base for their operations. Between France and Singapore, economic and trade ties are deep and growing. In 2008, total trade between France and Singapore stood at more than eight billion Euros, making Singapore the third largest Asian export market for France, after China and Japan. France, on the other hand, is the sixth largest European investor in Singapore. Some 800 French companies from a wide range of industries including petrochemicals, electronics, telecommunications, aerospace, biomedical sciences, education, and luxury goods are located in Singapore.

French financial institutions have a significant presence here. BNP Paribas is one of Singapore’s earlier Qualifying Full Banks. SocGen celebrated its 30th anniversary in Singapore recently. Credit Agricole would count as the oldest French bank in Singapore, through its acquisition of Indosuez which was set up more than a hundred years ago in Singapore in 1905. Natexis has been here for 27 years, while CIC just celebrated its 25th anniversary in Singapore this year. These institutions carry out significant banking and fund management activities here. There are also insurance firms like AXA with a major presence in Singapore.

We appreciate the contribution of French financial institutions. Mr Claude Bebear, Honorary Chairman of AXA, was recently awarded the Public Service Star (Distinguished Friends of Singapore) Medal during our 44th National Day celebration. Mr Bebear is the first representative of the financial sector to receive such an award. This is a special award that recognizes individuals who have contributed significantly to Singapore in business, industry, technology and science.

I hope French financial institutions, with strengths in particular areas of finance, will continue to find ways to serve investors, corporates and governments in the region. Your strengths in Islamic finance, project finance, trade and structured finance are very relevant to Asia’s growing needs in building infrastructure, facilitating trade and developing enterprises. Asset managers and insurance firms can serve the growing class of Asian investors, as well as global investors who look towards Asia to grow their assets and diversify risks. We hope that Singapore will continue to serve as a useful base for you to understand and serve the region, and that you will find many valuable partners here.

In this regard, the close collaboration between Singapore and France in research and education in the areas of finance and business will contribute to a deeper understanding of the region. Last year, HEC Paris and the National University of Singapore celebrated their 10th year of collaboration. Two well-known institutions – INSEAD and ESSEC Business School – have established their Asia campuses in Singapore. INSEAD has also set up the Asia-Pacific Institute of Finance in Singapore to conduct regional executive education programmes, as well as conduct Asia-specific financial research.

Financial institutions like AXA and BNP Paribus have also set up training and research centres in Singapore. I understand that there is also well-established financial research infrastructure under the ambit of Paris Europlace and the Europlace Institute of Finance. We look forward to greater collaboration between French and Singapore institutions. In particular, given the importance of risk management in finance, I hope that French institutions specializing in this area can bring their expertise to this region.

Conclusion

In closing, the global financial crisis has presented many lessons for the financial community and policymakers. In Asia, the crisis has accelerated structural reforms. There are many challenges ahead, including the development of the financial services sector in appropriate ways to support economic restructuring. I hope that financial institutions in France and Singapore will contribute meaningfully to this development and help bring about a more resilient and robust global economy.

I wish Paris Europlace every success in hosting this Forum, and look forward to many more such exchanges in the future.

source: http://www.bis.org/review/r091028e.pdf

bis, Heng Swee Keat, keynote address